Issue Date: Car Dealer Insider Apr 15, 2012, Posted On: 5/1/2012
The seven essential elements for buy-here, pay-here success The buy-here, pay-here (BHPH) concept is not new. In fact it has withstood the test of time. And now more and more dealership owners are seeing the wisdom of creating their own BHPH business that either works out of their existing facilities or is housed in off-site locations nearby.
Don Miller is a 24 year veteran consultant and trainer in this realm and he presented a DealersEdge webinar workshop that laid out a seven-step plan for success in this market. Dealers who are on this plan rave about it and its effectiveness in providing a new and vibrant profit center. This whitepaper is based on Don's workshop.
First some background.
Customers with damaged credit histories represent a huge profit potential for car dealers. A buy-here, pay-here operation can be a challenge to set up, but the return on investment is well worth the effort.
Here's an interesting statistic: There are approximately 45 million used vehicles changing hands annually in the U.S.
Of those 45 million units, 13 million are sold by franchised new car dealers. Independent used vehicle retailers and private party sellers sell the remaining 32 million.
For the most part, the franchised new vehicle dealers concentrate on the one- to four-year-old used vehicles while the independents stock their inventories with five- to ten-year-old cars. To put it another way, franchised dealers are selling to people who want that late model used car. Independents sell to customers who need a car for transportation.
That sort of segmentation in the used vehicle market has always existed. But the growth of buy-here, pay-here operations among the franchised dealer groups was fueled by the knowledge that there were profit opportunities in selling cars to the dealership's "worst" customers. The problem, however, was that those "worst" customers got that way because they had poor credit records and spotty work histories. They were extremely hard to get financed. Even the C and D lenders wouldn't touch them.
The solution to the financing problem ultimately developed into dealer-controlled financing (only the old timers call them "tote-the-note lots" anymore).
A growth business
More dealers than ever are eyeing the profitable, but controversial buy-here, pay-here businesses as a way to do deals with customers whom they can't finance today and provide an opportunity to retail older trade-in vehicles they typically would have wholesaled in the past.
Franchised dealers are among the groups with the keenest interest in buy-here, pay-here operations -with hundreds showing at conferences hosted on the topic. Consultants, like don Miller, note they're forming training schools and 20 Groups with franchised dealers who have buy-here, pay-here operations.
"We're in the thick of it," says Chris Leedom, president of Leedom & Associates, Sarasota, Fla., a firm that hosts 20 Groups and consults on buy-here, pay-here operations.
Why the interest? It's a product of economic conditions and the availability of financing. In the late 1980s, the growth of buy-here, pay-here operations drew significant interest and attention from finance companies. Through the 1990s, those companies began offering financing on C- and D-tier customers, spurring dealers to create special finance operations to handle credit-challenged customers.
Since then, two dynamics have taken place. Prominent special finance lenders have exited the business - the shakeout of special finance lenders, coupled with the rise in bankruptcies, job losses, under-employment and other circumstances, now means we've got a growing market for buy-here, pay-here customers. And dealers, always a group with a keen nose for opportunity, are entering the buy-here, pay-here fray.
Selling finance, not cars
It's not about what they will pay, but what they won't pay.
But the business is different than what you're accustomed to in your stores. The whole process is the exact opposite. Instead of finding a vehicle for a customer and determining a payment, the buy-here, pay-here process starts first with determining a monthly payment and "building into the payment a vehicle that will work."
Another way of looking at the buy-here, pay-here business: Instead of asking what a customer will pay, you're asking "why will this person not pay?" Chris Leedom says. "This is a customer you have to baby-sit for 24 months" and dealers in the business carry more risk of losses.
But despite the risks, dealers say it can be a profitable business with net profits running 12 percent or more for dealers who astutely manage the risks, Chris says. (That compares to most franchised stores, which average about 2 percent net profit, according to NADA data.)
Look for people with experience in collections. The buy-here, pay-here business is not the car business, it's the finance business. Look to banks, rent-to-own and other businesses where collections are an integral part of the business. Why not try to hire collections people from a local bank? They're structured and they follow a process. Example: Within 48 hours after a customer has failed to make their weekly or biweekly payment, the collections person is on the phone soliciting payment.
Typical ad for new car dealer's BPH lot:
Be firm about managing your risk. Remember: If you sell a buy-here, pay-here vehicle for $7,000, and collect a $1,000 down payment, the remaining $6,000 in the vehicle is your money. In addition to a down payment, sharp buy-here, pay-here stores require steps similar to those special finance companies require: Pay stubs to indicate a stable job, phone/utility bills to indicate a fixed address and $1,000 in cash to do a deal.
Here's a look at some other operational pointers and tips to help you manage a successful buy-here, pay-here operation:
Plan for losses. Buy-here, pay-here operations carry risk, to the tune of between 12 percent and 25 percent loss ratios each year. And you can expect your first year losses to run lower than they will in subsequent years. First year losses can run about 12 percent and consistently run about 25 percent thereafter. As a rule, once a customer has demonstrated consistent payments for a year, you can typically consider the loan stable. Most defaults occur in the first trimester of a loan term.
Expect a sizable cash investment. Don Miller says your startup capital for the first 18 months to run $250,000 to $400,000 and as much as $750,000 in available funding. Those funds are needed for inventory, facilities and personnel. In addition, the operations also trigger sizable tax consequences. One dealer says he earned $120,000 in his first yearâ€â€with a $75,000 tax bill. (The tax hit diminishes with losses and the use of a related finance company to handle your buy-here, pay-here operations.)
Use your franchised store to feed inventory. Astute dealers get about 40 percent of their inventory from the franchises they own. Typical vehicle: Five years and older, 80,000-plus miles with a wholesale value between $3,000 and $4,000. The typical retail sale runs $7,000.
Don't skimp on reconditioning. If the car stops running, the customer will stop paying. That's a fact of life in the BHPH business.
Expect to average $550 in reconditioning costs -mostly for mechanical items like brakes, batteries, steering, etc. If vehicles have serious leaks or other problems, wholesale the vehicle right away.
Treat customers with respect. Buy-here, pay-here customers are loyal to those who help them obtain transportation. Dealers note about 50 percent of their business comes from repeat sales - and some, after a second buy-here, pay-here deal, may become customers at the franchised store.
Tip: Put customers in a new vehicle as their loan terms sunset. Some dealers offer to make a customer's last payment or two as an incentive to purchase a newer vehicle. In addition, it can pay to do some goodwill service work for customers.
The seven essential elements
The preferred term these days is Dealer Controlled Finance (DCF), which covers Buy-Here, Pay Here (BHPH), Lease-Here, Pay-Here (LHPH), and Rent-to-Own models. While this business may be new to your store, DCF has actually been around for nearly 100 years, starting in 1915 in Indianapolis. It is now a $50 billion-a-year business worldwide.
Entry is open to anyone with sufficient capital. There is no interference from the automakers or financial institutions. The dealer controls the terms of the financing.
#1. Business models
The first decision to be made after deciding to get into the DCF business, is what form will your operation take: BHPH or LHPH? There are advantages and disadvantages to both.
LHPH has been gaining traction in recent years because it has several inherent advantages over BHPH:
Sales tax is paid to the state on a per payment basis but collected upfront from the customer so the dealer can hold the tax payment in escrow as a sort of security deposit.
The tax-free security deposits provide extra protection against losses
There are tax advantages in the way income is recognized. There is no taxable gain when the lease is signed. Depreciation allowances effectively create a tax loss at lease inception.
Repos are easier since the dealership owns the vehicle.
The lease is unaffected by bankruptcy.
Disadvantages LHPH:
There are fewer source of capital available for LHPH operations than for BHPH dealers.
Dealers will need a separate computer system to keep track of the business.
Lawsuits for vicarious liability are still possible.
LHPH uses terminology that is different from BHPH. Staff and customers must be trained not to confuse the two (Regulation M vs. Regulation Z).
Advantages of BHPH:
More sources of capital are available
Customers and staff are more familiar with the terminology.
Dealers can generally run the BHPH business using their current DMS.
Disadvantages of BHPH:
Sales tax must be paid over to the state at the time of sale
Income has to be recognized at the time of sale for tax purposes
Repo laws are more complex and vary from state to state
The debt can be discharged in bankruptcy.
Capital requirements
Regardless of the form your DCF business takes, remember that cash is really king in this industry. Before taking the plunge, do a thorough analysis of cash flow needs.
Key measurements to watch are the breakeven point (how many active accounts are needed to cover expenses) and the average cash in each deal (CID). Here's a quick exercise to illustrate how this works:
CID DETERMINES YOUR INVENTORY LEVELS:
Monthly amount of capital at risk / Number of projected sales = Average Cash-In-Deal
Average Cash-In-Deal + Average projected down payment = Average total inventory cost
Average total inventory cost - Anticipated recon expenses = Average purchase price of inventory
A $1,000 increase in CID may require as much as $250,000 in additional capital in just one year.
Sources of inventory
With the just-over recession, depressed new car sales has meant that used vehicles are harder to find. That's true for DCF-type cars too. We're looking for low-end cars that are, nevertheless in good shape to keep a lid on reconditioning costs. Don suggests the following sources for good DCF inventory in order of importance:
Private party/street sales
Regular review of newspaper liner ads for used cars
Dealer "we buy cars" advertisements
Street signs saying "we buy cars"
Other dealerships
Wholesalers
Auctions, as a last resort. Remember, most DCF auction cars are brought there by other dealers and wholesalers. Why add an extra layer of profit. Plus these cars may have been sitting longer on someone's lot and could use more reconditioning.
And don't forget some alternative sources of vehicles:
Estate sales
Credit unions (they have repos too)
Legal notices in the paper
Rental agencies
Private party displays (the car with a 4 sale sign on it)
#2. Controls
Written policies and procedures are a must for anyone entering the DCF business. Written policies help ensure consistent processes and also allow for duplication in case you want to open a second or third location.
A written policy manual is invaluable for training new employees and the policies can help avoid claims of discrimination.
Written policies and procedures allow the staff to work independently of management.
Also make sure you have written "chain of command" guidelines for staff members. As a rule, the general manager for each DCF location should be only non-owner authorized to approve:
Loan underwriting
Loan modifications
Repossessions
Charge-offs
Develop written job descriptions for each position in the business.
Metrics:
"What can be measured can be improved" and "Inspect what you expect" should be the mantra in the DCF operation as well as your conventional dealership.
Owners and general managers need to audit and inspect the store's performance weekly. Try to spot negative trends early.
Recency (% that have paid within a set time frame)
Rewrites (contract alterations)
INVENTORY:
Units Available for Financing
Average Purchase Price
Reconditioning (as % of purchase price)
Average age
Average mileage
#3. The selling system
The selling systems in DCF stores are only slightly different from those sued in conventional dealerships. It's the customers who are different.
As Don Miller points out, 90% of the customers who finds themselves doing business with a DCF lot are good people who have fallen on hard times. The other 10% are scammers who will try to separate you from your vehicle a quickly as possible.
The DCF customer is typically not a good money manager nor are they good savers so coming up with down payment money is a real challenge.
As we have said before, if the car stops running, the customer stops paying. So don't do things that are likely to make the term of the loan outlive the car.
The DCF customer is also likely to take on accept more financial risk than they can afford. It's up to the DCF employee to keep them in the $60 to $80 per week range.
DCF customers have learned to lie in order to get "bought" by a car dealer. Verify what they tell you. But this customer will follow the rules if they trust the DCF manager.
The DCF customers will often not be able to pay on time. Charge-offs typically run upwards of 20% annually. It's up to the DCF staff to keep customers in line.
The DCF selling process should begin by introducing the financing program. Remind the customer that because his credit is bad, the two of you should talk about what the customer can afford to pay before picking out a car. The customer knows his credit history is bad so this conversation usually goes smoothly.
Above all, the selling system should support the collection system and sell some cars.
SELLTHE PROGRAM NOT THE CAR
SALES PROCESS (ROAD TO THE DCF SALE)
Greeting / Presentation
Qualifying Conversation
Test Drive
Terms Presentation
Loan Application
Verification Calls
Underwriting / Approval
Delivery
Structure for success
There are a handful of keys that experienced DCF operators know will help them be successful. The first is to align the loan payment date with the customer's pay day. This is easier for the customer to remember and, because the customer is not good at managing his money, it makes it more likely that the DCF dealer will get paid first. Also, a missed payment on pay day is a good indication that there is a problem in the customer's life. Be flexible in structuring down payments. Remember, the customer and his down payment are separate considerations. Don't be tempted to approve a loan just because the customer comes up with more cash. DCF sales made around tax refund time have an alarming history of default.
Evaluate the customer based on his ability to pay. Use the down payment to help select the right car.
Setting payments too low may make the loan term outlive the car. Payments that are too high increase the likelihood of repossession. Longer loan terms increase the risk that the car will develop mechanical problems and they increase the chances of a problems developing in the customer's life.
GROSS PROFIT:
In the Retail Auto Industry:
Gross profit is a point of purchase event
1 risk factor associated with gross profit; not enough
In the DCF Industry:
Gross profit is a long-term event
2 risk factors associated with gross profit; not enough and too much.
#4. The approval process
Make sure the customer knows how long the application process will take. If he can't stay, make an appointment for another longer visit.
Always take the application in a private area. The customer will be more likely to open up about his past problems and it's the law these days. Offer the customer a soft drink to put him at ease. Minimize distractions. If the customer brings his children with him, be sure to have something to keep them occupied.
NEVER let the customer take an application home to complete it himself.
DCF applications tend to be fairly long. Don Miller uses a six-page application to cover both the buyer and the co-buyer, if any.
Verify, verify, verify
The DCF customer has learned to stretch the truth to get approved. Verify all important information. The application should contain a written authorization for the dealership to verify employment and residency.
Ask to see utility bills and rent receipts that include the buyer's address. No post office boxes. Ask the buyer to provide his last two pay stubs. If those are not available, call the employer to verify the information. For self-employed folks, ask to see recent bank statements to verify regular deposits.
Call the landlord and find out what you can about the buyer's living arrangements and genral behavior.
UNDERWRITING METHODS
To Approve or Not to Approve? This is the Question
The customer has the means to pay.
The customer is a stable person.
The customer has been completely truthful.
The customer is going to be the driver of the vehicle.
The vehicle can be retrieved if necessary.
There are good feelings about doing business with the customer.
The responses fit reasonably within the dealership's guidelines.
#5. Processing payments
Most DCF dealers encourage customers to pay in person. This has the advantage of promoting the relationship and keeping in touch with both the customer and the dealer's collateral. Take a look at the car when the customer drives in.
Customers are also more likely to pay with cash if they pay in person. Checks can bounce. Cash is good.
More and more dealers, though, are modernizing their DCF payment systems to allow for the use of debit cards, credit cards, and ACH transfers. Also, encourage the use of auto-pay authorizations so that your store can charge the appropriate account every week automatically.
#6. Delinquency management
The rule for managing delinquencies in DCF is to "Repossess the customer, not the car."
Field visits are the norm when the customer gets two payments behind. The field visits allow the DCF representative to demonstrate the seriousness of the situation and to physically inspect the collateral.
Field visits also provide an opportunity to take back the collateral if necessary.
REPOSSESSING THE CUSTOMER, NOT THE CAR
PAYMENT AGREEMENTS:
Allows the customer to catch up a delinquent payment
Series of payments over a short term
One payment on a set date
REWRITES:
Restructuring of the original contracts terms and/or conditions
Ensure the customer's due date is the same as their payday
Ability to add any major repairs (in some states)
Ability to bring an account to current status
#7. Marketing your DCF business
Merchandising and advertising are the two key elements in marketing a DCF location. Make sure your lot creates a favorable first impression. Will people want to stop and look around? Does your lot look better than your competitor's? Do your employee's look better than your competitor's?
While social media may be the rage among conventional dealer, it has not yet proven effective for attracting DCF buyers.
