By Jim Rhoads - October 2020
I’m not a partner in a BHPH software company, nor do the providers compensate me for referring dealers to their product. I have no financial motivation here. As a former dealer and current consultant and analyst, my interest is in 1) happy clients, and 2) high-value reporting and analytics. In recent years, I’ve had direct access to many of my clients’ DMS systems - more than a dozen and all the top names. We log in directly to capture key reports used in tracking deal structure, collections results, portfolio performance and all of the most important KPIs for dealers and their managers. This data mining work has taken me deep into the reports of the best BHPH has to offer.
In short, Buy Here Pay Here management reporting is downright awful! Most are woefully incomplete or frustratingly cumbersome. I’m in a position to know. Don’t get me wrong, I’m sure these companies mean well. However, of the dozens of execs and developers and support folks I’ve spoken to in the last few years, I doubt that 2 of them ever worked in the trenches of a BHPH operation. I mean really worked in one … prepared quotes and contracts with actual BHPH customers or taken payments or managed a customer’s account. Most agents I deal with are nice enough, but too many are clueless! I should say that some providers have excellent support but when you get a prompt call back that says “Unfortunately, our system can’t do that,” only the bitter taste of frustration remains.
I’m not saying there isn’t a good product on the market but the name that comes up consistently as the best is priced on the luxury end and really tailored for big operations. Most of my clients don’t have luxury budgets. They shouldn’t need a big budget to do the parts I find most important. For our purposes here, I’m disregarding the basics - all DMS solutions can stock in inventory, price and sell the cars, generate terms for a finance contract and collect the payments. But reporting … wow! Some of them are downright awful. At Octane, we’ve been surveying dealers to help us better advise new clients on software selection. Dealers and managers are unhappy too!
It may help to know that, at Octane, we are pretty handy with Excel. We can sort and filter and create fairly complex formulas. Many of my clients don’t have that experience or time. If they had good BHPH reporting, they wouldn’t need that experience or time. Besides, our company shouldn’t have to perform high-level calculations to get to the things dealers need to manage their business effectively. What does a BHPH dealer need that is different from retail? How about portfolio performance and cash flow analysis?! What about theft analysis? Good data for better bonus plans? To do those well, you’d need far more than simple delinquency or recency reports. You’d need a clean breakdown of ALL types of cash collected and ALL changes to the portfolio across a given range. This last one is critical and it’s where we burn too much time creating our own reports! Why? Because the DMS providers don’t seem to really understand your needs as a BHPH dealer!
As one example, could you easily produce a report in your DMS that breaks down the principal change in your portfolio last month? To include the exact transactions (detailed and summary version) that contributed to the change? That is essential data! Accounting would benefit. Dealers or consultants looking to identify leakage and theft would rely on it. And certainly dealers, managers, and analysts working to track results and trends in the portfolio (a BHPH dealership’s largest and most important asset) would run that report first. If that type of report is not easily generated in your software, email me! If you are looking for frank feedback before choosing or moving to a new provider, reach out! I’ll gladly share my perspective on which systems to avoid and why. My interest is simple: good reporting and happy and successful BHPH dealers and clients.
Quality of reporting is where the separation begins when it comes to BHPH management systems. The DMS sales reps will try to dazzle prospective dealers with integrations for GPS, sales platforms and the like. Fancy add-ons are nice, but not at the expense of higher-priority management tools. Your needs in BHPH are much different than the needs of independent retailers. You should demand a system with useful reports from a company that truly knows your business. “My Daddy owned a car lot” will never be good enough! [JR]
By Jim Rhoads - BHPH Magazine August 2020
What could be more important than portfolio performance in Buy Here Pay Here?! But, what are the right “benchmarks” or “analytics” to follow? Which ones should prompt BHPH dealers to take corrective action? There are a handful that we monitor on behalf of our clients but I’ll give you one to put at the top of your dashboard: principal collected as a percentage of principal charged off. We urge our clients to strive to stay above 125% on that ratio. Allow me to explain.
The table shown in Image 1 (right) was pulled from an actual client’s portfolio performance report. Rows 4 and 5 are among the data points we chart regularly for all clients. But, row 6 shows the ratio that I view as key if I were to pick one that will apply to virtually all BHPH operations, regardless of business model, average pricing, loan terms, etc. Using the 6-month average of 545K collected per month and about 306K charged off per month, the result is a ratio of 177.9%. Said another way, for every dollar that this operation charges off, $1.77 is collected – a very healthy ratio.
Buy Here Pay Here dealers should collect more principal than they charge off! If necessary, read that sentence again. We don’t need a Harvard statistician to tell us that this should be true. Yet, I see far too many dealers running below the line – charging off more principal dollars than they are collecting. If I were to advise someone looking to buy a dealer’s portfolio or business, this performance indicator would be in the first 3 figures I’d calculate.
It is clear from the data laid out in the illustration above that this dealer is managing the portfolio well. The results are consistent, making projections predictable. The value of predictability is too often overlooked in this business. Effective management is a crucial component in achieving such stability and reliability.
What’s the fix if running below 125%? The answers are many and vary by the operation. Some fixes may be quite simple and improvement may be evident right away. Others may take more time to produce dividends. If a client engaged us to identify and correct the problem, I’d be examining the typical inventory/collateral, pricing strategy, underwriting/approval method, length of contract and other finance terms, reconditioning practices, solutions for post-sale support, etc. All of these are what we’ll call “slow fixes” to portfolio performance. But, the problem solver in me knows that hemorrhaging must be first attacked at the source. Otherwise, Band-Aids provide temporary relief at best but the bleeding continues. My approach is always to solve the larger problem in the most permanent way possible.
Quicker fixes can include collections training, updating pay plans, implementation of key technology, and timelier and deeper performance tracking, to name a few. Of course, personnel changes are recommended in some cases. More often, subtle changes translate into significant improvement in profitability and cash flow.
In the management education or mentorship we received, most of us heard the statement that “You can’t manage what you can’t measure.” I find the sometimes-overused statement to be true. Fixing a collections problem like the one described here starts with reliable, comprehensive, and timely reports. We must first do everything we can to identify the root cause of the problem(s). Good numbers can be a huge help. Then, we can begin to turn to the less tangible parts such as processes, attitudes and motivations.
Naturally, there may turn out to be multiple drivers of the collections problem. Until those factors can be determined, it important to begin by acknowledging that charging off more dollars than we collect is a problem that can and should be improved. [JR]
Image 1: Actual client results
By Jim Rhoads - BHPH Magazine June 2020
As an industry or segment, Buy Here Pay Here gets a bad rap. It is perceived by many to be risky and messy. Granted, it is a risk business. This just means that the reward must justify the risk. But when some describe an operation as "messy", they are typically seeing ineffective management, not something that can be tagged on the entire segment of self-financing.
In BHPH, we are now navigating uncharted waters in the wake of COVID-19. In recent decades, the segment has weathered economic downturns and swings in access to capital. I've been on record for years saying that the BHPH segment has shown to just chug along as always when things change on Wall Street or in the economy. I'm not one to use the phrase "recession proof" but my professional perspective allows me to predict with confidence that BHPH will "stay the same" when other segments falter. What makes me say that? Simple: it's about needs versus wants. Most of my BHPH clients are meeting needs. So, regardless of what is happening on the stock market or housing starts or the Reserve's prime rate, most poor credit consumers still need to get to work on Monday. They still needtheir car!
This overarching premise assumes, of course, that the BHPH customer/consumer still has income. Unemployment is the greatest threat to a Buy Here Pay Here dealer's portfolio and cash flow. I'm on record on that point too. I have always added that disclaimer when stating that BHPH is unfazed by economic downstrokes. Mostly, I'm raising that point in the context of local jobs such as a dealer losing a top employer like a major manufacturer in their backyard. COVID-19 has resulted in widespread, unprecedented, and sudden unemployment. Painful for many consumers and many of my BHPH clients.
Why, then, would I still be recommending self-financing of poor credit consumers on the heels of such a devastating setback? The answer lies in simple mathematics, actually. It's all about cash flow! The typical BHPH customer has an average monthly payment of $375. Multiply that by 200 accounts. Now try 500 accounts. Next, do the math on 1500 accounts. Imagine $75,000 coming in monthly. How about $187,500 or $562,500 going to the bank monthly. Every month ... for 24 months or more. Wow! Even if unemployment caused 30% of that to dip and get deferred for a stretch, 70% is still business-sustaining cash flow. Cash flows in even if the dealership goes months without financing a single new customer! How many cash-only retail dealers wish that were their situation during this recent period of crisis?!
Now considering the basic math and the value of oxygen-like cash flow, is being in Buy Here Pay Here risky? Or is bypassing those incoming BHPH payments the greater risk? [JR]
By Jim Rhoads - BHPH Magazine April 2020
I’ve heard it too many times. Dealers approaching retirement or otherwise looking to exit the business say there are no buyers for their established Buy Here-Pay Here operation. The feedback they receive is there are no parties willing to acquire and operate an established BHPH business. They’re told the only way to exit is to sell off the assets – inventory, any real estate and the portfolio of contracts. Of course, the contracts would be sold to a third-party bulk buyer at a significant discount. Years of building a successful business to end up there? In a liquidation “fire sale”?
Now, I’ll be the first to recognize not everyone has the stomach for BHPH – at least not as so many from the outside perceive it. And acquiring a portfolio of contracts originated and serviced by someone else has its dangers. But bulk buyers do it all the time. Why? Because there is interest income and profit and cash flow in it for them. In short, the portfolio has more value to them over time. Nothing earth-shattering about that. How is it, then, that other entrepreneurs are able create businesses that build equity and value and can eventually sell their enterprises for three, five or 10 times their net profit [or some multiple of their cash flow]? How do they fetch a juicy multiple and move on to their next venture or retire in comfort? What are those sellers able to convey or transfer to the buyer/next operator that BHPH dealers cannot?
Of course, the answer as to what makes any business marketable can vary. And what might appeal to one buyer might not interest the next. Some buyers are looking for growth and expansion opportunities. Others might be looking to increase market share within their industry. There are buyers that seek underperforming businesses with the expectation they will be able to improve margins and volume and sell at a higher value/multiple. I’ve known buyers looking to simply sustain a successful business and pull down a salary or management fee along the way. The point is buyers have many motivations for acquiring businesses as a going concern or continuing operation. So why not our Buy Here-Pay Here operations?
There are many reasons, some of which are too complex to take on here. From a high-level perspective, let’s tackle it this way. If I were to buy your established BHPH operation, what would I be getting? If I could examine the balance sheet, I could easily understand the asset section. If I had a look at the income statement and perhaps the sales reports from the DMS, I could identify sales volume and margins – gross and net. And if I looked under the hood at the historic portfolio performance, I could probably project future repo losses and cash flow to be generated – if the portfolio was to continue to convert to cash at the same rate. But that last “if” is a big one. What could you show me that would give me any degree of certainty that performance would be sustainable? Could I expect the relationship you’ve had with all those customers would remain the same once my name was on the letterhead?
One way to cash in on value is to create and demonstrate sustainability. Any of us can buy a solid used car and expect when we fuel it up and maintain it properly, it will start and run and deliver us reliably to our next destination. We can reasonably expect it will perform the same for us as it did for the previous owner. Can we say the same about our established BHPH enterprise? If so, how would we prove it?
The best way to demonstrate sustainability is through well-documented systems. Do we have systems in place that can be adopted and maintained by someone else? Returning to the used car analogy, does our business have an “owner’s manual” and “maintenance record” to provide to the next owner? If not, we open ourselves up to questions and can expect to take a hit on resale value. Or worse, we might be limited to the liquidation type of exit. And that’s unfortunate.
The sellers of those other businesses fetch the multiples because they have created something repeatable and sustainable. They’ve developed systems and can hand over that “owner’s manual” at the time of closing. We know BHPH businesses can generate tremendous profit margins and positive cash flow, and there are plenty of buyers who would be happy to acquire both. As sellers, we must be able to demonstrate during the “test drive” that we have sustainable systems in place. We must be prepared to show transferable value. Only then can we expect to enjoy the fruits of those years of labor spent building a great business. [JR]
By Jim Rhoads - as appeared in MARIADA 2019
FDR, Shakespeare, and Jesus are among the most famous to speak to the subject of fear. In their own way, each said there is nothing to fear. While I can’t say that about the business of Buy Here Pay Here, I can say that there is little to fear and there are certainly ways to protect against or mitigate risk.
On the surface, the notion of extending financing to those with poor credit is reckless or perhaps even frightening to some. What would make anyone think they could have the loans turn out well? Or build a highly profitable business from taking that risk?
Having been in the BHPH business for more than 20 years and consulted in that space for more than 18 years, I know that the answers lie in structure – two kinds of structure. The first would be what I refer to as deal structure. This means how the financing is set up with the customer – the terms of the note itself (APR, down payment, payment amount, length of contract, etc.). Then, the cost side of the deal must also be well-structured. In particular, it is critical in BHPH that the “reward to risk ratio” be healthy. In its simplest form, this means having ample markup or gross profit to justify the exposure or cash risk on each sale. For our clients, we examine this in multiple ways – with and without finance charges added in. We suggest that all dealers be rewarded appropriately for taking on the risk that other lenders are unwilling to accept. Not egregious or abusive, just sufficient.
The other formula that I view as essential to making BHPH work well is the funding structure or method of capitalizing the operation. Understanding how to capitalize a Buy Here Pay Here enterprise in terms of equity and/or debt is very important. Maintaining sensible ratios of debt to assets can make the difference between failure and success.
When we succeed at getting those 2 types of structure right, we all but eliminate the risk (and therefore the fear) that comes from being in the business of self-financing! For every dollar we put at risk, we get far more than a dollar of gross profit and finance income! And for every dollar of assets we create, we only have a few dimes of debt. Now who wants to be in the Buy Here Pay Here business?!
Of course, there are other considerations. Dialing in underwriting and managing collections are certainly important in BHPH. But, having the deal and funding structures well-balanced allows the business to absorb more mistakes that will occur in underwriting and collections. Bad decisions will occur. Repossessions will become necessary. Charge-off losses will appear on the income statement. The question is not whether losses take place. Rather, it is a question of whether the company is structured properly to withstand the repo losses and remain in good standing with its lender and/or investor. Of course, in many cases, the dealer principal is the lender and/or investor.
Bottom line, there is nothing to be afraid of when it comes to in-house financing. Fear not! Structure it right and enjoy the profits and positive cash flow that some many Buy Here Pay Here dealers get to experience. [JR]
Pay plans can be difficult in Buy Here Pay Here. Should we tie collectors’ and managers’ compensation to delinquency? Repo losses? Recency? If I were to pick one, it would always be net collection efficiency. The formula: weekly principal and interest collected (net of large, unexpected payments such as insurance payoffs) as a percentage of P&I contractually projected for that same period. To do this, the dealer’s software would have to produce that projected payment report. Regrettably, not all systems do that reliably. For our clients, we capture the data every Sunday. We archive the projected amount, then at the close of the week, we measure the net amount collected compared to the amount anticipated for that period. There is some work to arrive at the filtered or net figures, but it is a simple process overall. We track results over a longer range, typically a 10-week rolling average to sufficiently cover all types of payment schedules (bi-weekly, monthly, etc.).
Have a look at this sample, a 10-week period from an actual client (Figure 1):
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The green cells indicate weeks where the net collected amount exceeded the target we set for all clients: 93%. This client’s average is at 94.7% over 3 full years. Very good! Let’s examine that number carefully. What does the 94.7% mean? In a nutshell, it simply means that the dealer collected almost 95% of the dollars they were contractually expected to collect each week. Remember, this is net of insurance settlements or other premature payoffs. These are regular car payments.
So, why is the dealer deficient 5.4%? Why would The Octane Group suggest a target of 93%, allowing for a shortfall of 7%? Perhaps an illustration of a sample customer will help to better understand the source of the deficiency. Imagine that Mary Smith shows proof that she has a short paycheck due to illness. She can only pay $40 of her scheduled $100 payment in Week 1. See Figure 2 below.
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In this illustration, the collections department draws up a payment arrangement for Mary to pay $120 (extra $20) for each of the next 3 weeks. Once she meets that agreement, she will be current again and can resume her regular $100 payment. In this example, Mary would clearly run past due for a few weeks but would have paid $400, or 100% of what was contractually expected in weeks 1 – 4. In other words, all customers who fell behind but caught back up would pay 100% of the expected amount over time. This is why I promote flexibility and cooperation and urge that collectors and managers be compensated based on collection efficiency rather than delinquency.
The 7% shortfall over a long range would come from two sources: 1) unresolved delinquency that ultimately results in repo and eventual charge-off or 2) deferrals. While in the case of deferrals it could be argued that the consumer ultimately pays 100% of the payments, the customer would not pay what was contractually expected during the range of time being measured. The money did not come at the time that it was expected. That expected but deferred money will not help the dealer pay this month’s payroll. Allowing managers or collectors authority to defer payments creates shorter delinquency reports but it also hurts cash flow – painful for dealers!
Managers and collectors on a pay plan tied to collection efficiency quickly learn to limit unresolved delinquencies and resist deferrals. To maintain efficient net collections ratios, dealers will need to process repos and charge-offs in a timely manner. The latter is something I recommend anyway – a weekly process. When these practices are followed, the portfolio is clean. Accounts in the active portfolio are performingaccounts.
How much delinquency, then, is tolerable? To answer that, let’s study Figure 3 below (same client as Figure 1):
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Note first that the delinquency is reported as of Sunday with all our clients. Clearly, this number will run higher than Friday morning’s low. Figure 3 above shows that this client’s delinquency (10-wk rolling average) typically runs 25 to 30%. Should that be a concern? I say not at all. This client runs a portfolio of about 1800 accounts. 25% of accounts past due on Sunday would be 450 customers. 15% would equate to 270 customers. This difference translates into a question of management. How much more time is required week in and week out to manage the delinquency? If it is easily managed using the general rule of 300 accounts per collector, then I’d suggest that the 450 past due customers is not a problem. In fact, it has not been a problem at all during the 3-year period we’ve provided analytical services for this dealer. Consider this: across 3 years (156 weeks), this clients collection efficiency was 94.7%. Think about that for a minute! All poor credit customers. 100% Buy Here Pay Here. And the client collected 94.7 cents of every dollar expected. The 25-30% delinquency means very little.
Understanding how collection efficiency is measured, it is easy to see that collecting efficiently will translate into healthy recency (time to last payment), collateral recovery rates, etc. Flexibility with poor credit customer is crucial. Applying excessive pressure, especially in response to delinquency, will result far too many repos and charge-offs. Deemphasizing delinquency, at least in pay plans, and shifting the emphasis to getting the money in the bank (even if a bit late) can be the difference in saving more accounts, cutting repo losses, and increasing cash flow. In other words, it pays to cooperate! [JR]