Detroit Automakers' Dirty Little Secret

Today we're going to talk about the Detroit's dirty little secret. No, I'm not discussing some celebrity gossip headline you might see on the E! channel. I'm talking about how Ford , General Motors and Chrysler use massive fleet sales to juice their market share figures. Toyota and Honda treat fleet sales like an infectious disease and avoid them almost entirely, while Detroit's Big Three welcome them with open arms. How much does it really matter, and are fleet sales really that bad? Let's look at some details, and you can decide for yourself.

Why fleet sales are bad
Fleet sales have traditionally been frowned upon for two reasons. The first is that it adversely affects resale values. The second is that people claim it hurts the bottom line - a misconception I'll address later. The first point is valid - think of the last time you shopped for a used vehicle and found out that it was a rental or fleet vehicle. You likely cringed while thinking of all the abuse it took from drivers who had zero incentive to take care of the vehicle. In addition to that, companies buy fleet vehicles in bulk which lowers their price substantially, and that discount eventually filters down to the used vehicle lot - potentially lowering resale values.

Regarding the second point about fleet sales hurting the bottom line - I disagree. Or perhaps I disagree with how people describe the argument. Fleet sales are completely separate from retail sales and for that reason they are incremental sales. Incremental sales do nothing except add value to a company's top and bottom lines. The truth is that fleet sales hurt margins as they command a price near wholesale numbers.

That's why fleet sales catch a bad rap. Another fact to consider is how fleet sales juice a company's market share.

Fleet sales by the numbers
Since Detroit's Big Three typically welcome incremental fleet sales, do they enjoy an advantage in market share numbers? The answer is yes. Let's look at the table I made below using Wall Street Journal and Automotive Data Center numbers for YTD sales through April:

If you noticed slight discrepancies in the numbers it's because rounds the numbers where the WSJ does not. It's a simple table but it might take a couple minutes to see how I did things - so here's an overview.

Firstly you can see that Ford, GM, and Chrysler all have fleet sales that represent over 25% of their totals where Toyota's and Honda's represent only 13% and 2%, respectively. You could also note that Ford has more fleet sales than Toyota and Honda combined, two and a half times over.

Secondly, you can see the effect it has on market share. If you subtract fleet sales and only consider retail sales, Ford and GM's market share drops by about 5% each - a significant amount. Consider that with fleet sales Ford has more than a 2% market share advantage over Toyota, but without fleet sales Ford trails Toyota by 1%.

Fear not!
Take a deep breath, Ford and GM investors, all is not lost. The caveat is that while Detroit's Big Three juice their market share with fleet sales, their retail sales have also increased more than their Japanese rivals. According to the numbers, YTD retail sales through April versus the prior year shows Ford, GM, and Chrysler up 15%, 10%, and 14%, respectively. That compares favorably to Toyota and Honda which were up only 9% and 6%, respectively.

While we're at it, let's debunk the two arguments of why fleet sales are an "infectious disease". Here's why fleet sales won't hurt resale values for Ford and GM.

The complete nose dive in new vehicle sales during the recession has had a caused a decreased supply of used cars today. Combine that with an abundance of cheap financing and the result is more people are opting to buy new. That means used car values are likely to remain high, regardless of fleet sales, until this wave of new vehicle purchases hits the used vehicle market years down the road. The graph below shows the trend.

On a separate note, GM and Ford should especially notice a rise in resale value since their newer vehicles are selling extremely well due to improved quality and design. Simply put, transaction prices are up and incentives are down - helping support higher resale prices.

Regarding the second point about margin pressure, I believe Ford and GM will mitigate this overall. Both are much leaner companies. Ford CEO Alan Mulally's "One Ford" plan has already cut costs and drastically improved operating efficiencies. That helped Ford report an impressive North American margin of 11% last quarter.

Both companies can use a different strategy by producing specific vehicles for fleet sales. GM will be bringing back two mid-size trucks next year. One will be designed as a more premium truck for higher margin retail sales, while the other will be designed to cost less for fleet buyers - mitigating margin pressure.

Bottom line
Ultimately it comes down to this: Do you want the incremental sales or not? Absolutely - take the fleet sales and find ways to minimize costs. The two reasons that gave fleet sales a bad rap don't look to have any major downside for Ford and GM. I say keep on keeping on, Detroit; it's not such a bad dirty little secret after all!

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Motley Fool contributor Daniel Miller owns shares of Ford and General Motors. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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