Car finance is a growing sector, and there is certainly money to be made here, but how can a new financier set up their stall in an already crowded market? Chris Farnell writes.
Car finance is a promising sector for financiers, but from the outset it is clear that the marketplace is a competitive one.
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For new competitors, the playing field is made doubly challenging if they are not also a car manufacturer. In the new vehicle market, it can look like anywhere between 80% and 90% of purchases are from captive markets, with car manufacturers selling new cars through their own dealerships, financed by their own finance products.
The advantages of this kind of arrangement are obvious: it means an existing relationship between dealer and financier, better terms, and even smaller things like a smoother document-management system. However, it also makes things more difficult for new funders looking to enter the market.
“In terms of opportunity coming into the UK dealer market, the first thing I’d say is it’s fairly crowded, so think carefully before coming in as a new player,” explains automotive finance consultant Peter Cottle.
“One thing I’d be asking myself is: what can you offer that’s slightly different without getting yourself into an over-risked position? It’s easy to go in and offer the world, but it’s not sustainable. What can you bring that’s new?”
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By GlobalData“They’re going to need to approach dealers with a competitive package and one that takes in the needs of the dealer’s customers so that what they’re offering is the right product package,” says Louise Wallis, head of business management for the National Franchised Dealers Association (NFDA).
“I think there are some absolute givens you need to have in approaching the UK dealer network,” Cottle agrees. “You need really good systems and very seamless processes. Dealers expect fast responses to their proposals, but one thing I would emphasise is that this must be balanced with proper and adequate assessment of customer affordability.
“It’s easy to make a quick decision, but if it’s not good for you or the customer, that’ll be frowned upon. You need quick responses that are adequately reviewed from an affordability and underwriting perspective.”
You also need to be able to back those processes up with capital.
“On the other end of the process, once you’ve agreed a deal, you need be able to fulfil quick payouts and all the things that go along with that, such as documentation and paperless processing. On top of that, you need to be geared up to deal with the online world,” Cottle says. “A lot of dealers are offerings cars on the web: the customer doesn’t always show up at the showroom.”
The Rise of PCP
Of course, when entering a new market, one of the most important things is to know which products are going to sell. At the moment, the motor finance sector is undergoing a huge shift away from outright car purchase towards purchase hire, PCP and other lease-like agreements.
“I think the new car market is particularly well covered, because manufacturers want to sell cars that way. These days there are plenty of options outside the captive market,” Wallis says. “There is plenty of demand, and that’s being fulfilled.”
A challenge for financiers, however, is that while fewer and fewer customers are buying their cars outright, the customers themselves do not seem to be aware of the fact. In a recent survey, 93% of customers who had used PCP to finance their car said they owned the car, when in fact a PCP is more akin to a lease or a rental. Cars under PCP can be taken back, brought in early, or exchanged at the financier’s discretion. In simple terms, customers believe they own the car even when they do not, and it is the job of financiers to explain clearly to their customers exactly what it is they are paying for, particularly in the current regulatory environment.
However, the fact is that industry information on how customers purchase their cars is incomplete. While there is data on how many customers are opting for various motor finance products, there is still a proportion of customers who buy their cars outright. Of those, we do not know how many are paying with their own money, or how many have borrowed from other sources such as retail banks to pay for the car.
Nevertheless, it is impossible to deny the critical role that PCP has played in transforming the car market for manufacturers and finance houses alike, with premium brands in particular driving the trend and achieving a greater market share as a result. Whereas typically high end, luxury brands such as Jaguar would be out of reach to the average consumer, financial products such as PCP are allowing premium brands to take around 26% of the market share.
The other factor that makes lease or rental-type financial products such as hire purchase and PCP appealing to consumers, especially in the new car sector, is that it is a truly all-inclusive expense.
While buying a car outright can become a merry-go-round of expenses – including insurance, maintenance and more – these products offer a full package covered by a single monthly fee, something that has a strong appeal for younger consumers who are used to the Netflix model of business.
Regulatory Flux
A constant companion in the motor finance industry is the changeability of the regulatory environment, and financiers need to beware of shifts in the law.
“The treatment of PCP from a VAT perspective, which is very far-ranging under the new tax laws, is going to have a dramatic influence on what is offered in the future,” says Cottle.
“Fundamentally, what a finance company needs is to be able to offer the customer a full range of finance products that meet their personal need. The danger is selling only one product; you need a range, and they need to be fully explained to the customer. The dealer side of things needs to be robust in that respect.”
Wallis also cites the residuals and fluctuating values of vehicles as possible pitfalls for financiers.
“The biggest risk is around the residual values of vehicles and setting them correctly, particularly with PCP products,” she says. “The best approach is to use one of a number of companies, such as Glass’s and cap hpi, which set values for end of life and end of lease, so make sure you use an established valuation company to set the values.”
Relationship Issues
As well as regulatory shifts, the automotive market itself is undergoing some significant changes, with many dealerships consolidating operations and looking to do more business from fewer outlets.
Some 48% of all turnover in the UK is accounted for by the top motor retailing groups, but even Volkswagen recently announced a complete restructure to potentially reduce the number of dealers by nearly 25% over the next few years. As dealers are the primary place where most customers get their car financing, that makes them a critical conduit for funders. The people Motor Finance talks to in the industry all agree on one thing: for a funder hoping to succeed in the sector, strong relationships with dealers are essential. This means it is important to communicate with dealers, but even more important to choose carefully when deciding which dealers to work with.
“It may sound touchy-feely, but your relationship with the dealer needs to be very transparent. You need trust: that’s so important for both sides of things,” Cottle says. “Don’t go for something just because it looks like a good opportunity. You need a good personal relationship. Review your business relationship on a regular basis so both parties’ expectations are not being breached. Don’t leave things until the end of the year: have a quarterly review, sitting down with open discussions. From the outset, have clear objectives so both parties are aware of what’s expected.”
As has already been pointed out, breaking into the car finance market is a big challenge. There are already a lot of players in the sector, many of which are well established and already have the network of relationships and connections that are essential for them to thrive. New contenders are going to have to work hard to build a network of relationships of their own.
To do that, a financier needs to make a strong first impression. In the motor finance sector that means a number of things: firstly, it means saying clearly what it is you are doing, and how you are going to do it. Finance providers need to set out a strong table, showing what products they intend to offer, so they can connect with dealers and consumers who are looking for that product.
Technology
Another priority that is mentioned time and time again is to be competitive on a technological level.
Providers need a strong, well-designed and user-friendly online presence, with competitive online products that consumers and dealers can access quickly and make transactions rapidly.
“The other thing I’d add, and this is two-way process, is that you need to good due diligence when choosing your dealer partner,” Cottle adds.
“The vast majority are very straightforward and proper people, and dealers need to look at their finance company in the same way, asking whether the company will meet their own values. Know your customer, do some work, make sure both sides have the right FEA due diligence before you’re in a contractual arrangement.”
When it comes to putting together a contract for motor financing, the rules are much the same as putting together any contract: be clear about what you’re committing to from the outset, and make sure the other parties are as well.
“As far as the contract is concerned, it needs to be in plain English, with no complicated clauses. Make it very clear what that contract intends to tie both parties to. No surprises,” Cottle says.
“If you do not do some research, you can have unrealistic expectations. You could be looking at a considerable amount of business between two parties, but still not have those expectations reached which can damage relationships, so have a good look beforehand.”
That research also means looking into the quality of the business you are taking on to avoid bad debts – something about which there have been more than enough cautionary tales over the last decade. But it is also important to know in advance the sort of customers and deals a dealer will be passing on to you, if you want to avoid disappointment on both sides.
“You do not want to be seeing a huge number of proposals coming in that you cannot afford, because it makes for a costly relationship. That’s part of the pre-discussions with the dealer,” Cottle says.
“It’s not very fruitful for either party, because from the dealer’s perspective, they’re sending a lot of proposals and you aren’t agreeing to many of them.”
The consensus among the experts Motor Finance talks to is that it is a hard market to break into, but if you can, the rewards are worth it. “A new player has to have a really good hard look at themselves and question whether this is a market they can flourish in,” Cottle says.
“It is a competitive sector, but there is money to be made. You’re looking at a big product, so even if the margin is thin you can do well,” Wallis agrees.
Indeed, the rewards of the motor finance sector are not just in the margins.
“If you have a very strong proposition in terms of the product and service that you offer, and you can develop a good open relationship with a dealer, then there is an element of loyalty in this sector,” Cottle points out.
“If you can prove to a dealer that you can achieve what you set out to do, and you’re transparent to deal with and truly add value, then there is loyalty, and that builds into a much longer-term relationship, because you don’t want churn with your clients. If you can maintain a relationship, that is good for everybody.
“Despite the challenges in the industry, there is good business to be had, but you need to constantly challenge yourself. Are you adapting to changes – be they legislation, market changes or technology? You have got to be alert to things changing.”
