Audi: A sweet spot of days' supply

When he first became chairman of the Audi National Dealer Council in 2021, what Don Flow wanted to do most was to change the relationship between the German premium brand and its U.S. dealers. That work is completed and paying regular dividends, he said.

Yet, Flow chose to take another turn as Audi dealer council chairman in part to make sure the newfound cooperative working relationship between factory and dealers gets cemented. He said the brand and its dealers have learned valuable lessons about how to operate at maximum efficiency and balance during the pandemic, and he sees that situation continuing this year.

Flow, 67, is CEO of Flow Automotive Cos., a dealership group headquartered in Winston-Salem, N.C., that has 44 new-car franchises, including four Audi stores.

Flow spoke with Staff Reporter Larry P. Vellequette this month. Here are edited excerpts.

Q: You have a lot of brands in your portfolio, so what's your take on the state of the economy and the industry right now?

A: If I look at it, I think we're going to have an unusual recession, for us. Usually a recession for us means we're way overstocked with vehicles, the market's really slowed down, we're crushed in floorplan, margins evaporate on us, and there's a huge strain between the OEM and us about taking more cars or not taking more cars. Then eventually, the OEM shuts [production] down and we sell through everything. That's what's been like since 1974 or '75.

This time it's become a different situation, where I don't think the demand is for 16.5 million units in a recession, but it's probably for 13 or 14 million, and that's all they project to produce next year — maybe 14.2 million. I doubt at the end of this year if we'll have many more days' supply than we have right now. I'd be surprised if we do.

The only thing that might change it is if the automakers are unable to produce what the market wants; for instance, if they are able to build sedans but not SUVs.

It sounds like those conditions may give us perhaps our first supply-driven recession in decades.

If you looked at that on a graph with supply and demand, what was happening is that if the demand stays constant, the supply recession price goes up, right? Then demand drops a little bit, and we find equilibrium. But it's not going to be like it was before, because in the past there was no supply source shortage. And presently, in speaking to almost all the OEMs, no one has confidence, real confidence, about how many cars they could produce next year. They have a range, with an optimistic side, and you ask them if that's their plan, and they say it's not the plan, it's optimal [production].

What was 2022 like for Audi dealers?

Audi dealers did extremely well in light of the product shortage, and we were able to succeed because of the fact that demand far exceeded supply in the marketplace. We had strong margins. There were many opportunities for us, we had very strong used-vehicle business and very strong fixed operations business.

How was your supply in 2022? It improved as the year went on, correct?

It got better, but Audi lost market share relative to the demand that there was for its products, which you could tell by deep pipeline selling and an almost zero day supply of inventory on the ground. So that part was unfortunate for the entire car business in one sense, though we did get a clearer picture of what an ideal situation actually looks like for Audi dealers, what level of turn maximizes profitability for the entire system along the way, where customers still have a great experience.

It turns out, we don't need 69 days' supply. Yeah, we really don't — the actual number is probably 20. More than we have now, yes. But in the premium segment, if you produce the right cars, we've learned that somewhere between 20 to 30 days' supply of cars is all we actually need to maintain market share. And when Audi had that day supply, it was at its maximum market share and the dealer had their maximum profitability as well. So everybody wanted that mark in that model.

Were there lessons learned in 2022 for the brand and its dealers to move forward?

Yes. The first thing we learned was that less than 30 days' supply of vehicles is a sweet spot for both Audi and its dealers — that when we have between 20 and 30 days' supply, we don't lose market share, we have sufficient market share, and we are in balance all the way through the system. So our focus going forward will be: How do we retain that balance and keep that in place and keep that discipline there?

That might mean accepting a lower market share, correct?

Actually, no. We found that we didn't lose any volume. We went back and looked, and when we had a 30 days' supply, we were able to maximize our market share, maximize our volume and our [profitability], and we didn't lose anything. When you drop below 20 days' supply, you start losing because then you don't have what people want. But if you have the right cars and between 20 and 30 days' supply, you don't actually lose anything in the premium sector.

That's an interesting finding. Are consumers willing to wait longer for their vehicle in the premium segments?

Well, in the premium segments, I would say that's more likely. Not everybody, of course. But also, if you have a 20 to 30 days' supply on the ground of your core product, and you're able to sell into your pipeline and tell your customer when their vehicle will arrive, and customers are comfortable with the value of their vehicle and they're protected on an interest rate inflection, we found that set out Audi's maximum market share. Everything happened right when we were in that sweet spot. The question is: Is that true for the entire industry, that you don't actually gain market share when you go from 30 to 60 to 90 days on the ground?

When that happens, what you see is margin compression, excess floorplan [expense], and you denigrate the brand, especially in the premium segment, when a customer can look and see 60 other vehicles out there just like the one they want to buy.

Another thing we actually learned through this is that pipeline selling really does work if you tell the story all the way out, you have clarity about what is coming and what that looks like for us there.

The last thing is everybody is working on some type of omnichannel digitization strategy, and how they work closely with us to develop one that is a very collaborative approach, that does not diminish the role of the dealer in the process, and allows us to be full partners all the way through it.

I felt that it was a very important statement that Audi rejected the agency model in the United States and understands that we are full partners in how we go to market, and that was a very important step for Audi of America to make.

When you first became chairman, you set out to reset the relationship between Audi of America and its dealers to make it much more collaborative. Can you check that task off your list now?

We have a really great process we put in place as we work through issues of margin, issues of pipeline selling, issues of digitization, issues on warranty, and I give the Audi executive team great credit. We really developed a process where points of view are communicated, where we find areas of agreement and where we're focused on the areas of disagreement. We went through and looked at areas where we could adjust, test, compromise, verify what it was. It's been a remarkable change, and I give [Audi of America President Daniel Weissland and Thiemo Rusch, head of sales operations] really great credit for opening themselves to that, and also explaining to Germany they were going to develop a very collaborative approach, that if they really wanted to win in America, that was going to happen, and so they bought in.

Hildegard [Wortmann, head of marketing and sales for Audi] came over and spent time with us and really understood what we were trying to do, and she embraced that as well, and said, "Let's work together on that."

I think we've laid the framework for what we want to do. It's difficult to know right now with the lack of product what our full opportunity is with Audi. The brand lost market share last year, but it had nothing to do with turning the product. It had to do with access to the product. But the headlines for all brands in 2023 is going to be the same: He who has the chips, wins.

How has this new working relationship worked in practice?

We were able to work through issues of margin in a very collaborative way; we had task forces working on it. We did the same thing with digitization. We start off like everybody does with pretty contentious kind of views, but we came to a point where we felt like it really was a collaborative approach. We addressed issues with used cars, with warranties, and a whole variety of other things along the way. Now, the key for us will be as we look forward, how does Audi grow its market share in America? Everybody has plans for growth, and it'll be key for that for the future of Audi as well.

I want to make sure we talk about Audi vehicles. The brand has a new EV starting point in the Q4 E-tron. Is it at the right price point?

Yes, we've had great success with the BEV lineup. Audi was probably a little early in its conversion to BEVs, but I think both Audi and the dealer body got very serious about selling its current lineup of BEVs. We're in a really good place in terms of demand; it's just been constrained by the supply of vehicles. But it's been clearly demonstrated that there is consumer demand for BEV Audis out there, and I think Audi has made a major commitment to it. Like everybody else, making an investment in manufacturing [in the U.S. to qualify for federal tax incentives] is going to be important very soon.

Audi executives said last year that they were seriously considering U.S. manufacturing to help its vehicles qualify for tax credits. Do you see that happening?

Everybody's going to have to make those types of investments, right? So there are lots of conversations about where that takes place, and how important that will be for the future of Audi of America.

In the premium segment, do customers demand that additional tax credit?

It's hard to know what that's going to look like in the premium segment. It's easy to imagine that it is a major deciding factor in the mass market brands, but in the premium segment, I wouldn't say that price has been the primary driver. It's not that it has no role, like it does in the superluxury and exotic segments, but in premium, it's hard to say what it looks like. So we're going to see and probably get an answer to that over the next 12 months or so. I'm not going to wave a magic wand on politics, but it's hard for me to imagine that independent OEMs like Hyundai are going to commit $10 billion to something and not get anything for that. My guess is that we end up with something like when you put shovels in the ground, you start getting credit, or something like that.

I also want to talk about leasing because historically it's been such a big part of the premium segment.

Leasing effectively doesn't exist right now. Premium brands stepped away from leasing because it wasn't financially viable right now, but I think it's likely that brands will consider leasing again going forward.

Leasing is effectively an incentive program, and when you're selling every vehicle you have without incentives, it probably doesn't make sense to incentivize leasing. So the question will be, if for any reason any OEM was unable to sell what they were producing, what is the least costly way for them to sell the difference between the demand they have and what they're able to produce? And they'll look at leasing, or at owner loyalty, or APR subvention, and the brands will make those decisions based on what works best for that model.