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Burning Down the House

A former car dealer launches an on-line start-up that is reshaping the industry.
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Revolutionaries

A failed car dealer has launched an on-line start-up that's doing what even Web stars like Amazon.com can't: blowing up, and then remaking, an industry--in this case, the $1-trillion auto business

Andy Gill had no intention of hooking up with someone like Pete Ellis. Gill was a lone-wolf entrepreneur; he had always made it on his own. Gill had hit it big in insurance before cashing out, 11 years ago, and plunging into the car business. Today he's a successful dealer in metro Atlanta.

So Gill wasn't searching for fresh answers last February when he walked into a meeting at the annual National Automobile Dealers Association (NADA) convention and found himself in the midst of what amounted to a gripe session. Dodge dealers were hammering Chrysler's national sales manager about losing business to competitors selling through the Internet. "The dealers were all over the guy," Gill recalls. "Finally, he says, 'Look, I've been telling you people for four or five years now that you'd better get ready for this revolution. I can't tell you how high it's gonna go, but this is the wave of the future.' " Then the executive mentioned a company named Auto-By-Tel Corp. (ABT) as this new wave's major force.

"Auto-By-Tel," Gill repeated to himself. Hadn't he heard that name half a dozen times already around the convention? He bird-dogged the man from Chrysler out of the room. "What's this Auto-By-Tel deal you're talking about?"

The executive, lowering his voice, said, "Look, I'm not really supposed to be telling you this, but if I were you, I'd run, not walk, down to their booth."

Gill ran. At the booth he ended up talking to Pete Ellis, ABT's founder. "I said to him, 'Show me,' " says Gill. The two spoke for an hour, during which time Gill mentally debated--"Am I getting reeled in on this thing?" --whether the silken-voiced Ellis was the Second Coming personified or the slickest pitchman this side of P.T. Barnum.

Gill told Ellis that he was a Chrylser, Plymouth, Dodge, Jeep, and Eagle dealer in Atlanta. Ellis replied that it just so happened that ABT was looking for someone in Atlanta. "Yeah, sure," Gill thought. This guy was good.

But so, too, was his idea.

ABT, as Ellis explained to Gill, sold cars over the Internet, funneling would-be car buyers to a national network of some 2,000 dealers with whom it had signed exclusive contracts. Just two years old, ABT was already getting 3 million Web-site hits and, at that time, passing along 40,000 electronically generated "purchase requests" (serious, detailed inquiries from buyers looking for a specific make and model of car) to its participating dealers each month. Buyers got exactly the car they wanted, for a low fixed price without haggling. Dealers got more sales (in some cases a 30% boost) and lower transaction costs--as much as 75% lower than the cost of a traditional "walk-in" sale.

Pete Ellis wasn't the only pitchman on the Atlanta midway. Everywhere Gill turned, he saw evidence of an industry in transition, if not turmoil. CarMax, Circuit City Inc.'s foray into used-car superstores, was at the convention, as was Driver's Mart Worldwide, a similar concept that envisioned 100 used-car superstores by the year 2000, along with a sales site on the Internet. Then there were "dealer groups," such as Cross-Continent Auto Retailers, United Auto Group Inc., and Lithia Motors Inc., which had formed megadealer combines and floated public stock--a move previously unheard-of in the industry. And then, of course, there was the big guy, H. Wayne Huizenga. He had waded into the car business last fall, paying unimaginable sums for premier dealerships in hypergrowth markets. His empire--Republic Industries Inc. and its AutoNation USA subsidiary--ran the gamut from new and used cars to rental fleets; he owned Alamo and National. Last November, Huizenga's new-car sales were nil. By March he had acquired his way to being the largest new-car retailer in the United States.

Wayne, change, and pain were the talk of the NADA convention last February--for good reason. "This industry's cost structure is under tremendous assault," observes Jeremy Anwyl, president of Marketec Systems Inc., a Santa Ana, Calif., analyst for a number of car makers. "The pot's been bubbling for a long time, and now the lid has finally blown off."

Andy Gill felt the heat as he absorbed Pete Ellis's pitch. An inner voice told him he couldn't just stand there and do nothing. Maybe, he thought, ABT offered a salvation of sorts. "Am I getting had on this?" he asked his wife. She shook her head. "No."

Gill said he wanted to think about it overnight. Ellis replied that there would be no overnight. "The territory will be gone by dark," he said.

Gill said he didn't have a check on him. Ellis said he took credit cards.

Gill looked at his wife again. Again she nodded. "They hit my American Express card for $12,500 right there. I kept thinking to myself, 'I've never been hammered like this before.' "

All Gill could do now was hope for a feeling that would hurt so good.

It wasn't so long ago that people abruptly stopped throwing money at Pete Ellis. The owner of 16 auto dealerships and related businesses in California and Arizona, Ellis had enjoyed a great run in the 1980s. In 1988 he operated the largest Jeep, Eagle, Chrysler dealership in the United States. But then came the quasi depression of 1990, which put a hard tarnish on the Golden State, where most of his dealerships were located. As car sales crashed Ellis began closing his stores or selling them off to cover his debts. At his flagship store, near Los Angeles, Ellis made one final stand. But that location, too, was failing. "I went from selling 500 cars a month to 200," he recalls. "I owed $5.6 million on a piece of property that was worth $3.6 million. I decided to kill myself." Metaphorically speaking, that is.

After putting a bullet through the brain of P.R. Ellis Corp., in 1994, Ellis filed for Chapter 7 bankruptcy. He lost two houses and $15 million. He was out of the car trade.

But the car trade was not out of him.

"God gave me a life in the car business. This is all I know how to do. Why torch that and walk away?" Ellis explained recently. His father had been a car dealer; Ellis had sold his first car at 16 and owned his first dealership at 24.

So when he went into exile, it was not on some sun-washed island but in the bedroom of his condominium, where he started fiddling with his wife's personal computer. "I know there's some kind of trick pony in here," Ellis recalls thinking. Translation: There must be a way to sell cars on the Internet.

He flew to New York to speak with executives at Prodigy, the on-line service, having prepared to give an hour's presentation. After five minutes his listener interrupted him. "Let's try it," the Prodigy executive said.

Ellis launched his program on Prodigy in March 1995. He figured it would generate 500 purchase requests a week. On the fourth day it received 1,348. The pony had been found.

Today, ABT occupies the second and fourth floors of a squat brown building across the street from the airport in Orange County, Calif. The elevator opens into a lobby dominated by a six-foot-long aquarium luminous with tropical fish. Hawaiian shirts and shorts seem to be the favored mode of dress among the 105 employees here; the sockless look is big, too. Walk into ABT and you'd think you were in a travel agency booking cruises on the next boat out of Long Beach.

The company's leisured air neatly disguises its headlong rush to blow up one of the biggest and most traditional of American industries, the car business, in which annual sales of new and used autos exceed $650 billion. Throw in service, rentals, and assorted miscellany, and you're talking $1 trillion worth of business. Each and every year.

ABT's business model attacks that market in a novel way. The company spends heavily on marketing (40% of this year's sales), mainly to promote and support a prominent Web site that is designed to attract educated, serious car buyers looking for a specific make and model of car. That buyer fills out a purchase request, which then gets routed to the nearest ABT-accredited car dealer of that make. In return, the dealer must contact the customer within 24 to 48 hours with a low, firm price.

Since February 1995, when ABT started, the monthly flow of purchase requests has risen from 5,000 to more than 60,000, which means ABT has become a giant funnel for market share. It sucks in a desirable demographic--affluent, educated, motivated buyers--and makes its money not by taking commissions on the cars bought by ABT users but by charging for access to those users. Who wants access? First, car dealers, who pay monthly and annual fees in return for exclusive ABT franchise rights in their area. (There are 2,000 such dealers so far.) And second, providers of auto-related financial services looking to ride the deal flow. ABT has forged strategic partnerships with Chase Manhattan Bank, one of the largest auto lenders in the United States; American International Group (AIG), the multinational insurer; and General Electric Auto Financial Services, a major force in auto leasing. Some of these players invested $15 million in ABT last August. In January they ponied up another $9 million.

"Aside from the tremendous growth in volume, they have one of the few business models where you can actually make money on the Internet," says Jeff Coats, managing director of the GE Equity Capital Group. "They had a great idea first, and they're leaps and bounds ahead of nascent competitors. One of their biggest advantages is that they have a strong network of key dealers who are early adopters." Nine out of 10 of the country's largest "megadealers" participate in the ABT program.

The ABT model is unusual, believes Matt Ericksen, a vice-president in the Chicago office of Boston Consulting Group who specializes in Internet commerce. He contends that ABT does more than merely adapt an existing business model to the Net. "Wal-Mart may team up with select auto dealers that will offer special prices to Wal-Mart customers, but it doesn't ask the dealers to make tangible changes in the way they conduct business," says Ericksen.

ABT changes the way that companies that do business with it operate. It drives manufacturers to streamline distribution by guiding volume away from marginal, expensive-to-serve dealerships, where customer loyalty has languished. It slashes dealers' costs, notably in advertising and labor, which together account for 63% of the typical dealer's operating expenses. It steers the customer--and the industry--toward a low, "no haggle" price, free from the dread and intimidation that have typically poisoned the car-buying experience.

At the same time, the ABT model will inflict change on those who try to steer clear of its new approach. "The losers will be traditional finance and insurance companies, including auto-company finance subsidiaries," says Ericksen. "Their customers are no longer captive. With a click of the mouse, the car buyer can pick and choose among an array of financing alternatives."

Newspapers, too, stand to lose big, as ABT dealers will no longer be enslaved by the process of spending huge sums on advertising to lure buyers. ABT will deliver those (motivated) buyers at low cost, meaning that dealers can forgo spending the more than $3 billion (almost one-tenth of all newspaper ad revenues) they paid for newspaper ads last year.

Commissioned salespeople will disappear in favor of those earning a flat salary and a bonus for each car sold under the ABT model. Says Ellis, "We tell a lot of our dealers they've got the wrong salespeople."

John Honiotes, ABT's director of new business, says that the ranks of salespeople will shrink and shift because only the computer literate and softer selling will be needed. "It's a classic case of survival of the fittest," he says. "Many will embrace the new technology. Others won't and will have to find something else to do."

Technology, Ellis understands, has changed the balance of power in a car purchase. For 50 years the true cost of a car was information closely held between the manufacturer and the dealer, putting the buyer at their mercy. Now, through the Internet, buyers have access to that information--24 hours a day. They have the edge. Dealers who can't deliver a low, haggle-free price and superior service will be history. "Car dealers don't like being told how to run their business, but in a couple of years a lot of these guys aren't even going to be in business," says Ellis. "The biggest thing they've got to figure out is how to drop their costs. I see the Internet as destroying the old structure."

What drives Pete Ellis is a rich stew of car dealer's self-loathing, Chapter 7­induced pain, and a raw competitive drive to simply be proved right. He readily admits, "I hated my dealerships. I hated the way there would be 20 salesmen waiting to jump on the next customer who walked in the door." Selling cars has always been a commission-based business that explicitly encourages the salesperson to mug the customer's wallet. Sell the car for the highest price possible--and somehow gull the customers into thinking they're getting a great deal.

Manufacturers encouraged such behavior by granting too many franchises, leading to oversaturated markets. Ellis, who had a Ford store in San Diego, could count 15 other Ford dealers within a 30-mile radius. That forced dealers, trapped like rats in a cage, to gnaw one another to death. Bait-and-switch advertising became the norm. Lure the buyers in by advertising an impossibly low price on a car that you don't even have in inventory--then sell them something more expensive. "The competition among dealers creates price advertising, and that creates unsavory sales practices," says Ellis. He sees it as his mission to change all that--for good. And he'll try almost anything to do it. A year ago Ellis called up his media-buying service. "Give me a quote on the Super Bowl," he said. The price for a 30-second ad was $1.2 million, ridiculously extravagant for a company with 1996 sales of just $5 million and no operating profit.

In a subsequent ABT board meeting, Ellis suddenly interjected, "I just bought some time on the Super Bowl." The idea was so ludicrous that nobody even responded. Ellis, as usual, was playing the merry prankster. The more serious business at hand continued. Five minutes passed. "Really," he said. "I'm not kidding. I just bought the Super Bowl." Sure, Pete. Another five minutes passed, at which point Michael Fuchs, an ABT board member and the former president of HBO, suddenly said, "You know, Pete, I think you should buy the Super Bowl." Board members, assuming that Fuchs, a media insider, knew what he was talking about, then began solemnly nodding their heads in agreement.

Ellis, ever the marketing tactician, argues that his decision to buy the ad was a no-brainer. "The Super Bowl is not where it's happening," he explains. "It's not that 30-second spot. It's the publicity surrounding the event. People forget that the Super Bowl is a promotion over three months. It's a 90-day campaign, and in that campaign we got all sorts of publicity. We also became known as 'The First Internet-Based Company to Advertise on the Super Bowl.' "

Ellis, the perpetual salesman, says things in a way that people tend to remember. Speaking to dealers at the NADA convention last February, he offered a word to the fence-sitters in the face of onrushing industry consolidation. "If you're not coming with us, then I suggest you call 1-800-WAYNE."

Wayne, of course, is Wayne Huizenga, another latter-day binger in the car trade. Huizenga built Waste Management and then Blockbuster Entertainment, but now he is doing something even more ambitious: trying to vertically integrate the car industry by selling, renting, leasing, and servicing cars at every level imaginable. No car story these days would be complete without the reporter's making the obligatory pilgrimage to Republic Industries, in Fort Lauderdale. The actual distance between Huizenga's Republic headquarters and ABT's may be 3,000 miles, but the cultural distance is a million.

Republic's AutoNation USA megastore in the nearby suburb of Coconut Creek encompasses around 1,000 vehicles sitting on more than 20 acres of concrete freshly laid through thickets of palmetto and saw grass. On a tour of the site, store manager Jeff Dyke explained that the location had gone "from dirt to fully operational in three months. It's the McDonald's concept." In fact, he added, "we'll open one of these superstores every two weeks for the next three to four months." Dyke himself seemed to be part of this fast-moving game plan. The manager of the Houston store, he'd come to work one Monday and been told to start work in Fort Lauderdale on Wednesday. That meant leaving behind a wife and infant daughter to follow him later.

To date, AutoNation has 15 used-car superstores in four states. It's an operation that relies on laser beams, bar codes, and computers to track every car that leaves every lot on every test-drive, to ensure it is being marketed efficiently. Every two days, the entire inventory is washed. It is tirelessly shifted around the lot, fitted with eye-catching accessories, and otherwise promoted to speed the sale.

A visit with the (nearly) top brass preceded the car-lot show-and-tell. While Huizenga, Ozlike, remained at some remove up in his penthouse office on the 14th floor, down on the 13th, three trusted lieutenants--company president and co-CEO Steve Berrard, AutoNation president Larry Rich, and the president of Republic's new-car division, Mike Maroone--gathered around a conference table.

Berrard, a solidly built man with a handshake of iron, arrived late to the meeting. He looked distracted, sitting quietly down at the far end of the room. Finally, he spoke up.

He explained the principle on which he and Huizenga had built Blockbuster. A videotape had an economic life of a certain duration. When rental revenues for that tape began to tail off, they would move it to a new store. Revenues would invariably blip up again--no matter how old the tape. The new location juiced sales. After moving that tape three or four times, the process would exhaust itself. Then the tape would be sold to extract whatever economic life was left in it.

In Berrard's mind, a $20,000 car was no different from an $8 videotape. It had a certain life span, and at every phase of that life, there was a way to squeeze money from it. "We want to control that asset for the duration of its economic life," he said. How that played out was that AutoNation owned new dealerships, used-car superstores, rental-car fleets, and discount-used-car lots among which the company could keep shifting its assets, depending on where in the life cycle they stood. "Seventy-three percent of Americans can't afford a new car," Berrard noted. "That provides an opportunity to go to short-term leasing. The question then becomes, How do we maintain the relationship with the customer for life?" In the future, Berrard envisioned a plan even more encompassing. "Maybe we'll build freestanding service centers near airports or train stations. You leave your car for service, and we take you to the airport. It's the convenience factor." The car store as the neighborhood dry cleaner or coffee bar.

Listening to Berrard, it's hard to tell if his master plan is the product of towering genius or equally outsize hubris. Republic's assault on the $1-trillion auto industry certainly does not suffer from a lack of ambition.

Compared with Huizenga, Ellis appears to have exercised a form of entrepreneurial judo. He has gotten his market share the easy way--and at less risk. To date, ABT has spent $50 million to establish what amounts to a nationwide dealer distribution network. Huizenga has spent more than $1 billion acquiring new-car dealerships over the last year, albeit in stock he has manufactured, and landed 122 dealer points in 10 states. "I think AutoNation has magnified the old model in terms of their cost structure," says Ellis. "We have changed it. We are an umbrella marketing program for a national dealer distribution base."

Moreover, ABT, blessed with a far lower cost structure, can undersell AutoNation. It creates a low sales price while maintaining the net margin, because it can drive down dealers' costs dramatically. Last year the typical dealer incurred $820 in personnel costs and $225 in marketing expenses for each new car sold. Ellis claims that ABT can reduce those numbers to $150 and $40, respectively.

Sherry Atamian of Atamian Honda Volkswagen, in Tewksbury, Mass., says of the ABT program: "You have to embrace it because the auto industry is changing to being customer driven. These people who come through Auto-By-Tel represent found business for us. It's delusional to think we'd get it otherwise." In a good month Atamian now sells 40% more cars because of ABT. And those sales cost 70% less than traditional sales.

Bob Bridge, owner of Bob Bridge Auto Center, in Renton, Wash., says that ABT has increased his sales volume by 25% so far this year. "There's excruciating pressure on margins due to too many cars and too many dealers. The dealer has to find a way to lower his cost of transaction."

Perhaps most striking about ABT is that the company is being built not by paying dealers-- but by having dealers pay it. It is a royalty business. Pete Ellis is diverting assorted revenue streams his way, steadily panning out his cut, one deal at a time.

Dealers pay ABT an annual fee ranging from $2,500 to $4,500 per car brand, as well as a monthly fee of $500 to $3,000. They also put their used-car inventory in ABT's used-car "cyberstore," and for that ABT receives $750 to $2,500 per month, depending on the size of the inventory for each dealer. The cyberstore expects to have 100,000 of its dealers' used cars listed--complete with digitized photos and detailed descriptions--by the end of this year. Meanwhile, for channeling business to its strategic partners in the form of car buyers looking to lease, finance, and insure the purchase, ABT receives origination fees ranging between $50 and $125 on each deal, or a small fee for each policy generated.

Ellis originally projected ABT revenues for this year of between $25 million and $30 million, up from $5 million last year; a recent deal with America Online now makes those figures look conservative. He foresees ABT's breaking even in the first quarter of 1998, three years after he started the company.

ABT gives large companies greater access to the market. "We are able to reach out and touch the consumer for a GE or a Chase," says Randy Ellspermann, ABT's senior vice-president. "We are a single-channel service. We see the customer before the dealer, the bank, and the insurance company do."

Adds Boston Consulting's Matt Ericksen: "Ellis is sitting on a database that's invaluable. He's saying to the manufacturers, 'Every month, I've got 60,000 new names of people who are within days of making a $20,000 purchase.' "

As if fattening a Christmas goose, car makers have historically force-fed the market, assuming that the more retail outlets they licensed, the more cars they would sell. That strategy worked fine in the boom years right after the war, when the number of dealer sites approached 50,000. But selling cars has become capital-intensive, owing chiefly to the high cost of carrying inventory.

The number of U.S. dealerships has declined by 27% in the past 25 years and now is at 22,000, according to J. D. Power and Associates. Moreover, according to NADA, the productivity of the average retail salesperson has not changed in 18 years, though labor and overhead costs have continued to rise. Last year the pretax profit on the average new car sold was a slim $77 on a purchase price of $21,974.

Ericksen of Boston Consulting thinks the dealer population could fall to as low as 10,000 by the year 2005. He points to metropolitan Chicago, which has 67 Chevy dealers and 70 Ford dealers. "That's way too many. It's ridiculous," he contends, noting that a successful superstore like Home Depot has just 19 locations in greater Chicago. "People will drive half an hour to buy a hammer from a Home Depot," he notes. "There's no reason to think they won't go as far to buy a $20,000 car."

Ericksen says that if Pete Ellis selects five high-volume, high-quality dealers for each brand of car sold in the Chicago area, he could capture a disproportionate share of the market and, in effect, become the auto-retailing equivalent of Home Depot. "In a Cincinnati or Charlotte it could be done with just one or two dealers," says Ericksen.

But for now, the car-selling process remains notoriously inefficient. Automakers and dealers spend $10 billion a year advertising their wares--and then another $10 billion inducing people to buy the product through rebates and assorted other programs. Pete Ellis, for one, knows there's a better way. His company is really more than a restructuring play. It's an agent of cultural war.

In his mind the car world as it is currently ordered is dysfunctional. Salespeople, he says, "are trained to be short-term thinkers," while the manufacturers, driven by greed, have created a marketplace oversaturated with dealers. The net result is that both margins and ethics have been under pressure for years.

Ellis says that ABT's mission is "to put ourselves in a consumer-advocacy position"--and "to give our dealers a total survival package to keep them in business and profitable for years to come."

Gill, the Atlanta dealer whose $12,500 ABT sign-up at the NADA conference delivered 230 purchase requests in his first three weeks alone (and who is now revamping his sales force around ABT's soft-sell model), describes Ellis's mission in a way that's a little less delicate. The powers that be don't like it, he says, "but this is what's coming down. A lot of these second- and third-generation dealers are chuckling and saying, 'Get out of my face with this computer stuff.' Well, the new blood's gonna take this thing and shove it where the sun don't shine."

Edward O. Welles is a senior writer at Inc.


Resources

At its core, the Auto-By-Tel story is about the blossoming of the Internet as a novel and viable venue for business. In Auto-By-Tel's case, what's being offered is a place to price, select, and actually buy a car at any time of the day from the privacy of one's home. To see what that process entails and what a radical shift it embodies, visit the company's Web site or see related sites that provide detailed pricing information on automobiles ( www.edmund.com and www.carpoint.msn.com).

International Data Corp. estimates that the dollar value of goods and services purchased over the Web will increase from $318 million in 1995 to $95 billion in the year 2000 as the number of Web users rises from 16 million to 163 million in that time. No surprise, then, that there's been an explosion of books related to doing business on the Net. Two useful texts on the practical side are Growing Your Business Online: Small-Business Strategies for Working the World Wide Web, by Phaedra Hise (Henry Holt, 800-488-5233, 1996, $14.95), and Guerrilla Marketing Online Weapons: 100 Low-Cost, High-Impact Weapons for Online Profits and Prosperity, by Jay Levinson and Charles Rubin (Houghton Mifflin, 800-225-3362, 1996, $12.95). Hise, a former Inc. staff writer, brings to the task a reporter's eye for the issues that are real, immediate, and specific. Her book is replete with case studies of small companies that solved particular business issues with creative use of Web sites. Guerrilla Marketing Online Weapons is drier, yet still rich, offering a compendium of simple, low-cost tactics for making it on-line--a reminder, perhaps, that in most cases a business rises or falls depending on how much common sense its management exercises. Net Gain: Expanding Markets Through Virtual Communities, by John Hagel III and Arthur G. Armstrong (Harvard Business School Press, 800-338-3987, 1997, $24.95), is denser, more jargony stuff. Part overview and part manifesto, it nonetheless speaks cogently to the authors' belief that thanks to the Net, we're in the midst of a radical transformation: buyers have wrested power from sellers. Identifying, understanding, and gaining the loyalty of the "virtual communities" of customers out there is the name of the game. Finally, Webonomics: Nine Essential Principles for Growing Your Business on the World Wide Web, by Evan I. Schwartz (Broadway Books/Bantam Doubleday Dell, 800-223-6834, 1997, $25), strikes a balance between being academically theoretical and everyday practical. It's an original and penetrating look at what really matters in successful Web commerce. Written by a journalist, it's also far more readable than most business books.

AUTO-BY-TEL, Pete Ellis, 18872 MacArthur Blvd., Irvine, CA 92612-1400; 714-225-4500 66

AUTONATION, Republic Industries, One Financial Plaza, Suite 1700, Fort Lauderdale, FL 33394; 954-627-5100 66




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