The Best F&I Strategy for Declining Front-End Margins

By Scot Eisenfelder, CEO, APCO Holdings LLC

Most auto industry experts began 2022 predicting dealerships would have more inventory by now. But supply replenishment has taken longer than the experts predicted. Now, just as manufacturers hint at more supply, we may be heading into a recession. How will this impact dealers?

Even though sales volume typically drops during a recession, there is still plenty of pent-up demand for vehicles. Because of this, a recession will not reduce sales volume in line with historic norms. However, it will place downward pressure on pricing and margins, just as supplies increase. A simultaneous demand reduction and supply increase will be a double whammy for prices and margins.

Although front-end margins may not go as low as before the pandemic, they definitely will decline from their all-time highs. As in difficult times in the past, it’s a good time for dealers to start looking at other profit centers to make up the difference in revenue.

Service Challenges

The service department is the first profit center dealers typically pivot to in hard times. However, dealers may be challenged to increase service revenue for the following reasons.

First, the average number of units in operation (UIO) for dealerships has dropped significantly due to the supply crunch of the last two years. That means fewer new vehicle owners coming in for warranty and customer-paid work.

Second, dealerships have been selling more pre-owned, off-brand vehicles than ever before. The percentage of these buyers that return to the purchasing dealership for service is typically low.

Peak F&I Per Vehicle Retail (PVR)

In the F&I department, we’re already at record levels of PVR. How much further can dealers raise PVR to make up for the loss of front-end profitability, particularly in a recession? Realistically, not much.

The best F&I strategy to have right now is to focus on selling products that bring customers back into the service department. Here are two actions to take right now:

1. Sell more Pre-Paid Maintenance (PPM)

Based on a nationwide analysis of APCO’s dealers over the last ten years, customers with both a PPM and vehicle service contract (VSC) are 40 percent more likely to bring their vehicle back to the selling dealer or group for claims covered under their VSC.

—VSC customers without a PPM have a claims retention rate of 55 percent
—VSC customers that also have a PPM have a claims retention rate of 77 percent

Additionally, after analyzing franchise new, franchise used, and off-brand used customers, a PPM impacted off-brand used customer retention the most.

—Off-brand used customers with only a VSC had a claims retention rate of 29 percent
—Off-brand used customers with both a VSC and PPM had a claims retention rate of 44 percent

That is a 51 percent increase! Additionally, a PPM increased the selling dealer’s VSC claims yield by $142 on average per VSC written.

This analysis shows that a focus on selling PPMs can have a significant and positive impact on long-term service revenue and service retention.

The main problem with this strategy is that PPMs don’t have a high profit margin for dealerships, so F&I managers are not incentivized to sell them. You might want to think about providing that incentive, either by altering pay plans or offering a bonus for PPM sales objectives.

2. Advantage Selling

Advantage selling is when dealers add a product such as a lifetime warranty onto a vehicle’s transmission. These products are perceived as high value by the consumer, but they are not necessarily high cost for the dealer.

The primary benefit of advantage selling is brand-building for the dealership. Many dealers have pulled back from this practice during the recent supply crunch because they haven’t needed to focus on brand-building. But pulling back on advantage selling was short-sighted.

The long-term benefit is that it will help protect margins when we return to a normal supply situation. Additionally, advantage selling links the customer and the dealership, increasing service retention.

Think about how two years of significantly fewer units-in-operation (UIO) sets your dealership up for long-term service retention and revenue. By building value into the consumer experience with PPMs and advantage selling, you are creating a strategy that will alleviate the pain of declining front-end profit margins. But the time to make these changes to your F&I strategy is now, not six to nine months from now when we are back to a normal inventory situation.