×

Why Warren Buffett is wrong on car-dealer model

Warren Buffett recently said he thinks the car-dealership franchise model isn't going to change. I wouldn't be so sure.

At the NADA/J.D. Power Automotive Forum in New York recently, Buffett said, "When a distribution system [car dealers] becomes that firmly established, there's a reason for it."

But, of course, everything changes. We have seen entire established industries collapse given the technologies that are available to us today.

Warren Buffett held on to his stake in post-IPO Verisk, which has earned a hefty 207 percent return since October 2009, as of the close of business Sept. 30.
Adam Jeffery | CNBC
Warren Buffett held on to his stake in post-IPO Verisk, which has earned a hefty 207 percent return since October 2009, as of the close of business Sept. 30.

And few segments are as inefficient and in need of an overhaul as the car dealership, a made-to-stock retail business model for an unusually expensive product. Yet, the industry endures, even prospers. Just last month, Warren Buffett's Berkshire Hathaway acquired the Van Tuyl Group, the largest privately held dealership group in the country.

Billionaire Buffett, who, in case you're wondering, bought a Cadillac XTS from an Omaha, Neb. dealer last year, said he would like to be seeking out even more car-dealerships acquisitions in the next couple of years.


Is the Oracle of Omaha getting a little near-sighted in his old age? After all, Elon Musk is building his own direct-to-consumer model for his Tesla car brand.

Read MoreWarren Buffett gets into auto dealers in a big way

For sure, substantial barriers remain for anyone trying to disrupt dealerships: state franchising laws, dealers' political clout; customers' service expectations; and the billions invested by dealers in the auto industry capital structure, which in many ways benefits the manufacturer as it alleviates much of their own inventory risks.

Still, the business model will change over time. It could be smaller showrooms where you can look over example models, sit or drive in a vehicle, then place your order, customized to your personal specifications. It might even be direct sales, as Tesla is already offering in some states. Who knows? In the future, maybe you will order up your test drive like you can order an Uber today, or a self-driving car will come to you. If that sounds sci-fi, imagine what personal 3D printers or drones might do someday.

The automotive-franchise model, once as revolutionary as the automotive assembly line, was created over a century ago, and has it served its purpose well: supporting the once rapid growth of the auto industry by using the capital of entrepreneurs to finance inventory, sales and distribution.

Read MoreJim Cramer: Tesla's Musk should be on 'SNL'

The model already has altered in size; each year since 1949, there have been fewer franchises, and smaller ones are disappearing the fastest, leaving the miniscule profit margins (2-to-3 percent) to large chains of higher volume dealers.

Buyers have changed, too; they are more informed, Internet-savvy and less likely to accept high-pressure sales techniques.

Most customers dislike the current model, despite recent enhancements.. They still feel forced into a choice and lack trust in sales personnel. Buyers in one survey said they would rather give up sex for a month than haggle on a price with a sales person.

Consumers want changes in how car sales are structured, including the paperwork and servicing agreements among other things. Test drives, in particular, appear to be especially irksome, as the study found that 88 percent will not buy a car without test-driving it, and most who take test drives do not want to do it with a sales person.

Read MoreBuffett: These investments are a 'fool's game'

Thus the real key to significantly changing the dealer model will be finding a system that provides customers with the choices and responsiveness to which they have grown accustomed and improving them. In other words, if they can buy the car they want, customized to their desire, without compromise, on a timely basis — perhaps two weeks, at a fair price — then there is a chance for an alternative system.

There will be challenges. Tesla, for instance, is, as Buffett noted, small and sui generis; it will face real capital challenges as it scales in size.

But the bottom line is that the current dealership business model is very costly and inefficient. The idea of stocking two months or more of demand on a retail lot would bankrupt most companies. Ask Wal-Mart or Target or Costco how much inventory they try to carry at any point in time. They talk about turning it over as fast as possible, in days and weeks.

So, Uncle Warren, the future, as you of all people should know, will be different; it always is. And the car-dealership business model won't be an exception.

Read MoreCramer likes this car-dealer stock

Commentary by Daron Gifford, the partner leading automotive industry strategy consulting at accounting firm and consultancy Plante Moran in Detroit.

Disclosure: Neither Daron Gifford nor Plante Moran have any investments in or business relationships with the companies mentioned in this article.