While discounting is good news for new customers who are entering the market, dealers and fleet buyers are feeling the pressure because elements of the favoured model for electric vehicles (EV) sales, agency and direct-to-customer (DTC) are hampering responsiveness to the market.

There is an argument to be made for switching the retail sales model back to a franchise model that was the structure most dominant in the market until COVID hit.

But first, let’s explore what has changed recently with an eye on northern hemisphere markets that are ahead of Australia.

As COVID disrupted trading and supply chains, EV demand significantly outstripped supply and inadvertently created the perfect model for DTC sales. Prices were set and, until recently, customers were happy to wait for their EV to be delivered.

By August 2022, used EV prices were inflated and, in some cases, higher than the purchase price of a new EV. But that scenario was too good to last and the EV market has turned a corner in recent months.

Steve Bragg

As Tesla and others started to drop their new car prices, existing EV owners found to their horror that their vehicles were less valuable.

The fallout also hit fleet management organisations (FMOs). 

FMOs do not typically get bulk purchasing discounts, which makes them particularly vulnerable to OEM price cuts because of the way these companies secure finance. Loan-to-value-ratio (LVR) covenants are tied to residual values of EV fleets.

With every EV price cut, the impact on the LVR would force FMOs to inject cash and reduce the loan balance outstanding, which in the US has pushed some FMOs to the brink.

See case study.

This case study demonstrates the Loan-to-value-ratio (LVR) scenario:

• A fleet company has 1,000 EVs, average cost $80,000

• Total fleet value = $80m

• The LVR for financing is 80%, and the initial loan is $64m ($80k x 1,000 x 80%)

• The book carrying value of the EV fleet is $80m

If the OEM cuts the price of EVs in the fleet by $10,000:

• The fleet residual value would decrease by ~$10m (1,000 EVs – $10,000) 
• This breaches the LVR covenant, which is now 91.4% ($64m loan against $70m fleet residual value)
• 80% of the fleet residual value = $56m. $64m loan – $56m new loan value = $8m
• Therefore, $8m is needed to reduce the outstanding loan to $56m and remain compliant with its LVR covenant.

As a result of these price cuts, prospective buyers of new EVs became less inclined to accept the current sticker price and delayed their buying decision, which led to stock piling up and further price cuts until the price reaches a level the customer is happy to pay.

Customers were now conditioned to wait for further pricing cuts before making a purchase, which exacerbated losses that OEMs incur and in the meantime, FMOs kept stumping up more cash to avoid breaking their loan commitments.

What does all this have to do with the sales model?

The OEM carries the entire balance sheet risk in a direct-to-consumer (DTC) and agency sales model. The risks of doing this were not exposed for as long as the market boomed.

But through the franchise model, an OEM can set a recommended sales price and sell the vehicles to its independent network via floorplan financing, which transfers the inventory balance sheet risk to the dealer network.

Another advantage to the franchise dealer sales model is the buffer it provides for OEM factory production and against struggling models.

The breakeven production point for almost any car factory is 80 per cent and OEM factories want to produce EVs at this level or higher every day of every month.

Inventory piles up when demand drops but independent franchised dealers buffer the factory’s inventory from most demand fluctuation factors, such as weather, holidays or economic downturns.

When the inevitable rotten egg model comes along, independent dealers can more effectively exit unwanted car models better because of differential and dynamic pricing.

Under an example of a DTC sales model, there might be 10 units in inventory priced at $100 each and the breakeven production is eight units.

When there is demand for 12 units, the price might be pushed up to $110 per unit and the revenue increases from $1000 to $1320, well in excess of our breakeven of $800.

But if the reverse happens and there is only demand for eight units, under the DTC model there might be a price cut to $80, increasing demand to 10 units to reach the breakeven.

Given this, how does dynamic pricing work under an independent franchise dealer sales model?

The OEM sets the recommended sales price at $100 and provides the dealer a margin of $10, which they can apply however they see fit to sell the EVs

If customers are happy to pay $100 the dealer gets a $10 margin, but if the customer thinks their trade is worth more than the market, the dealer can reduce the margin by $2 to induce the transaction.

The OEM gets 10 or more vehicles sold at $90 or $900 revenue, and the recommended sales price is maintained, which ensures the residuals of current EV owners and the LVRs on fleets are not impacted. 

A dealer might end up charging 10 different prices to 10 different customers but it doesn’t undercut the market because the market doesn’t know the actual selling price.

Now, differential pricing might sound like a lack of transparency in the selling price, which is an understandable perspective, but the DTC and agency model price changes, which are made public to the whole market, severely undercut owners who bought a car at a higher price, including fleets. 

The moment that sales are made at a lower price, and those changes are publicised, buyers have lost a significant amount of value in their vehicle. So the franchise dealer system is defending a massive cumulative loss of wealth by existing car owners across the market.

The discussion around the merits of new-car sales channels often takes the top-down view, from the customer back to the supply chain, rather than bottom up factory-to-consumer perspective. 

Undoubtedly what the customer wants is crucial to the sales equation but it is not the only factor and the missing piece in the debate is often the reality of car production.

The last six months has seen a shift, with EV production ramping up and demand coming off the boil, and this evolving landscape might just be the saviour for the franchise distribution system.

If demand is elastic, an OEM is likely to get more revenue and sell more cars with a franchise model and while some cars may be sold at a loss, the overall sales picture may be healthier.

In the end, the OEMs may be forced by economic and financial reality to abandon the direct-to-consumer and agency models.

By Steve Bragg