ATLANTA and SANTA MONICA, Calif. -

While some general sales managers might cheer stair-step incentives as compensation for moving new metal, Manheim’s Tom Webb cautioned about the predicament used-car managers might face later when it comes to the incentives’ ramifications on residual values.

Webb brought up the topic because stair-step incentives have been a water-cooler topic at franchised dealerships nationwide. For store personnel who might not be familiar with the process, Edmunds.com offered a snapshot of how stair-step incentives are intended to work.

In simple terms, Edmunds explained that a stair-step incentive is a manufacturer-to-dealer incentive that’s tied to sales volume. For instance, an automaker might pay a dealership $500 if they sell 10 vehicles while a stair-step program is in effect.

However, the site indicated if that dealership sells 20 units, it might earn $1,000 per unit. More aggressive programs will even compensate dealers retroactively, such that the aforementioned $500 could be paid out even for the first 10 vehicles sold, not just those sold after the quota is reached.

Webb wasn’t surprised OEMs would use such a tactic to push certain models and provide financial compensation to stores that meet sales quotes. Earlier this week, he shared a hope with Auto Remarketing that manufacturers won’t go to the stair-step incentive method too often.

“There was a lot of talk regarding stair-step incentive programs in recent months. That is justified because a certain amount those stair-step incentive programs can be the most harmful of all to used-vehicle residual values,” Webb surmised

“However it appears that programs have been relatively nuanced. In some cases, dealers were not close to making the goal so to that extent, the incentive didn’t have an impact on used-vehicle valuations,” he continued.

“All in all, I think we must admit the manufacturers are maintaining price discipline and also maintaining inventories that are reasonable levels,” Webb went on to say.

The Manheim economist pointed out that he thinks OEMs have gone away from “bad practices” such as pushing new vehicles onto the dealerships, heavy incentives and lease subvention.

“Those were driving used-vehicle values down more than they normally should have been,” Webb said. “I think to the extent that we now operate in a more rational environment with industry restructured, not having to move metal just to get it out the door, we now can maintain a more logical residual value.”

Other Effects of Stair-Step Incentives

While Webb took the residual value angle, Edmunds.com vice chairman Jeremy Anwyl continued the stair-step incentive discussion by reviewing how they can pit large franchised dealers against smaller operations.

“Manufacturers typically refer to their dealers as partners,” Anwyl said. “This is generally true, but it’s 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,” he continued.

Anywl evaluated numerous points covering stair-step programs, both pro and con, coming to a conclusion that there is one vital piece being overlooked.

“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,” he pondered.

“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,” Anywl cautioned.

To back up his argument, the Edmunds executive put some numbers together that might be on a dealership sales board.

“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,” Anywl offered.

“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 to 14, not just 10 to 14. As you can see, one aspect of stair-step programs is that they can get very complex very quickly,” he continued.

So what happens when a stair-step program is announced?

“Each dealer gets his quota and needs to make a decision,” Anywl responded. “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,” he added. “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.”

As a result, Anywl believes the problem for smaller franchised 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,” Anywl stressed.

But what about automakers? Do they prefer to use stair-step incentives?

“During the program aggressive dealers push down transaction prices, which increases sales. Smaller dealers often have to follow suit,” Anywl explained. “To the extent dealers don’t hit their quotas, the reduction in pricing has been funded by dealers lowering their margins.

“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,” he continued.

From that point of view, it might appear dealers and OEMs would be clashing significantly over stair-step incentives. Anywl offered a prediction.

“Despite the protests, look for stair-step programs to continue,” he projected.

Anywl’s entire commentary and analysis of stair-step incentives can be found here.