Billionaire investor Warren Buffett recently announced his plans to purchase the Van Tuyl Group, the country's largest privately owned dealership network. The company, which was founded in 1955, boasts $8 billion in revenue and sells about 240,000 cars a year. Soon to be be renamed Berkshire Hathaway Automotive, Van Tuyl is expected to become a major competitor in the retail automobile industry.
"We will hear, I predict, from hundreds of dealerships in the next year," Buffett said on CNBC's Squawk Box.
Berkshire Hathaway certainly has the capital to take advantage of that prediction; perhaps Erin Kerrigan, founder and managing director of Kerrigan Advisors, said it best when she called the deal "a harbinger of what's to come" in a recent interview with The Wall Street Journal.
Why is Warren Buffett investing in car dealerships?
In a time of tech-heavy investing, the purchase of a car dealership might seem like a lateral move; car dealerships have low margins, with an average pre-tax profit in 2013 of just 2.2 percent, and independently owned dealerships are usually not profitable. Despite this, the return on equity is high, and dealerships require little capital to run. For example, dealerships typically purchase new cars by borrowing from manufacturers on very generous terms, which means they can hold onto cash from car sales and pay loans back over long periods of time.
Financing for new cars is still relatively easy to obtain, and new car sales are expected to continue to rise. Still, dealerships don't typically make money from new car sales -- the bulk of the profits are in the sales of spare parts, service and financial products like insurance, financing and warranties. It's no coincidence that Buffett is already heavily invested in insurance -- and there is a huge opportunity for him to push financing and insurance packages that benefit his own subsidiaries.
Finally, perhaps Buffett sees something in car dealerships that he saw in local papers and real estate brokerages: fragmented markets with dwindling competition. Car dealerships were hit hard by the recession and those that remain are enjoying record profits. Competition is low and current dealership franchise laws regulate where new dealerships can be located and how far apart they should be, as well as allow carmakers to restrict the number of stores that sell their products in a particular area. If Buffett is planning on acquiring more dealerships in the future, he could be on his way to developing a sort of monopoly.
What does this mean for consumers?
There have been several recent disruptions in car dealership franchise laws, with a push from Tesla CEO Elon Musk to allow manufacturers to sell to consumers directly through websites and company-specific physical stores. Tesla has seen impressive sales and profit margins, but we are talking about an $80,000 car here -- not exactly affordable to the average American. While consumers like to go online to find specs, reviews, pricing information and to apply for financing, the vast majority of Americans still prefer to test drive cars prior to purchase, as well as compare other models and get assistance with trading in or disposing of their old vehicles.
It is likely the retail auto industry will see an evolution of Musk's vision and the traditional model. A recent McKinsey report on car dealerships argued that new dealership formats -- pure test-drive centers, small urban showrooms, pop-up stores and more online selling -- will mesh with consumer demand. As Buffett told CNBC, there is a great deal more innovation and consolidation waiting to happen among American car dealerships.
Related: What's in Warren Buffett's Wallet?
In a fragmented industry, Berkshire Hathaway has the opportunity to acquire smaller groups and stores, consolidate those companies, and offer an integrated car-purchasing experience from start to finish. Consumers might see the end of expansive dealerships with high-pressure sales environments and the rise of smaller, boutique stores that offer a more relaxed car-shopping environment. Considering a recent study by Edmunds revealed one in three of those surveyed would rather do taxes, go to the DMV or sit in the middle seat of an airplane than go through the car-buying process, it's clear consumers are ready for a better way to purchase a vehicle.
Berkshire Hathaway has the capital to invest in innovating an industry that is due for an overhaul, Buffett seems to be attracted to family owned businesses with strong prospects, and the Van Tuyl family has a solid reputation and strong relationships with other car dealers. If Berkshire Hathaway Automotive can remain dedicated to improving the customer experience and offering competitive pricing, while maintaining the established integrity of the Van Tuyl Group, consumers should be happy to have Buffett driving this change.
Tell us what you think: Would you buy a car from Warren Buffett?
This article originally appeared on GoBankingRates.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.