Are These Dealerships About to Cut TrueCar Out of the Loop?

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Being a middle-man in business is extremely difficult, because companies are always looking to cut costs, boost margins, and cut out the middle-man. However, TrueCar, Inc. (TRUE 2.13%), a middle-man connecting consumers looking for a car and dealerships looking to complete a sale, has found a great niche within the automotive industry where consumers have long distrusted salesmen. TrueCar offers consumers easily accessible and accurate pricing information, and it offers dealerships cheaper, quicker and simpler sales leads. 

It works pretty well in part because the dealership industry is extremely fractured, and that makes cutting out the middle-man more difficult. That said, two of America's largest automotive dealership groups have grown large enough to perhaps cut TrueCar out of the loop -- should investors be concerned?

How would TrueCar be cut out?

Here are two examples of companies developing website services that could replicate what TrueCar does for their businesses. Sonic Automotive Inc. (SAH -1.90%) is planning to launch an online sales initiative dubbed Sonic Digital One-Stop. The goal is for the website service to enable consumers to shop for a vehicle online, get a trade appraisal, and even complete the purchase online without walking into a dealership. Sonic has already tested this out at five dealerships in Charlotte starting a couple of years ago, and the system, which is aimed to complete a vehicle purchase in 45 minutes or less once the consumer arrives, is expected to expand to all of Sonic's dealerships early next year.

America's largest new-car retailer, AutoNation (AN -1.47%), which has had a well-documented and bumpy relationship with TrueCar, has made a similar move in the past. AutoNation, which has over 260 stores and 360 franchises, made a large $100 million IT investment in 2014 to consolidate its national brand to the AutoNation name and developed an online presence with AutoNation Express. The latter will enable customers to select a vehicle online with a price available, reserve the vehicle with a credit card, and then have it delivered to the nearest AutoNation store for a test drive.

How online buying exploits scale

Remember, this can turn into a huge advantage for Sonic and AutoNation because of their larger size and scale compared to the smaller dealership groups within this fractured industry. Few dealership groups can afford to pour that amount of capital into creating a well-maintained and functional online car-buying website. Further, few dealership groups own the number of stores necessary to create a network effect. Would you rather log onto a website where you can buy a vehicle from a pool of two stores and 250 vehicles? Or would you rather buy from AutoNation that offers more than 260 stores and 360 franchises boasting roughly 100,000 vehicles? 

For more context on the difference these websites could make, listen to some figures from AutoNation. About midway through 2014, third-party websites, including TrueCar, generated almost 20% of AutoNation's vehicle sales, and its own website generated about 10%. After pouring capital into developing AutoNation Express, it flipped that to only 9% of sales from third parties and its own website generating 20% of sales around October 2015. 

Let me preface this by saying this quote is from late 2015, and the relationship between AutoNation and TrueCar has improved immensely, but it does show how serious AutoNation was about developing its website. "We went all in. We burned all the ships," AutoNation CEO Mike Jackson said. "Imagine, that during the pivot, we fired Costco, broke with TrueCar, instituted our customer-friendly ... recall policy -- which disrupts 5 to 10 percent of our inventory on any given day -- and our sales have gone through the roof."

Should TrueCar investors be concerned?

Let me be clear: Dealerships creating effective online buying websites is not a positive development for TrueCar because it does indeed start the ball rolling on cutting out the middle-man. And as smartphone apps and online websites become easier and cheaper, the online purchasing trend is unlikely to reverse. However, we have to put this in perspective: Because the industry is so fractured, it won't hurt TrueCar in the near term. Consider that AutoNation's 260 stores are a drop in the bucket compared to TrueCar's over 10,000-strong dealership network.

Also, we have to consider that even if AutoNation and Sonic continue to develop these websites effectively, they will essentially compete with TrueCar, but they shouldn't eliminate TrueCar as a valuable partner -- that's probably why AutoNation will be using TrueCar in all of its stores again by the end of the year. Ultimately, TrueCar has taken huge steps this year in repairing the relationship with its network of dealerships, and as long as it can help dealers convert cheaper sales leads, it will always remain a valuable partner.