Stair-step Programs, Good or Bad for Business?

My last column covered June sales and mentioned that several manufacturers are using stair-step dealer incentives that had the potential to lift the sales pacing for the last week of the month. I also mentioned these programs are controversial. Indeed, the last few issues of Automotive News have featured several articles and Op-Ed pieces covering stair-step programs. A couple weeks back NADA even ran a full page ad calling stair-steps "bad for business and confusing to consumers."

Arguments against stair-steps generally claim they are unfair to smaller dealers. Sometimes the consumer card is played and stair-steps are claimed to add to consumer distrust.

Here's a question: How can stair-steps be credited with increasing sales for the last week of the month and yet be bad for business? Seems we must be missing something.

In reviewing the statements covering stair-step programs, both pro and con, there is one vital piece that is being overlooked. Before I get to that, let's think for a minute about what happens when a stair-step program is launched. Stair-step programs are basically incentives to dealers that are tied to sales quotas. These quotas are generally based on prior sales, but this can vary. The key point is that the quotas are usually different for each dealership.

The way the programs work is this: As sales increase, the incentive amounts increase as well. For example, a dealer might earn $500 per unit if they sell 10 units over the course of the program, $750 if they hit 15 and $1,000 if they hit 20 units. Often there will be a fast-start bonus as well. There is a more aggressive version of a stair-step program and that is when the incentives are paid retroactively. This means that if a dealer hits the first tier, the $500 would be earned for units 1-14, not just 10-14. As you can see, one aspect of stair-step programs is that they can get very complex very quickly.

So what happens when a stair-step program is announced? Each dealer gets his quota and needs to make a decision. Generally larger dealers will expect to earn the maximum payout. To make sure this happens, they will adjust retail pricing downward, sharing some or all of the bonus with consumers. Larger dealers always set "market pricing," but in most cases, the discounts are limited in that all dealers pay the same amount to the manufacturers for a vehicle. When a stair-step program is active, this is no longer the case. A dealer's cost will vary, based on what level of payout has been earned. (This is why NADA often calls stair-step "two-tiered" pricing.)

The conundrum for smaller dealers is simple: Do they match the lower prices being offered by the larger dealers and risk losing money if the sales quotas are not achieved? Or do they continue with previous pricing and risk being seen as not competitive? You can see where this can put smaller dealers in a tough spot, which explains why many dealers don't like stair-step programs.

Now put your manufacturer hat on. During the program aggressive dealers push down transaction prices, which increases sales. Smaller dealers often have to follow suit. To the extent dealers don't hit their quotas, the reduction in pricing has been funded by dealers lowering their margins. Consumers have benefited from lower prices and the manufacturer from higher volume, but dealers have taken a hit. From the manufacturer's viewpoint, stair-step incentives can be a relatively efficient way to push down transaction prices as some of the reduction comes from the dealer's margin.

This gets to the nub of the issue. Manufacturers typically refer to their dealers as partners. This is generally true, but it is a partnership with points of tension. A big one is that dealers want to optimize their businesses around profitability. The manufacturers would prefer that dealers optimize for volume. The enduring appeal of stair-steps is that during the program, the interests of dealers are aligned with the manufacturers. Both are reaching for volume. So despite the protests, look for stair-step programs to continue.