Canada: Beware The "Taj Mahal" Dealership Renovation

Last Updated: August 9 2013
Article by John Sotos

Renovating a dealership is expensive. It's usually the most expensive capital investment a dealer will make, aside from building from scratch. Accordingly, dealers need to ensure that renovations will produce a good return on their capital (ROI).

For a large urban dealership, renovations can easily cost in the range of $5 million to $10 million. The cost of servicing that debt can add $500,000 to $1 million per year alone to the cost of doing business. However, not all renovations are created equal. Certain improvements will add to a dealer's bottom line over time, while others are simply sunk costs.

All dealer contracts include an obligation on the part of the dealer to upgrade its facilities periodically. The purpose of these clauses is to ensure dealers continue to represent the brand and service their customers consistent with evolving standards in order to grow the business. Properly conceived imaging programs are tested in a variety of settings (urban/rural) and demonstrate strong ROI before being rolled out. Unfortunately, not all factory imaging policies meet this basic and obvious first step.

A recently released NADA/CADA research project which examines certain factories' answer to failed marketing practices (ever changing image programs) concludes that such programs often fail to provide dealers or their factories with any economic benefit. Worse still, the study found that factories' insistence on dealers building "Taj Mahal" facilities can turn viable dealers into money losing ones. To make matters worse, discriminatory enforcement of factory imaging policies where not all dealers are required to adhere to the same imaging standards handicaps those dealers that do comply with imaging requirements.

The NADA/CADA study cited above concludes that there are basically three different aspects to facilities renovations. Each aspect has a different associated ROI for dealers.

The expansion aspect of renovations tends to have the highest dealer ROI. It relates to the physical expansion of the dealership, such as building a bigger showroom or an expanded service bay. The rationale here is simple, assuming there is unmet demand: bigger dealerships can make more money.

The modernization aspect has a mixed effect on dealer ROI. The benefits of modernization end up getting split between the individual dealer and the brand. Modernization refers to having comfortable, modern facilities that are pleasant for customers to be in. While everyone likes a beautiful and comfortable dealership, modernization renovations don't always pay off financially for the dealer.

Finally, the standardization aspect of facility programs appears to have no ROI benefit at all for individual dealers. The benefits (if any) accrue entirely to the factory. Standardization refers to renovations which are made to adhere to the factory's current branding standards.

What can the individual dealer do when their factory comes knocking, asking them to build a Taj Mahal facility? Ask for the evidence that supports the business case.

Many dealers make the mistake of assuming that they have no legal right to refuse factory demands to re-image. Such dealers simply accede to factory demands to their detriment.

Dealers are well advised to push back on the modernization and standardization aspects of facility upgrade plans. This is especially true if they do not believe they will produce any tangible benefit for the dealer. Furthermore, dealers may wish to push back on the expansion aspect if the factory's expansion plans are based on overly optimistic volume estimates.

Dealers do have some obligations to keep up with factory branding and standardization efforts. This makes sense, since dealers are the public face of the brand. They also benefit from the brand's collective goodwill. However, dealers' legal obligations rarely rise to the level of having to invest millions of dollars into renovations which rarely if ever pay off.

A dealer faced with a demand to re-image should perform its own objective market analysis in order to determine if all or part of an upgrade will result in a real benefit for the dealer in the short-to-medium term. Unlike other retail establishments that can be converted readily to other uses, dealerships are single purpose buildings. If the re-imaged buildings fail, the dealer will rarely be able to repurpose the building without taking a huge economic loss.

Determining a dealer's legal rights in the face of a demand to invest in a suspected Taj Mahal calls for skilled legal advisors with the depth and experience to resist the legal and business pressure that may result. Such advisors can also held find the right experts to advance a dealer case to a successful outcome.

Sometimes, dealers will dutifully invest in re-imaging while neighbouring same brand dealers don't. In such cases, the dealers who took the plunge and sunk millions of dollars into renovations find themselves at a competitive disadvantage. This is clearly unfair!

The question asked is whether such dealers have recourse. Depending on their individual dealership contracts and provincial franchise laws, factories may have an obligation to compensate where their actions discriminate between dealers. Factories generally cannot favour certain dealers by forcing some to re-image while allowing other to continue with out-of-date facilities.

In Ontario at least—and likely other provinces with franchise legislation in place—factories have a duty to treat franchisees (i.e. dealers) fairly and not to discriminate amongst them arbitrarily. These are not just words on paper. If a factory fails to maintain a consistent imaging policy, then dealers who have been negatively impacted as a result may have a right to compensation. As a result, they may be able to negotiate benefits from the factory to compensate them for the competitive disadvantage they have suffered due to the factory's actions or inaction.

Imaging is a critical step in the lifespan of any dealership. It is expensive and can break a dealership if done carelessly. Dealers do have legal rights when dealing with their factory. Failing to exercise those rights in a timely fashion is always costly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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