TheFranchiseSystem3 6 • S E P T E M B E R 2 5 , 2 0 0 6

Donna Harrisdharris@crain.com

It was a big deal when CarMax Inc. opened aused-vehicle superstore in Atlanta in 1995.

How big? Cutting the ribbon at the dealer-ship was U.S. House Speaker Newt Gin-grich, who had won national attention a

few months earlier by engineering the Republicantakeover of Congress.

Revolution was in the air. Circuit City Stores Inc.,which ran CarMax, had launched four superstoressince it got into used-vehicle sales in 1993. The big-box electronics retailer vowed a shake-up in autosales practices that would leave traditional fran-chised dealers in the dust.

It didn’t happen. The dealer franchise system hasfaced massive changes and challenges since the1990s — not only used-car superstores but also therise of multifranchise megadealers and publiclytraded dealership groups, Internet retailing andfactory-owned stores.

But each confrontation ultimately strengthenedthe franchise system. Dealers adapted to new tech-nology, found better ways to sell used vehicles andlobbied successfully for tighter franchise laws. Thevalue of dealerships soared.

Super threatGingrich’s fame drew attention to the CarMax

business model, says George Hoffer, a professor ofeconomics at Virginia Commonwealth University.

“When it hit the national spotlight, people sud-denly got the impression that CarMax was going todrive dealers out of business,” says Hoffer, an auto-motive researcher. “There was this panic.”

Superstores boasted of their consumer-friendlysales environment, huge selection of late-modelused vehicles, no-haggle pricing, extended war-ranties and inventory searches on computer

kiosks. Their technology was formidable to typicaldealerships, which were still making do with old-fashioned “green screen” computers.

In response, some of the nation’s largest and mostsuccessful dealers formed their own used-vehiclechain in 1996. They named their company Driver’sMart Worldwide Inc.

Billionaire Wayne Huizenga, chairman of the

waste management behemoth Republic IndustriesInc., also entered the fray. He called his chain ofused-car dealerships AutoNation USA.

On the way to dominance, though, the super-store chains displayed serious flaws. CarMax isthriving today, but it took some hard knocks before

1993Circuit City opensfirst CarMaxused-vehiclesuperstore inRichmond, Va.

1994Seattle dealerMarty RoodlaunchesDealerNet.com,one of the firstdealer Web sites.

1995U.S. HouseSpeaker NewtGingrich cutsribbon to openAtlanta CarMaxstore.

1996Dealers’ group forms Driver’sMart Worldwide Inc.

Cross-Continent AutoRetailers Inc. becomes firstpublicly traded dealershipgroup, followed byUnitedAuto Group Inc. andLithia Motors Inc.

Investors group led by WayneHuizenga, chairman ofRepublic Industries Inc.,launches AutoNation USAused-car dealership group.

1997Republic beginsacquiring new-vehicledealerships, enterscourt battle withToyota and Honda tolet it acquire theirstores and reaches asettlement withToyota.

Group 1 AutomotiveInc. and SonicAutomotive Inc. gopublic.

1998Ford launches AutoCollection retailnetwork.

Republic acquiresDriver’s MartWorldwide, settleslegal dispute withHonda.

Hometown AutoRetailers Inc. goespublic; reduces sharesoffered because oflukewarm response.

1999Online broker carOrder.com launches with$100 million in seed money, plans to build chainof 100 dealerships.

Republic becomes AutoNation Inc. Companynames Mike Jackson CEO, spins off rental-carbusiness and closes used-vehicle superstores.

GM plans DriverSite, pilot program for onlineused-vehicle sales.

CarMax earns first profit.

GM announces plan to acquire dealerships. Itdrops GM Retail Holdings venture a month later,citing dealer opposition.

THREATS, VICTORIES

Up to the minute: System survives challenges, emerges stronger than ever

MODERN ERAThe franchisesystem is astrong one. Ithas beenprovedthroughouttime that thebest way to

retail vehicles is through adownstream partner like the autoretailers.

The system works because itrewards good performance andallows you to become one with thecommunity. The system fostersgood competition among dealersand provides the consumer withan array of choices of productsand services. The franchisesystem also promotes brandloyalty and continuity.

Over time, the franchise systemhas adapted to changes in themarket. Back in the 1960s,30,000 dealers retailed about 10million vehicles annually.Customer-satisfactionrequirements were minimal.Questionable ethics werecommonplace, and truth inlending didn’t exist.

Today, that has all changed.Fewer franchises sell morevehicles. Dealers operatemultifranchised points. Vehicletechnology has advanced.Customer demands are higher.The Internet plays a vital role inour business.

Dealers have changed with thetimes and kept the franchisesystem strong, while traditionalretailers focus more oncannibalization of existingmarkets, suffer from highemployee turnover and do notfocus on customer satisfaction.

Roger Penske, CEO, UnitedAuto Group Inc.

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see GROUPS, Page 38

Competition from CarMax superstores forced franchised dealers to upgrade their used-vehicledepartments. This store is in Las Vegas.

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TheFranchiseSystem3 8 • S E P T E M B E R 2 5 , 2 0 0 6

2000carOrder.com Web site folds.

GM, Subaru say they will not givefranchises to online auto brokers.Ford announces penalties for dealerswho sell new vehicles to onlinebrokers.

Internet broker CarsDirect.comlobbies states for e-dealer license,enabling it to sell cars withoutphysical location.

AutoNation enters alliance withAmerica Online to sell vehicles.

GM scraps DriverSite program afterTexas won’t give it dealer license.

Legislatures in 20 states pass lawsrestricting factory-owned dealerships.

Ford launches joint venture withdealers, FordDirect.com.

2001First e-dealerlicense lawtakes effect inIndiana. Lawsays dot-coms,like brick-and-mortardealerships,must havephysicallocation,businessphone, vehicleinventory.

Ford says it willsell AutoCollectionstores.

2002AsburyAutomotive Inc.goes public.

Huizenga retiresas AutoNationchairman.

Congresspasses ban onmandatorybindingarbitration toresolve dealer-factorydisputes.

Alaskabecomes 50thstate to enactfranchise law.

THREATS, VICTORIES

it finally made a $1.1 million profit inits 2000 fiscal year. AutoNation USAand Driver’s Mart collapsed.

Despite its retail sophistication,Circuit City proved to be unfamiliarwith the mechanics of used-vehiclesales. AutoNation’s leaders alsolacked essential knowledge of the carbusiness. Driver’s Mart, even thoughdealers conceived it, launched toohastily, Hoffer says.

Marshall Chesrown, a former deal-er in Denver, says the superstores’huge, multimillion-dollar facilitiesinflated the dealerships’ breakevenpoint. Chesrown sold his dealershipsto Republic, AutoNation’s parentcompany, in 1997. He was the com-pany’s senior vice president of mega-stores before he resigned in 1999.

“The overhead was crazy,” Ches-rown recalls. “The business model wassound, but the problem was the waythey built their expense structure.”

Bill Wallace, a dealer in Stuart, Fla.,and a former Republic dealer, saysAutoNation spent too much to re-condition vehicles.

Creating a monsterCarMax opened 14 superstores

with 100,000 square feet of space and1,000-vehicle inventories, Hoffersays. But the company quickly dis-covered that most markets could notsupport such a vast inventory, and it

killed the concept. Only two of thestores survived.

At AutoNation, inventory didn’tturn quickly enough, and the cars de-preciated, Chesrown says. “The super-store operators never took into consid-eration that used cars aren’t like wine,”he says. “They don’t get better withtime.”

Conventional franchised dealerscould match or beat their superstorecompetitors handily. They alreadyhad used-car operations, they hadaccess to late-model trade-ins, andthey understood auto auctions.

“The used-car business is not likethe videotape business, where themore you buy the cheaper price youget,” says Ramsay Gillman, chairmanof Gillman Cos. and a former presi-dent of the National AutomobileDealers Association. “When you buya used car at auction, you are thehighest bidder.”

Ultimately, the superstore threatvanished — but not before dealerslearned better ways to sell used carsand trucks and to make better use ofcustomer databases, Hoffer says.

As NADA president in 1997, Gillmaninsisted that franchised dealers wouldwin their war with the superstores.

“As fate would have it,” Gillmansays, “I was right.”

Going publicIn 1996 and 1997, several dealer-

ship groups went public, raising mil-lions of dollars through stock offer-ings. As publicly held Republic In-dustries experimented with used-carsuperstores, it also snapped up new-vehicle dealerships.

Many dealer entrepreneurs fearedthe public retailers because of theiraccess to capital and aggressive ac-quisitions. They worried that publicdealers could sell vehicles at cut-rate

prices because of economies of scale.Some sold their dealerships to con-solidators rather than compete withthe public groups.

“I wasn’t sure what the impact ofpublic ownership was going to be,”says Chesrown, one of the first deal-ers to sell out to Republic. “My con-cern was that if (public dealers) exe-cuted the business plan as stated, Ithought they would be tough com-petitors. Because of their size, Ithought they would have a benefit inhiring good people.”

Dealer Wallace says he sold out toRepublic because he wanted to ex-pand his operation with public mon-ey. But a few years later, he boughtback part of his operation and re-turned to being his own boss.

“It sounded so wonderful,” Wallacesays. “We thought we could do all the

continued from Page 36

GROUPSEarly mistakesweren’t fatal

State(franchise)laws, stateregulationsare alwaysgoing tomake itdifficult for

manufacturers to alter the waythey do business.

I have financial partners in everydeal, because it’s critical thatthe people running theoperation, that their life’s in it,their blood is in it, their money’sin it. Then your level of energyand effort is increased. You’renot ‘working for’; you are a partof the organization. You’ll knowthat by how people talk. Onceyou get ‘part of’ vs. ‘workingfor,’ you can do amazing things.

Forget the capital and the time— the manufacturers canalways go get that. It’s statelaws and individual ownership.

Joe Serra, president, Serra AutomotiveInc., Grand Blanc, Mich.

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see GROUPS, Page 42

As dealership groups grewover the past decade, theybecame bigger targets for

trial lawyers, government regulatorsand media exposes.

Most of the salvos were aimed atthe finance and insurance depart-ment — generally a dealership’sbiggest profit center. Many dealer-ships and groups found themselvesaccused of racial bias in theirmarkups of wholesale interest rateson vehicle loans.

The scrutiny reached a peak in late2003 and early 2004. Network TV in-vestigations focused on two publiclyheld auto retailers.

A December 2003 report on “Date-line NBC” featured Sonic AutomotiveInc. of Charlotte, N.C. The report sug-gested that unethical and illegal F&Ipractices are common at dealerships.

In April 2004, CBS’ “60 Minutes”

zeroed in on UnitedAuto Group Inc.of Bloomfield Hills, Mich. The reportquestioned markup practices at aUnitedAuto store in Memphis, Tenn.

At the same time, consumer advo-cates sought to instigate lawsuitsagainst other large dealership groups.They often cited the accounts of for-mer employees of the companies.

Plaintiffs’ lawyers brought class-action suits against large vehiclelenders. The suits alleged that inter-est-rate markups were the result ofracial discrimination. Dealers coun-tered that the markups were an ap-propriate charge for the servicesthey provided buyers.

Despite the political clout of state-house dealer lobbies, legislatures inseveral states considered legal re-strictions on rate markups.

The industry responded with vol-untary disclosures. Many dealerships

limited finance charges. They also in-troduced fixed-price menus for after-market finance and insurance prod-ucts. Lenders, including automakers’captive finance companies, restricteddealers’ finance income.

The National Automobile DealersAssociation and several automakersendorsed the Association of Financeand Insurance Professionals’ certifi-cation program, which trains dealer-ship F&I managers in law and ethics.NADA also launched a public educa-tion campaign about vehicle finance.

The industry’s moves curtailed thelegal onslaught. Most of the lawsuitswere settled. Legal challenges waned.

By 2006, only two states, Californiaand Louisiana, had passed laws thatlimited interest-rate markups. Andthe Louisiana measure was promotedby that state’s dealer association.

— Donna Harris

For a time, F&I was legal battleground

George Hoffer:Superstorechallengecreated dealerpanic

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