22% AT RISK JOBS -3,800. STUDY In-depth knowledge for decision makers DEALERSHIPS -200,000 RE:THINK AUTOMOTIVE RETAIL NETWORKS OUTLETS

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1 ROLAND BERGER STRATEGY CONSULTANTS STUDY In-depth knowledge for decision makers -3,800 OUTLETS -200,000 JOBS 22% DEALERSHIPS AT RISK RE:THINK AUTOMOTIVE RETAIL NETWORKS The next challenge for the US auto industry

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3 STUDY 3 RE:THINK AUTOMOTIVE RETAIL NETWORKS THE NEXT CHALLENGE FOR THE US AUTO INDUSTRY US automotive retail networks are stuck in legacy structures. Transformational change and further consolidation is needed to reflect the realities of a changing automotive landscape. A study by Roland Berger Strategy Consultants CONTENTS EXECUTIVE SUMMARY Time for fresh thinking about dealer networks 4 RETURN OF AUTO RETAILING? Dealer profits have been restored to healthy levels but will it last? NEW REALITY Current network structures are not sustainable 3,800 dealers at risk and further consolidation needed 8 12 TIME TO RE:THINK NETWORK OEMs need transformational change to address market challenges 20 INSIGHT FROM AN INDUSTRY THOUGHT LEADER Interview with José Muñoz Executive Vice President of Nissan Motor Co., Ltd and Chairman Management Committee Nissan North America 28

4 ROLAND BERGER STRATEGY CONSULTANTS EXECUTIVE SUMMARY THE RECOVERY OF AUTOMOTIVE DEALERSHIPS POST-CRISIS HAS CERTAINLY MADE THIS INDUSTRY LOOK ATTRACTIVE AGAIN. BUT IS THIS REVIVAL BASED ON SOLID FOUNDATIONS? ARE THE CURRENT DEALER PROFITS TRULY SUSTAINABLE OVER THE COMING YEARS AND DECADES?

5 STUDY 5 According to a recent study by the National Automobile Dealers Association 1), the average automotive dealer in the US made over USD 840,000 in profit in 2012 a historic comeback for an industry plagued with bankruptcies just four years earlier. The recovery of automotive dealerships post-crisis has certainly made this industry look attractive again. But is this revival based on solid foundations? Are the current dealer profits truly sustainable over the coming years and decades? We believe contrary to popular opinion that things are not as positive as they seem. In our view, the massive consolidation of the recent past was not the end, but the beginning of the change needed for dealers to maintain healthy profit levels and for OEMs to transform their distribution networks. In fact, we estimate that an additional 22% or 3,800 outlets would need to be closed and approximately 200,000 jobs eliminated to maintain current profit levels through In a nutshell, it is time for OEMs to rethink the current structure and set-up of their dealer network. What lies behind our controversial viewpoint? Our belief that dealer margins will soon come under attack again. It is true that volumes are quickly recovering, but these volumes are less profitable than in the past. We are witnessing an inexorable shift toward smaller, less profitable cars. In addition, service and aftersales revenues are harder to come by as independent shops continue to take a larger share of the pie. And, last but not least, the internet is making the auto retail market a smaller place, with more and more dealers fighting for the same customers. The combination of these factors leads us to believe that the next wave of consolidation is just around the corner. In fact, it may hit much sooner than later. As the digital age rapidly evolves, it is creating a new type of car buyer that comes armed with deep product knowledge and full price transparency not to mention they also have a radically different demand and expectation of the retail experience. Today's consumers look online for information rather than making multiple visits to their local dealerships. They arrive at the dealership with a clear expectation for the price they should pay. They expect a world class brand experience the sort of experience provided by the likes of Neiman Marcus or Apple. These rapid changes will put additional pressure on dealers' margins and will make it difficult for the "mom-and-pop" outlet to survive given complexity and resource requirements. Of course, the auto manufacturers are not blind to these challenges and are responding in various ways. However, their actions do not go far enough and keep current structures un-touched. Instead of using the opportunity of a changing automotive landscape to transform their retail networks, OEMs are stuck in legacy structures and only remain focused on making incremental updates to their business model a model that is effectively obsolete. They have been slow to adopt radical measures in today's stringent legal environment, afraid of the risk and cost of making such changes. We believe that transformational change is both essential and needed. In the following pages, we look at what OEMs can do to make the radical alterations needed to put their dealers' profits back on a sustainable basis changes that will ensure that they remain winners rather than losers in the fast changing retail game. 1) National Automobile Dealers Association, NADADATA 2013

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7 STUDY 7

8 RETURN OF AUTO RETAILING? DEALER PROFITS HAVE BEEN RESTORED TO HEALTHY LEVELS BUT WILL IT LAST?

9 STUDY 9 Dealer profits are back to healthy levels The recent economic rebound, release of pent-up demand, network consolidations, and increasing OEM financial support measures have led to record profits for automotive dealers in 2012 and Those that survived the crisis have emerged looking better than ever: Average dealer profit margins increased from 1.5% to 2.2% between 2007 and ). To all intents and purposes, the industry has recovered from the financial crisis with a positive outlook on the future. F1 RETURN OF STRONG DEALER THROUGHPUT From around 2007, the financial crisis began to hit the automotive retail network structure hard. In 2009, the industry hit rock bottom with a meager 10.4 million new car sales in the US a drop of more than 38% from a few years prior. Several dealers were driven into bankruptcy as there was not enough volume to cover fixed costs. Future viability of the auto retail structure was brought into question. By 2009/2010, automakers were massively consolidating their networks, led by the Big 3 GM, Ford and Chrysler. Their reasoning was logical enough: Reduce the size of the network to a healthy number of outlets and dealers' profits will go up, as higher average throughput increases profitability. This led to a reduction of more than 4,000 outlets across the network structure. Even though this represented over an 18% net outlet reduction, many still questioned if the cuts went deep enough. As the recovery began to finally come around in 2011, these pessimistic views regarding the future outlook quickly dispelled. Volumes were rapidly recovering as all the potential buyers who had delayed purchasing a vehicle due to the financial strain began returning to the market. This quick recovery in volume plus the outlet consolidation helped increase average dealer throughput for volume brands by 249 units or 43% between 2009 and ). While the increase in volume has played an important role in the return of profits, it is only one piece of the puzzle. 1) National Automotive Dealers Association, NADADATA 2013

10 ROLAND BERGER STRATEGY CONSULTANTS F2 REBOUND OF THE PROFITABLE TRUCK SEGMENT Another key element that shouldn't be overlooked is the strong return of the profitable truck segment. During the downturn the truck segment's share of new vehicle sales went below 50% for the first time since This development was extremely painful for dealers because in a time where volumes were drastically declining so was their most profitable sales segment. In fact, dealers often lose money on several segments within their portfolio and depend on truck sales to make up a significant part of their profit. Without truck sales, more pressure is put on aftersales and service to carry the load. In 2010, the sales levels for trucks returned above 50% and has been well received by dealers and OEMs alike. The boost in volume per dealer combined with the strong return of the highmargin truck segment has played a significant role in the profits that are being seen today. INCREASE IN OEM SUPPORT HELPS FUEL PROFITS The other driver of recent dealer profitability has been the increase in financial support provided by the OEMs. Manufacturer dollars have helped fuel profitability by reducing the required investment F1 US retail networks Outlet development ['000] % Total Big Import E Source: Automotive News Dealer Census ; Roland Berger

11 STUDY 11 by dealers and providing large incentive bonuses for volume targets achieved. Many OEMs continue to subsidize dealer operations to ensure that they remain solvent, focused on the business, and keep facilities up-to-date in a time where competition is fierce and consumers expect a differentiated retail experience. For example, Ford announced in early 2012, that they would be guaranteeing dollar-for-dollar match of up to USD 750,000 for facility upgrade projects. Other OEMs, such as GM, Hyundai, Kia and Nissan have committed cash incentives for participation ranging from USD 50,000 to 1 million (and in some cases even more) per outlet. Mercedes Benz, Audi and others are offering dealers an extra bonus for every new car sold as an incentive for dealers that take on facility capital projects. In addition, volume based bonuses have been increasingly used to incentivize dealers to drive volume and gain market share. Many dealers have become heavily reliant on these incentives as they represent a large proportion of their yearend profits. HAPPY DAYS ARE HERE BUT THEY WON'T LAST All in all, the industry appears to have pulled through the crisis and rebounded with new energy. But does the recent recovery have solid foundations or is it built on sand? In this paper we set out to understand the future trends and the corresponding implications and it does not look promising. F2 US retail networks Network profitability [%] 2.1% 2.3% 2.2% 2.2%? 1.5% 1.5% 1.0% 0.8% E 2020F Source: National Automotive Dealers Association, NADADATA 2013; Roland Berger

12 NEW REALITY CURRENT NETWORK STRUCTURES ARE NOT SUSTAINABLE 3,800 DEALERS AT RISK AND FURTHER CONSOLIDATION NEEDED

13 STUDY 13 Current margins will soon come under attack. As volumes begin to stagnate, margins will quickly erode. Our investigation of the auto retail industry found that the current record margins enjoyed by dealers will be short lived. This is not a view widely shared by the industry, but we base it on solid facts, insights from industry leaders and our own model of the market. Based on results from our analysis, we estimate that return on sales will in fact drop from 2.2% in 2012 to below 0.8% in 2020 a reduction of over 64% in the coming years. Without significant change these low profits will in turn put tremendous stress on dealers as auto retailing is already low margin business. It is clear, any downward pressure placed on margin will challenge the future viability of dealers and the overall network structure. In fact, we estimate that 22% or 3,800 outlets and approximately 200,000 jobs are at risk and a continued consolidation is required to maintain today's profit levels. Our estimate is based on a specially developed model of the US automotive retail industry through In the model we evaluate the development of new vehicle demand, price, and model mix along with aftersales revenues and infrastructure costs to better understand how dealer profits would be impacted the results are less than positive. While the recent growth has been encouraging, new vehicle sales are quickly approaching mature levels. Once these mature levels are achieved, dealer profits will come under pressure again, driven primarily by four key issues: > > Downward pressure on new vehicle prices through increased transparency and thus intra- and inter-brand competition > > A shift toward less profitable product mix driven by increases in consumer demand for smaller less expensive vehicles > > Competition in aftersales and service driven by penetration of large national specialty and discount automotive repair chains > > Rising facility and infrastructure costs through increased focus on standards, brand identity, and customer experience

14 ROLAND BERGER STRATEGY CONSULTANTS DOWNWARD PRESSURE ON NEW VEHICLE PRICES The digital age has radically changed the way customers shop and ultimately has led to a systemic decline in prices customers are willing to pay a trend that will continue as more and more of the purchase process moves online. Customers are taking advantage of online accessibility; nearly 80% of buyers now use the internet as a primary source of information when researching vehicles. The web spreads the territory across which a potential buyer can shop and compare prices by an infinite amount. In this process the dealer is less important as customers have all of the information they need to make a decision. In fact, this trend is particularly apparent in the US, where 58% of customers only visit one or two dealerships prior to making a vehicle purchase as the primary research has already been done online 1). In an effort to attract consumers, price has become the primary mechanism which has created problems mainly intensified competition manifesting in two ways: Competition between dealers over sales of one brand ("intra-brand competition") and competition between different vehicle brands ("inter-brand competition"). Intra-brand competition has intensified over the last years and led to a significant erosion of dealer margin. Even with the recent wave of franchise consolidation, different dealers selling the same brand often within a single geographical area are competing with each other over the sale of new vehicles because customers are more easily able to shop larger territories by leveraging dealer websites and online tools. This gives customers the perfect opportunity to pit dealers against each other and drive down the price of a new car. In many cases, this sort of competition results in a dealer selling at very low or even negative margins in hopes to make it up with used car sales, future service revenues, and volume-based bonuses provided by the OEM. This game is particularly dangerous for the small "mom-and-pop" dealers because they are rarely able to reach the volumes needed to be successful. Large professional dealers that play the volume game will drive the smaller dealers to either sell their franchise or be at risk of going out of business. F3 In response to shrinking margins in the showroom, many dealers look to boost profit through online channels. Early adopters have had great success selling online as it expanded geographical reach, drove volume, and increased profit. Today, every dealer is online selling through a branded website albeit at lower margins than in the showroom. Dealers are typically losing 20-30% of their standard in-store margin when selling online because of additional price transparency; they lose the commission provided to OEM for lead generation typically $ per lead, and the ability to upsell because the customer has already determined the exact vehicle configuration they want to buy prior to stepping into the showroom. Increasing dealer usage of 3rd party retail websites like ebay Motors is further damaging margins by as much as 30-40%. On these sites, dealers are competing directly with one another primarily on price driving down margins even further. Since the whole transaction happens virtually other revenue streams are also lost. Dealers lose out on the highly profitable service revenues and used car trade-ins sales that typically make up for the low margin on new vehicle sales. Further complicating the issue, is the emergence of Truecar, a company that provides detailed pricing information and helps customers find a dealer that is willing to sell at a discounted price. In certain markets, for example, the arrival of Truecar has led to a systematic decline of dealers' profits by as much as 90% when compared to in-store sales 3). Once a single dealer within a given market signs up for the service the discounting process begins. The initial partner begins to generate leads through the website, which translate into sales, ultimately stealing share from those within the local market selling the same brand. As a competitive response, many dealers have resorted to honoring or even beating the price provided through the website. Once again leading to a volume game that many dealers are not equipped to participate in. At the same time, competition between different volume brands is growing fiercer by the day, especially in the small car segment. These vehicles are being increasingly commoditized a problem that luxury brands are essentially immune to. The commoditization of volume brands is driven on the one hand by the fact that today's consumer preferences are shifting away from vehicle ownership towards being mobility oriented, and on the other by the limited 1) AutoTrader.com "Have Internet, Will Travel," 2012

15 STUDY 15 scope for differentiation between vehicles in this segment with regard to quality, safety, and technology. This inter-brand competition has led to a battle between manufacturers for the number-one spot as illustrated by recent comments by Toyota about trying to reclaim the sales crown from Nissan's Versa, in the entry-level subcompact segment. To compete, Toyota plans to bring out a new generation of North America-made small car selling at lower prices. This intense inter-brand competition transcends to the retail landscape as well where dealers are once again forced to compete on price. F3 Impact on dealer gross margin AutoTrader.com Primary sources of information Cars.com Costco Auto Program CarMax Edmunds.com TRUECar Kelley Blue Book ebay Purchase method Acquisition costs Loss of dealer's gross margin In-store > > No additional costs for dealer 0% Dealer website 3rd party website > > Commission to OEM > > Choice of incentives > > Limited upselling > > Commission to 3rd party > > Choice of incentives > > Limited upselling > > Indirect competition with other dealers % % Aggregator website > > Commission to aggregator > > Choice of incentives > > Limited upselling > > Direct competition with other dealers % Source: Roland Berger

16 ROLAND BERGER STRATEGY CONSULTANTS F4 Vehicle segment 1) development <1% 1% 24% 52% 22% <1% ,323,585 <1% 1% 25% 55% 18% <1% ,956,218 3% 31% 54% 12% ,590,367 1% 3% 33% 52% 11% ,648,151 <1% 4% 34% 50% 12% 2015F 16,421,229 <1% 7% 34% 48% 11% 2020F 16,835,886 A B C D E F 1) Does not include HVAN Source: IHS Global Insight, Light Vehicle Sales, January 2014; Roland Berger

17 STUDY 17 F4 F5 A SHIFT TOWARD LESS PROFITABLE PRODUCT MIX Dealers will also be challenged to sustain profitability as the average margin per vehicle is expected to drop based on the types of vehicles consumers are demanding. The general shift toward smaller vehicles poses a problem for profitability. In 2005, for example, the B and C segments represented 26% of total sales in the US; today they represent 36% and are expected to grow to 41% by ). As noted, prices for small cars continue to come under pressure, while consumers are demanding more and more costly technologies such as electronics, safety, and performance features to be integrated into new vehicles as standard. To make things worse, share is declining from what is the most profitable segment at the moment: trucks and SUVs. Small cars are already at a margin disadvantage compared to larger vehicles, so as small cars start representing a larger portion of dealers' product mixes, the average margin per unit has nowhere to go but down. Adding fuel to the fire is the fact that premium brands are moving downstream into volume segments. Luxury manufacturers are developing high-end products at entry level prices the BMW X1 and 1 series, for instance and using their low price as a means to gain market share and draw younger buyers to the brand. All the major premium brands are following suit as they race to introduce concepts or production vehicles in the compact segment. As a result, volume brand dealers will need to sell even more volume in the future to maintain anything like their current level of profits. And with volume growth expected to stabilize in 2015, this will very soon become problematic 1). COMPETITION IN AFTERSALES AND SERVICE Strong aftersales parts and service revenue is critical to dealer sustainability; and dealers' continued loss of market share has huge impact on profitable operations. It is no secret that dealerships get a disproportionate amount of their gross profit from parts and service operations. In the first six months of 2013, for instance, 12% of total dealership revenue but a massive 40% of total gross profit stemmed from parts and service. The opportunity is still available average age of light vehicles increased from ten to almost eleven and a half years between 2007 and 2013 (stated in a recent Polk study) having older vehicles on the road is good for service revenues and the industry's service revenues have benefited. But, at the same time, according to the National Automotive Aftermarket Industry Association, dealers are getting an ever smaller share of service sales: dealers' share of service and parts has fallen five percentage points since 2000, from 32% to 27% of the total aftersales market 2). A number of reasons lie behind dealers' loss of share. First, traditional dealers are experiencing increasing competition from independent repair shops. We have seen the continued growth of specialty auto stores (i.e., tire discounters, brake shops, quick oil change) and emergence of superstores like Wal-Mart. Additionally, vehicles and parts simply do not require as much maintenance as in the past: Cars have become significantly more reliable and need fewer repairs. For example, dealer brake services for recent vehicles (zero to three years) fell from 10% to 6% between 2006 and 2011, a hefty 40% reduction 2). This trend may be profitable for OEMs as it reduces warranty costs, but it puts an additional strain on the dealer network, which is seeing its traditional basis for its business model undermined. 1) IHS Global Insight, Light Vehicle Sales, January ) AAIA Factbook, Automotive Aftermarket Industry Association, 2013 F5 Aftersales are under pressure Dealers are losing ground in this very profitable market % Dealer 32% Other % Source: Automotive Aftermarket Industry Association (AAIA), Factbook %

18 ROLAND BERGER STRATEGY CONSULTANTS F6 RISING FACILITY AND INFRASTRUCTURE COSTS As competition is pressuring gross margins at the top, customers' desire for a superior retail experience is increasing facility costs affecting the bottom line as well. Inevitably, people's expectations of auto retailing have evolved based on their other retail experiences. More and more of today's customers are attracted to brands that reflect their personalities, expectations of the future, and dreams. That is not news in itself: The car industry has been selling lifestyles since its earliest beginnings. Yet, the industry has been slow to evolve to the new ways consumers are interacting with their preferred brands and channels. The investment needed to differentiate and compete to attract consumers will further pressure margins and dealer sustainability. Dealers must be able to offer on-demand products and services and a consistent brand message across all channels. Today's customers are accustomed to physical retail sites being tailored to the desired brand experience as successful consumer goods and service retailers such as Starbucks, Apple, and the Ritz Carleton and others have shown. Convenience is still important, but it now goes beyond the traditional sense. While OEMs and dealers are still fixating on minimizing metrics such as "miles to customer", nearly 58% of purchasers many aided by the internet are willing to travel more than 30 miles to buy their cars 1). Convenience now encompasses personalized service, touchscreen kiosks, reminders, product expert sales associates, mobile applications, consistent and seamless integration between digital and physical experiences and other activities aimed at making the consumer experience more individualized. Against that background, dealers that do not evolve in line with the changing habits of consumers inevitably will lose sales. One of the things dealers aim to achieve through investments is differentiation in the eyes of customers, however, commoditization and speed at which competition is making similar investments creates a need to continuously upgrade and invest. There is evidence that service upgrades Internet cafés and children's play areas, do lead to better sales 1). Still, the required investments are sizeable, including facility upgrades, mobile and Web presence, inventory and CRM improvements. Cultural shifts regarding personnel, too demand recruiting and training time and expense. Dealers have become increasingly skeptical about the business case for modernization, standardization and expansion even in today's improving market as the memories from the economic crisis have yet to fade. Thus far, dealers have therefore taken a cautious approach and still lag far behind comparable service-based retail businesses. Dealers need to make the investments to remain competitive in the long run. These developments put dealers under a lot of financial strain, especially if they lack the support of OEMs. OEMs continue to request investment be made quickly and some OEMs such as Toyota have made facility upgrades mandatory. Independent dealers with only one dealership the "mom and pop" dealers have a particularly hard time coming up with the necessary capital to implement the changes called for. Going forward, these dealerships appear most likely to fall victim to further consolidation. UNHEALTHY PROFITS PUT DEALERS AT RISK It is our belief, the combination of the above mentioned factors will put tremendous pressure on net income margins and ultimately leave dealers at risk. However, the impact of these trends will not be felt equally amongst dealers. Small family owned franchises are more at risk as they do not have the resources or tools needed to manage the complexity created by these trends, ultimately leaving them vulnerable to bankruptcy or being acquired by a larger, more professional auto group. Several large auto groups have already begun this consolidation, albeit at a slow pace. This pace will begin to change as the pressure mounts. To maintain, what we believe (or what the industry believes) to be a healthy profit margin, the network will have to further consolidate or massively revamp how it does business 3,800 outlets are at risk of being closed or taken over. 1) AutoTrader.com "Have Internet, Will Travel," ) Polk Dealer Reviews Study, Dealer Rater, 2013

19 STUDY 19 F6 Other industries are raising customers' expectations regarding experience Address all senses Consistent appearance and customer service Everywhere (convenience) Example: Starbucks Luxurious surroundings Exclusive service Pampering convenience Example: Ritz-Carlton Hotels Virtual experience Simplified POS (on demand) Where I want, when I want Personalized experiences Deep product knowledge Exclusive locations Interconnected personal profile Example: Apple Store Example: Amazon Source: Roland Berger

20 TIME TO RE:THINK NETWORK OEMS NEED TRANSFORMATIONAL CHANGE TO ADDRESS MARKET CHALLENGES

21 STUDY 21 Today's retail networks need a transformational change. What can OEMs do in response to these challenges? With the trends unlikely to abate in the near future, OEMs need to enact transformational change to protect the financial health of their dealer networks. So far, OEMs have been slow to adopt the radical restructuring measures needed to respond to the evolving retail landscape. Networks have been consolidated to some extent, as we have seen, but rather than making a deep change, OEMs remain focused on small, incremental improvements to the traditional model. Many have held off from taking a more aggressive approach to restructuring due to the perceived legal constraints, investment requirements, and risks to brand image. However, at this point a more comprehensive approach, given the new market realities, would show an awareness of the changing environment and the need to manage the increasing complexity. Traditional network restructuring methods that focus on closing outlets to drive dealer throughput and reduce costs are less effective. These methods often negatively impact the brand image and market coverage as underperforming dealerships are pulled from the market. In many cases, such actions have made it difficult for OEM to return to the impacted market for several years with any level of success. To avoid these issues, we recommend an alternative approach that focuses efforts on creating bigger and stronger retail partners [eliminating 50% or more of current partners] rather than closing outlets. Bigger and stronger retail partners are established by providing top performers with large, adjacent, multi-outlet territories within a given market. Experience shows that this approach will help top partners yield higher volumes, mitigate intra-brand competition, while also reducing their cost base ultimately leading to higher and more sustainable profits. According to our model, if each dealer group (those with more than one dealership) were to acquire one additional standalone franchise, only a 5% reduction in outlets would be required to maintain the current 2.2% profit margin, saving roughly 3,000 outlets or ~85,000 employees through new ownership. This estimate is mainly derived based on cost savings from synergies which have been achieved in markets where this approach has been adopted.

22 ROLAND BERGER STRATEGY CONSULTANTS F7 Synergies are achieved once the professional dealer group is able to complete the consolidation and optimize the financial and organizational structure across all locations. We calculate the savings to be around 12% on average dealer expenses of USD 4.4 m 1) and is comprised of the following areas: Marketing: Approximately, 14% of the total savings is achieved in marketing by eliminating redundant advertising spend within given territories. For an average dealer, this equates to approximately USD 75,000. Dealers would typically need to spend significant dollars to compete with adjacent dealers of the same brand, where now, this is removed and dealers can instead focus on other competitive brands. Inventory: As a dealer is able to leverage inventory across multiple locations, significant savings can be achieved an estimated 30% of total savings or around USD ~160,000 comes from expenses related to inventory. They can reduce the total number of vehicles needed while still providing a service level that customers desire and manufacturers require (in terms of options and types of vehicles). Rent and other related expenses are thus decreased as dealers can consolidate lots. Though not included, dealers also have the ability to provide a more diverse range of product options across facilities creating positive revenue synergies as well. Reduction in the cost structure decreases the amount of breakeven volume required for the average dealer by approximately 20% which triggers an overall increase in network profit of between 0.7 and 1.5 percentage points annually rewarding partners and keeping them motivated and committed to the brand. OEMs that move forward with this approach have a real opportunity to take action and gain first-mover advantage. While this approach seems very simplistic and straight forward, it actually requires a lot of careful planning and detailed analysis to design. We have identified four key focus areas that are integral to the successful planning and execution: 1. Restructuring the network for profitable growth 2. Choosing the right partners 3. Enhancing partner performance and customer experience 4. Enhancing the internal organization and changing the mindset of field force 1) National Automotive Dealers Association, NADADATA 2013 Headcount: The biggest savings, approximately 46% is due to labor synergies achieved across dealership locations. Dealers can save significantly through headcount reductions. The average dealership spends roughly USD 2.9 m in labor expenses; consolidating shared services, such as accounting, IT, and even management can allow dealers to lower overhead expenses by roughly USD 250,000. Other synergies: Other synergies account for the remaining 10% of cost savings, or roughly USD 52,000. These synergies include having centralized parts inventory and other back office functions such as legal, insurance, etc.

23 STUDY 23 RESTRUCTURING THE NETWORK FOR PROFITABLE GROWTH One of the first steps in restructuring the network structure is to define the design principles. These principles provide guidance on the magnitude of change needed per market and are tied closely with business objectives. OEMs must determine what volume and profit levels are needed to capture and maintain the attention of professional dealer groups. However, this opportunity needs to be equally distributed across partners in a given market territory to ensure a balance of power. From these guidelines OEMs are able to determine initial estimates for volume per partner, outlets per partner and relative market share. The next step is to design the sales territories incorporating customer convenience or average driving distance to nearest outlet and shopping patterns with the design principles in mind. Customer convenience is looked at to ensure adequate coverage exists within a market. In the US, most dealerships are situated in auto malls or clustered in tight geographic areas; when large discrepancies are apparent it indicates a gap in representation and should then be addressed. Customer shopping patterns define the territory customers travel when making a purchase. When sales territories are incongruent with customer shopping areas, cross-shopping can create a bidding war amongst neighboring dealers. To the extent that adjacent territories can be joined it minimizes the consumer cross-shopping affect and reduces intra-brand competition. The result of this process is the ideal network design; the design will take into account partner selection, implementation timeline and the cost of execution. CHOOSING THE RIGHT PARTNER Partner selection is fundamental to the success of the network re-design, both in choosing the right growth partners and transitioning away from low performers. Similar to the network territory approach, criteria is defined on a number of qualitative and quantitative factors. While this baseline performance alone would seem an indicator of partner success, we have found that absent a predominant share of the dealer groups portfolio they do not perform well for the brand in the long-term. Predominant share in this context refers to the volume and profit contribution a brand has in a dealer groups' given portfolio. This is important to keep in mind because it is becoming more and more common for large dealer groups to have a diverse set of brands in their portfolio of outlets. Brand diversification becomes a major challenge for the OEMs as dealer groups begin to focus on portfolio optimization (i.e., "riding the hot hand") rather than driving sales for a specific brand where they are fully committed. Achieving a dominant brand share with retail partners is the key to establishing a strong relationship which leads to healthy profits and a sustainable dealer network structure. ENHANCING PARTNER PERFORMANCE AND CUSTOMER EXPERIENCE Transforming the retail network relies on well-conceived performance management processes. OEMs cannot implement further changes without reducing performance variability among the network: Better measurement and rewards for dealers will allow OEMs to create incentives for top-performing dealers and change franchise management when needed. In many cases, the process of transformation can follow a standard pattern. The first step is for OEMs to develop business plans side-byside with dealers, with the ultimate goal of improving performance. The performance goals will vary from dealer to dealer, based on the current situation and local market dynamic. The targets should also reflect the OEM's objectives for the market in question profit, market share, or whatever it may be. Once the business plan is finalized metrics and measurement of progress should be jointly decided between OEM and retail partner. Transparent communication of processes and measures is critical to the success of a performance management strategy. Ongoing discussions between dealers and OEMs must be integrated into the periodic evaluation and development of the performance plan. Our experience working with clients shows that implementing this approach leads to an average improvement in dealer sales between 15% to 27% in the first two years. In addition to sales performance, retail partners must be capable of delivering tomorrow's customer experience expectations both inside the dealership and beyond. All communication channels and touch points need to be integrated into a consistent brand experience which customers are used to for other retail industries.

24 ROLAND BERGER STRATEGY CONSULTANTS F7 Cost savings Metropolis, % net profit margin 2020 Status quo 0.8% net profit margin Drop in network profitability Outlet Source: Roland Berger Territory per retail partner

25 STUDY Consolidation 2.2% net profit margin Sustain current profitability Average dealer savings through consolidation 2020 [USD] Inventory Marketing Headcount Other synergies 160k 75k 250k 52k

26 ROLAND BERGER STRATEGY CONSULTANTS ENHANCING INTERNAL ORGANIZATION/ FIELD FORCE AND CHANGE MINDSET Developing a strong leadership team that has a shared vision for the dealer network transformation is imperative. The strong leadership is needed to help facilitate the change management that is required to alter the legacy mindset of the organization. Often people get stuck in the old traditional ways of working with dealers and are unable to take the necessary steps needed to transform. Implementation can also get sidetracked by the Marketing and Sales organization's short-term volume objectives therefore it is important to keep the restructuring team separate. Which is why we view this change process as being as important in a network restructuring as the tactical restructuring itself. Aligning the cultural mindset of both dealers and the field force can also be a major hurdle. The field force has been historically trained to largely focus on pushing volume rather than providing process improvement ideas. Under a new retail model, this role needs to change and become more of a consulting function, with the idea of working together with the dealer to improve profit and volume levels through more efficient operations. To change a cultural mindset OEMs need to put together a strong team and develop a comprehensive communication strategy with consistent messaging across internal and external (dealer) channels. In order to support this change OEMs must invest in tools and resources to help its field force measure dealer performance and recognize areas of improvement and opportunity. WINNERS AND LOSERS Transformational change is possible. Even given the complex legal framework, OEMs in our experience are able to improve their networks and create sustainable profits for their retail partners. OEMs that are able to transform their retail network effectively have the opportunity to gain significant competitive advantage. Radical alterations are needed to maintain profitability in the long-term. Restructuring to create synergies aroaund bigger and stronger partners is one possible way. But to do so, manufacturers need to choose the right partners that will stay engaged with the brand and develop performance management structures that align with business objectives and can motivate partner performance. Lastly, OEMs must align the culture around the changes to ensure sustainability. In enacting these changes, OEMs have the added benefit of being difficult to copy by competitors, ensuring that those who make them enjoy longer periods of leadership. And in a fastevolving world, winning is everything. METHODOLOGY We developed a comprehensive model to analyze the potential risks and implications of the emerging industry trends on dealer profits in the United States. We took into account several drivers that account for dealer profitability, including: product mix (segments as well as aftermarket), internal and external competition, transaction pricing, and input costs such as labor, marketing and real estate. The data for this study is mainly from industry sources: National Automotive Dealer Association, IHS for sales and labor information, and Automotive Aftermarket Industry Association as well as project experience collected working with OEMs on a global basis on network related topics. From this set, we analyzed the development of these trends and on how they relate to the number of dealerships. On this basis we were able to identify the relationship between variables to make projections for future expectations of dealer profitability and network sustainability. These projections are consistent with IHS estimates of future growth in each segment and in keeping with a conservative assumption on what a target profitability level should be maintained.

27 STUDY 27

28 ROLAND BERGER STRATEGY CONSULTANTS INSIGHT FROM AN INDUSTRY THOUGHT LEADER JOSÉ MUÑOZ Executive Vice President of Nissan Motor Co., Ltd and Chairman Management Committee Nissan North America

29 STUDY 29 We spoke to José Muñoz, Executive Vice President of Nissan Motor Co., Ltd and Chairman Management Committee Nissan North America, and former President of Nissan Mexicana, where he developed key dealer network initiatives. Under his leadership, Nissan became the absolute market leader in Mexico for an unbroken period of more than five years. Mr. Muñoz, dealer networks in the US are at their peak regarding profit margins right now. What is your view on the auto retail industry in the US today? JM: The structure of retail industry has not evolved to the extent that it should have in light of the increasing competition. When the market is growing and everybody is selling more cars, it's relatively easy to make money. But there are a number of dealers in all networks who are not making money, and the standards in many networks including top networks are not really at the level that customers would expect. This spells bad news for manufacturers when the market becomes less favorable. During the financial crisis, we saw a rightsizing of dealer networks, especially for domestic brands. Do you believe that this consolidation went far enough? JM: The legal limitations meant that OEMs could not receive the same protection as other companies in other sectors facing the same financial crisis. Experience tells us that every five years or so there is a market decline, and I believe that this might lead to further consolidation. This sort of forced consolidation is not necessarily ideal, as you can lose presence where you didn't want to lose it. "Consumers enjoy full transparency on margins. If they know that the dealer can give a 1% discount, they expect to get the entire 1% discount up front."

30 ROLAND BERGER STRATEGY CONSULTANTS "Most dealers have most brands, so they've created their own consolidation, so to speak." What is driving the current high profitability levels in retail networks, apart from the market upswing? JM: There are a number of different reasons. For instance, one of the segments that has grown the most is full-size pick-ups. Here, transaction prices have increased more than for other vehicles because the competitive offer is limited. Conversely, in the compact segment there is more competition and prices have not grown at the same pace, translating to lower profits. Another thing is that dealers are making more and more of their margin in the backend of the business areas such as insurance, aftersales and financing. The huge number of first-time buyers with low credit ratings means that manufacturers and dealers can make money here on commissions. How sustainable is this situation? JM: When full-size pick-ups stop growing so much, margins will be eroded. Likewise, if first-time buyers stop getting credit, we will suddenly see stabilization or even a drop. The market reality is that, with the exception of full-size pick-ups, there is not much growth in terms of Consumer Facing Transaction Price: Manufacturers are launching new models with significant new content but with only a small price increase. In simple words, Customers are getting more content for less. In the long run, this will constrain margins for the distribution networks. How is increasing pricing transparency impacting dealer networks and their margins? JM: The impact is huge. Variable aspects relating to pricing and pricing structure are visible through different websites in the US. Consumers enjoy full transparency on margins. If they know that the dealer can give a 1% discount, say, they expect to get the entire 1% discount up front, which can sometimes become a very tough arena for the Dealers business. Customer behavior is changing and the demand for an excellent retail experience is increasing. Is the industry able to adjust fast enough? JM: Not always. There has been a lot of investment in new technology over the last years, but not so much progress in terms of people. At the end of the day, no matter how good you are on the technology side, when it comes to delivering the vehicle and explaining how the vehicle works (the moments of truth when it comes to human contact) it is all down to the people that you have in place, their involvement, skills, training and motivation. Can you give an example? JM: Well, it is common for dealers to use negotiation and bargaining at the very end of the sales process as a way of differentiation. Our information shows that this is not something that customers appreciate. As an industry, there is a mismatch between the level of technology that is available and the level of human interaction. We lag behind with regard to other industries that are much more advanced in customer handling and customer satisfaction airlines, hotels, and so on. In automotive, people at the end of the funnel are thinking more in terms of volume than in terms of customer satisfaction and real differentiation. How does the US retail environment compare to other countries? JM: In Europe, the environment is highly regulated, although you are in most of the cases allowed to implement changes, which sometimes are necessary to bring additional growth and profit to Dealers and better attention and service to Customers. From that point of view, Europe is more advanced than the US. As a result, Europe has been able to evolve in a way that is more driven by the market, while the US has been highly constrained by legislation. When it comes to business management, however, the US is more professional in my opinion. This is because the business is bigger: Markets where Dealers operate are bigger, there are more business opportunities and margins are still there as you can even see from the compensation levels of the executive managers, dealer principals and executives of dealer groups.

31 STUDY 31 And Latin America? JM: Latin America is a mixture. Every market is different depending on the local legislation. In some ways, Latin America enjoys the best of both worlds: Some markets are big, so they can enjoy high margins like the US, but regulation is more like in Europe, so they can be much more market-oriented. Where you have no limiting factors, you can have more impact and profitability goes through the roof. Some of the big dealer groups in the US have spotted this opportunity and are investing in Latin American markets. Turning to your own company, what is Nissan doing in the US to support dealers and keep the network profitable? JM: It's interesting: For almost my entire career, I've been transforming networks by bringing in new blood constantly trying to attract high-performing dealers to the brand. In the US, by contrast, the dealers that we have are really good. Most dealers have most brands, so they've created their own consolidation, so to speak. We have the best dealers in the markets: The best private and public are part of our Network. Where we haven't been so good is in increasing our "share of mind" with those dealers the extent to which they focus on Nissan. And improving that is taking a very important place in our agenda. Have you had any initial reaction from dealers? JM: Yes a very positive reaction. Everybody wants to be a part of the team, part of a winning brand, part of making more profits. We managed to be the fastest market share growth brand year on year (YoY) in this Fiscal Year to Date (Apr-Dec) in the USA. We grew our sales volume YoY by 18%. The average profit of the Nissan dealer network is at all-time record, with an increase YoY of 19%. Our transaction prices have increased. The equation is working: We are winning dealers' share of mind. But we still have a long way to go. We are trying to improve every day, challenging conventions and developing best practices. Some OEMs Tesla or BMW, say are taking a completely different approach. What do you think about this? JM: If you are a new entrant like Tesla, for example, you have no limitations other than your own business plan. However, when you start achieving bigger volume, you find a great help in your Dealer Network. Dealers are crucial not only to ensure a fully satisfactory Customer management, but also to assist OEMs sharing the enormous financial burden that the automobile business means. As a manufacturer, when you hit a certain volume you can no longer cope neither with the financial burden of that number of cars nor with the complex and very necessary processes to provide the right service to the Customer: You need dealers to help you, and be together a much stronger player. Finally, what does the future hold for automotive retailing, specifically in the US? JM: Well, due to the reasons that I have just mentioned, I believe that dealers will continue to be important in the future. Nevertheless, consumers would make their decisions on the Internet, and then come to pick up the vehicle and get some explanations in a friendly, pleasant environment. We would also see a highly equipped, high-tech advanced aftersales network; at the end of the day, this will always be necessary. Whatever happens, I believe that we can do a better job in optimizing profits in the distribution network. "The equation is working: We are winning dealers' share of mind. But we still have a long way to go. We are trying to improve every day, challenging conventions and developing best practices."