A new report from Colonnade Advisors details the significant interest among investors and consolidators in the vehicle service contract industry. The following is an excerpt from the appendix of the whitepaper, which provides an in-depth look at the trends and growth drivers behind this expanding market.
Strong Macro Trends are Driving Acquisitions and Investments in the VSC Industry
U.S. consumers spent an estimated $35 billion on VSCs in 2018. VSCs are typically marketed at three points in the life cycle of an automobile:
(i) at original sale (the new vehicle segment – extended warranties),
(ii) near or after expiration of factory warranty primarily via direct-to-consumer sales (the end-of-warranty segment) and
(iii) at resale (the used vehicle segment).
The VSC market benefits from high new and used car sales and increasing penetration rates. Consumers value VSCs as they have limited funds to pay for repair bills and they are owning vehicles longer. Dealerships focus on VSC sales to enhance margins. F&I products provide increasing incremental profitability and represent 25% of total dealership gross profit, compared to 15% in 2009. We expect these dynamics to continue.
The VSC market size has grown by 6.9% to $35 billion since Colonnade’s last whitepaper in August 2017. The growth is attributed to three trends:
1) the increase in attachment rates on new vehicle sales,
2) the increase in used car sales and
3) the increase in vehicles out of the OEM warranty period.
Retail Market for VSCs in 2018 Compared to 2017
New car sales ultimately drive sales in the VSC market. New car sales were 17.3 million units in 2018, a slight increase from 2017. However, VSC attachment rates, or the percent of new vehicles sold with a VSC, have increased significantly in the last year causing the new vehicle VSC market size to increase by 5.9% to $16.2 billion.
Used vehicle sales are at an all-time high level and are driving the purchase of VSCs. Older vehicles have typically outlived OEM warranties and have higher maintenance needs, factors that have a positive impact on consumer demand for VSCs. There has been an influx of late-model off-lease vehicles returning to dealers which are older, higher mileage and outside of the manufacturer’s warranty, thereby increasing the need for VSCs on used vehicle sales. Colonnade estimates that 42% of used vehicle sales through franchise dealerships and 20% of used vehicle sales through independent dealerships have a VSC attached. The estimated franchise attachment rate increased from prior Colonnade analyses based on surveys completed by Baker Tilly and NIADA.
The number of vehicles post-OEM warranty has increased to an estimated 87 million vehicles from 86 million in 2017. These vehicles were post OEM warranty and less than twelve years in service, the “sweet spot” for aftermarket VSCs. Year 2017 represents the fewest vehicles in the sweet spot in the last seven years, as a result of the low number of new vehicle sales during the recession. Our research indicates that longer vehicle life coupled with continued high levels of new car sales post-recession will generate a continued growing market for post-OEM sales of VSCs.
Increasing Number of Vehicles Off OEM Warranty
Of the 276 million vehicles on the road, 48% are eligible for a VSC. This group includes new vehicle sales, used vehicle sales and post-OEM warranty vehicles that are less than twelve years old.
Increasing Consumer Demand for VSCs
Consumer demand for VSCs is increasing as the vehicles on the road are older and higher mileage vehicles have heightened maintenance needs. U.S. consumers are holding on to their cars for longer than ever, partially due to the higher quality of vehicles.
The average age of passenger vehicles on the road was 11.7 years at the end of 2017, up from 9.6 years in 2002. One of the reasons for the increase was the 40% drop in new vehicle sales in 2008 and 2009. The record number of new vehicles purchased in 2015 and 2016 will slow the rate of increase, resulting in an average estimated age of 11.8 years in 2020, according to IHS Automotive.
Length of Ownership
Vehicle owners are increasing their length of ownership. New vehicle buyers now own their vehicle for 6.6 years compared to an average of 4.3 years in 2006, according to IHS Automotive. Used vehicle buyers now own their vehicles for 5.5 years compared to an average of 3.3 years in 2006. This trend is due to longer loan terms and the higher quality of vehicles. By using longer-term loans, consumers can reduce monthly payments and afford more expensive vehicles. Over 85% of new vehicle and 53% of used vehicle purchases are financed, and six to ten-year loans are becoming more popular. As a result of the extended terms, borrowers are not in a net equity position until their fourth year and frequently beyond the manufacturer’s warranty. To increase a borrower’s ability to pay on loans, lenders include the value of F&I products in loan-to-value calculations as a borrower is more likely to stay current on a functioning car. These trends create the opportunity for higher VSC penetration.
The increasing number of older cars is creating more vehicles that need repairs and maintenance; repairs generally become more expensive as vehicles age. Many consumers are unable to afford repairs as the growth in costs is outpacing wage growth and 40% of Americans do not have $400 in emergency funds. These trends are driving demand for VSCs.
F&I Focus at Dealerships
Despite improved auto sales, dealership margins remain under pressure, and F&I products provide meaningful incremental profitability. Dealerships have become more dependent on F&I products, as they represent 25% of total dealership gross profit compared to 15% in 2009. This trend will continue as dealership margins on vehicle sales may be squeezed in coming years. In addition to increasing vehicle sales margins, F&I products improve long-term profitability by enhancing customer loyalty and retention by setting the stage for repairs, routine servicing sales and subsequent car purchases at the dealership.
Growth in the number of older vehicles is a positive trend for aftermarket repairs. However, dealerships will face strong competition for these increased repair revenues. Longer periods of ownership take consumers farther away from the selling dealership service lane to less expensive non-dealership repair facilities. Dealers seek to counter this trend by selling VSCs and prepaid maintenance plans to increase the likelihood of drivers returning to the dealerships.
For more details about Warrantech feel free to visit: https://warrantech.com/blog/january-2019/colonnade-provides-insight-into-the-vsc-industry/