Allocation: It’s More Than “Turn and Earn”

One of the frequent issues BSM attorneys provide advice on and litigate over is the allocation and distribution of vehicles. A generally accepted principle in the automotive industry is “you can’t sell what you don’t have.” With rare exception (e.g., a customer that is willing to wait for months for a special vehicle they ordered and can’t immediately get from a competing dealership), that principle rings true and has been demonstrated time-and-time again. OEM representatives commonly explain to dealers that the OEM’s allocation system of distributing new vehicles is a “turn-and-earn system.” That’s an oversimplification of complicated processes which include algorithms that few OEM representatives fully understand and, when pressed under oath, most will admit that. Without getting into the mechanics of the allocation algorithms (which vary by line-make), there are some truths that dealers would be well-served to know.

First, in most allocation systems, there are variables in the calculation aside from the number of vehicles historically sold by the dealer. Some OEMs use what is known as a “balanced days’ supply” system. Simply put, these systems allocate vehicles to the dealer with the lowest days’ supply at the moment the calculation is run. So, even if a dealer sold vehicles in the prior period, if other dealers are selling faster, (all else equal) the latter dealers are the ones to whom vehicles will be allocated. This increases the importance of having the right models and mix for the particular market. Also, some OEMs include those vehicles in transit to the dealer as part of the dealer’s inventory for this purpose. So even though the dealer may not receive a shipment of vehicles for weeks or months, those units are counted against that dealer for allocation purposes.

Second, a portion of the new vehicle production by the OEM’s is not allocated through the normal processes. Depending on the manufacturer, the percentage of production that is reserved varies, but it is often between 10-15% of all vehicles produced. And, many times the portion of production reserved includes the “hot product.” Even though OEMs may argue that this is a relatively low percentage of production, it has the ability to have a profound and compounding effect in the competitive arena. Just think, if a dealer (call it “Dealer A”) misses out on the reserve allocation, but the facing same line-make dealer (call it “Dealer B”) receives a portion of that product, and Dealer B is then able to quickly sell those vehicles, under the “turn-and-earn” rationale, Dealer B will then have a greater inventory moving forward and be better able to compete to Dealer A’s detriment. If Dealer B is able to continually turn the additional product it receives, then on balance, its inventory will be larger allowing it to provide more options for consumers. In this way, allocation, particularly the reserve allocation, acts as compound interest does in a bank account.

Third, for every allocation system we’ve analyzed, there is an inventory level below which dealers struggle to “earn” additional inventory. If you think about the “you can’t sell what you don’t have” rationale, this makes perfect sense. If a dealer doesn’t have a unit to sell, how would that dealer ever earn additional units? This dynamic is magnified when the OEM allocates vehicles on a model-line basis. How is a small volume dealer supposed to “earn” product when it has little or no units of a model line to sell?

Fourth, there are (other) ways for the OEM to manipulate their allocation systems to the detriment of dealers. For instance, dealers should be aware of when the calculations are run to determine the next round of allocation. If the OEM distributes vehicles to a dealer just before the calculation, the dealer’s inventory may look inflated potentially disqualifying them from receiving additional product.

The harm a dealer can suffer because of unfair allocation is significant. Many dealers who are not receiving the needed product are under threats of termination from the OEM. Dealers are also commonly losing out on incentive payments they would receive if they had additional inventory to sell as well as profits they would earn on those additional sales. Fortunately, many states have laws that provide specific protection for dealers as it relates to unfair allocation. In many instances, these laws provide dealers a right to challenge the unfair allocation or distribution of vehicles.