Could F&I lose its lustre?

I talked in my blog last week about aftersales and that despite it being a significant profit contributor for both manufacturers and repairers, it possibly does not get the attention that it deserves with new car sales taking the limelight, at least within the franchised sector.  It therefore seems appropriate to focus this week on the other area that is invisible to a casual observer of our industry but is actually a major profit source for manufacturers, retailers of new and used cars, and a whole range of specialist providers.  That is the area of finance and insurance commonly referred to as F &I.

General trends around the world are for cars to be increasingly bought with some form of financing, regardless of whether the customer is a private consumer or a business.  This has unlocked growth in markets like China and sustained high levels of car ownership in mature markets like the US.  It has been a valuable tool to make cars seem more affordable through attractive monthly payments and is a relatively elegant way for a manufacturer to disguise discounts without jeopardising residual values.  This is not limited to volume cars – one super-premium brand that I'm aware of was at one stage offering a deposit allowance equivalent to the price of an entry level premium car in order to move the metal (and leather).  But F&I is not limited only to the financing of the car itself.  A plethora of other products have grown up, mainly sold in conjunction with the car purchase but also some that are applicable at a later date like warranty extensions, service plans and the opportunity to spread the cost of a large repair bill.

In combination, for the dealer, the commissions on these F&I products may represent the whole profit that they make on a new car sale and an extremely important contribution on used cars.  Many of them are structured in a way that encourages retention of the customer to the OEM brand or dealer brand.  They have become so important that the specialist staff employed in dealerships to sell F&I can earn as much as the general manager.  Within the manufacturers, their captive finance organisations are a hidden gem, undervalued by investors, but over the long term – despite occasional issues related to residual values – have produced return on equity far greater than their parent companies pure automotive operations.

However, we now have some clouds on the horizon.  There is much more regulatory pressure and scrutiny particularly with respect to consumer finance products.  There have been repeated investigations in the EU, UK and US focused around whether consumers are treated fairly when they buy F&I products from car dealers.  There is a certain customer demand to bundle as much of their motoring related costs into one monthly payment as they can, and from the retail perspective the experience has been that it is much easier to sell F&I products at the same time as the car itself, rather than as a follow-up.  Depending on jurisdiction, different F&I products are subject to different regulations around their sale, with still further restrictions, again varying between markets even within the EU, in terms of what products can be sold online.  Given that we expect customers to do more of their journey online, which may well include making their finance choices there because of the confidentiality and sensitivity around sharing this information face to face, restrictions on online selling and added complexity is likely to have a negative effect on the take-up over anything other than the basic F&I products.

In the EU, the consumer credit directive (CCD-II) will progressively come into force through 2025 and 2026 in all member states with a strong consumer protection focus including marketing restrictions and affordability assessments.  Leases with the option to purchase (referred to as LOA in France or what we would call a PCP in the UK) will be affected, potentially rendering them unprofitable in France.   In the UK, regulators have put more responsibility on intermediaries to ensure that each individual F&I product sold meets a real customer need and offers value to that customer.  They are now looking retrospectively at products that allowed the retailer to adjust interest rates in order to fund higher commission rates, so-called discretionary commission agreements with the product providers.  All such products had to be withdrawn from the market with some adjusted offers now starting to reappear but the findings of the investigation with the potential for substantial fines for past malpractice will be published next week.

When we take all of this into account and set that against the need to improve omni-channel offers (in some cases moving to agency agreements where the OEM will generally be the contractual partner) and progress towards full electrification which introduces much more uncertainty into residual values for funders, it is clear that F&I is going to be under considerable pressure.  This effects retailers most directly both in the franchise sector and independent used car trade because of the substantial contribution that commissions have made historically to profits.  But it also affects the manufacturers because if their franchise networks lose such an important profit stream, then the retailers will understandably be looking for that to be replaced, putting more pressure on the debate around the levels of the margins and commissions.  The loss of the retention effect of some F&I products may also dent volumes and/or increase marketing costs.  It may also affect the opportunity for manufacturers to promote their products as effectively through subvented finance if any element of this can be viewed as not being in the customer interest.  F&I could become more of an ugly duckling than a golden goose.

 For further details on the regulatory picture in Europe relating to F&I, read Andrew Tongue’s briefing on the topic, available here plus a video extract from a presentation Andrew gave to our summer meeting back in June this year.