Dealer Leasing: What's It All About, an interview with Fred Miller of Miller Leasing

An interview with Fred Miller, owner of Miller Leasing Inc., and Miller Imports, Van Nuys, California.

More and more car dealers are entering the automobile leasing business, an area not restricted to domestic car dealers. Fred Miller, as a strong example, is a Quality Datsun Dealer located in Van Nuys, California, who began his own auto-leasing business in 1967. During the six years of his operation, Miller Leasing, Inc. has grown to over 500 auto leases. And the forecast is for the company to grow to 1,000 leases by the end of 1975. Miller Leasing operates from its own offices adjacent to the dealerships of Miller Imports, and employs a fulltime staff of six, Miller, in the interview which follows, explains why and how he entered the expanding auto leasing business.

What made you decide to go into leasing?

Miller: Beyond the obvious opportunity to sell more cars, it is an opportunity to broaden your base by fitting the needs of all people for any type of vehicle. Secondly, there's a great opportunity to develop another profit center in the dealership or build up another business with great profit potential. The future of leasing in this country is outstanding by all reports.

As a leasing company, are there different ways you can set up the organization?

Miller: There are really two ways. A dealer can set up a complete company and handle his own leases from start to finish, or he can set it up under what's called a lease brokering business.

Under lease brokering, you, in essence, generate the customer and the car and "sell them" to another leasing company or bank. This other leasing company or bank will pay you a retail price for the car rather than the fleet price. Then they'll handle the account from that point. In some cases, the dealer is responsible for buying the car back, in others he's not ... it all depends on the arrangements made with the cooperating lasing company or bank.

In my opinion, there's one major drawback to brokering and that's that a dealer can't stay close to his customer. You hand a customer over to another company and you lose all contact. That's bad since so much of this business is based on repeat and referral. If you hand your customer over, you never know how he's being treated and won't know until he fails to come back for another lease. And if he's upset about something, chances are he'll be mad at you since you put him into the lease and have not followed through for him.

On the other hand, if a dealer is not that interested in going into leasing in a big way and is just looking for added income without the bother of setting up a bank line or hiring people, brokering might be the right way to go.

If, however, a dealer is really serious about leasing and has the market potential to develop in excess of 300 or 400 leases, then I would strongly urge a dealer to develop his own company. There's a tremendous amount of work involved on the dealer's personal part, but the reward can be well worth the effort.

What kind of time would be demanded of a dealer once he's into leasing? When does a part-time job become a full-time job?

Miller: You're assuming that the dealer, general manager or sales manager will be handling the leases. On this basis, if a dealer can generate around five lease cars a month, it should take about 25-percent of his time and about the same amount for an office girl. If he generate ten or so a month, that's worth about 50-percent to 60-percent of his time. Usually after that, if he plans on servicing his customers as he should with hopes of a high percentage of repeat or referral business, he's going to need full-time help, like a knowledgeable full-time leasing manager and an office girl. This also assumes the dealer is going into a full leasing business and does not plan on brokering.

This may seem very basic to most dealers, but what are the various kinds of leases available?

Miller: There are three kinds. First, the open end lease otherwise known as the finance lease. The customer knows exactly what the original purchase price or capitalized cost of the car is, he knows how much it's going to be depreciated each month and he knows at any time during the lease how much he owes on the car when the lease is up. He is responsible for that balance at the end of the lease.

Having the customer owe anything on this type of lease is bad business and we really try to avoid it. In fact, in the six years we've been leasing we've only had one car come back with a balance higher than the market value. I'll get into the details of setting the "pay back" value a little later. But the important thing to remember is when you set a pay back at the end of the lease, be realistic and accurate. Otherwise, you're going to have disgruntled customers on your hands and a very slim chance of renewing.

I believe, by the way, that the open end lease is the most widely used in the industry.

The second kind is the closed end lease. Here the leasing company assumes full responsibility for the resale value. The customer's responsible for keeping the car in good condition and he's responsible for excessive wear and tear on the car. He is also responsible for mileage and pays a charge for mileage in excess of the amount that you and he agreed upon. In setting this kind of lease, there are a lot of value judgments that you have to make about the customer ... does he dress neatly and look as though he takes care of himself; what does his own car look like. If the customer is sloppy about himself and his car, chances are that's the way your car is going to come back. You must also consider what he is going to use the car for. A car for personal use with one driver or a driver and his wife will have better care than one that is being used for company business with many drivers. Also consider where it will be driven and how many miles it will be driven. All these factors help determine the value of the car upon termination.

The third kind of lease is the maintenance lease, which was used widely on the east coast but is now losing favor due to reduced warranties and unpredictable maintenance costs. These leases can be very profitable but can also be hazardous for the leasing company. They certainly are not recommended for a beginner in leasing.

How do you calculate the cost of a lease?

Miller: First you add a reasonable profit to the base price you paid for the car and that becomes your capitalized cost. Generally, the profit is about 10-percent of the acquisition cost.

Then you have to determine the value of the car at the end of the lease. Several things are involved here; what does the customer look like, what's his present car look like, how many miles will he be driving a year, etc. As I think I said earlier, and average lease customer should be an above average person. After all, you're giving him the use of your car with a very small cash outlay, and also he doesn't feel as if he has actual ownership of that vehicle and may not care for it the way he would if he actually owned it. Also review wholesale guide books and take from historical experience to try to determine what this type of car is going to be worth at the end of the lease. This balance is known as the residual balance.

If you subtract the residual balance from the capitalized cost and then divide that by the number of months the lease will run, you will have the monthly depreciation. You then add a service fee. This fee should cover your interest cost, administrative costs and a small monthly service profit. The service fee profit and the capitalized profit make up the lease gross profit. The amount of profit to add depends on various factors. There are certain guides, but I believe that is really a localized situation. Dealers should become involved with local leasing associations and talk to other lease companies to get a fix on how much to set their profits for service.

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What's the average length of a lease?

Miller: Not long ago, it used to be 24 months or less. Thee days, with the prices of cars going up, leases are getting longer; we write many 36 month leases as well as any period that makes a good lease. Our fleet average right now is 28.4 months.

What are the advantages of someone leasing a car in the first place?

Miller: Contrary to popular belief, there is no tax advantage to leasing.

There are, however, several important advantages to leasing. The primary reason is that a lease requires a minimal cash outlay. Usually for the first month's payment, a security deposit and the license fee, a customer can have a car.

There is also an important advantage for the customer who does extensive borrowing from banks. If he buys a car and finances it, he shows the balance that is owed is a liability on his financial statement. However, automobiles are quickly depreciating assets and the liability of the first two years will usually be greater than the asset. In leasing, by accepted accounting standards, the only liability that is shown on a financial statement is the current month's payment. This alternative, of course, makes the financial statement look best.

The most important point to most lease customers is that he receives preferential service treatment. That's a very important part of leasing and a very important selling point to a potential lease customer. If you don't offer much of a leasing operation. When the lease customer brings his car in for service, he deals with the man who leased him the car, not the service department. This way, the customer has somebody working for him that he knows, and frankly, someone who wants to lease him another car. So, the salesman who leased him the car is very interested in making sure his customer is happy. Remember, this business is built on repeat and referral and you can only get this through making his servicing needs quick, easy and efficient. As part of the service, a good leasing company must provide a loaner. We happen to have 15 loan cars in our operation.

Another important advantage is that you're a customer's complete "transportation man"; you're a professional taking care of every aspect of that car so that you customer will never have a hassle with any part of it. All he has to do is put gas and oil in it, and hopefully wash it once in a while. Beyond the basics of getting him into the car he wants and maintaining it for him, you should also advise him of the best time to recycle his car. Even though the lease may run 24 or 36 months, you should advise him of the best time to turn his car in, and that may be before the lease is up. For example, there may be an extremely favorable market on the Mercedes (which there happens to be right now) and you should tell him about it. You may even be able to get him some money back and then you'll have a very happy customer. Certainly with this kind of operating procedure, you'll guarantee yourself a continued lease customer.

Your primary business is selling Datsuns, but I assume that in the leasing business, you're leasing all kinds of cars.

Miller: Yes, and that's the only way to operate. You want to become the lease customer's dealer for his total transportation needs. It's to his benefit as well as yours. Making any car available obviously builds a customer's confidence in you, particularly if he knows you're operating an auto agency as well.

There are fringe benefits to the dealership as well as the leasing operation. We have many customers who lease Cadillacs and Mercedes and either buy or lease Datsuns from us for their second or third family car or for their second or third family car or for their business. They don't even consider another dealer. The know we're a Datsun dealer and feel that when we've done such a good job in taking care of them with a vehicle that wasn't our own product that we'll do an even better job with our own product. They've already established a relationship with us so they have confidence that their family or business associate will find their needs cared for satisfactorily. By leasing other makes you have the flexibility of keeping that customer no matter what his needs.

I assume you have to finance an inventory of cars of different makes to keep the leasing company going. Is there any way you can minimize your capital investment?

Miller: The arrangement that you make in financing your leases is the very critical thing. You should definitely make a deal with a lending institution to borrow at simple interest on the reducing balance as opposed to a normal automobile contract which is add on interest. Borrowing on simple interest allows you to build in a reasonable profit margin due to the lower cost of interest and allows you to be fairly competitive with the monthly payments that a person would make in regularly buying a car.

Of course, the second way that a savings is realized to the leasing company is to buy at fleet rates which is lower than what your customer could buy for.

What are some of the pitfalls that may exist in trying to set up a leasing company? What would you warn people entering the leasing business to look out for and to avoid?

Miller: I guess there are four primary things that must be considered carefully: cash flow, your banking relationship, determining leasing costs relative to competition and your own management.

Cash flow is probably one of the biggest problems, and a dealer has to have a complete understanding of it or he'll soon be in trouble. By its nature, leasing causes a negative cash flow, and a dealer is going to have to be willing to subsidize the operation for at least the first two or three year cycle. The dealer's profit comes from monthly payments, only in small increments, say around $10 per month per lease. The bulk of the profit is realized when the lease terminates. In the meantime, the bank is asking for their full monthly payment. Therein lies the problem. The dealer will have to determine how many cars he can afford to put out on a lease basis, recognizing that he will have to meet the bank's repayment schedule and carry the overhead on the leasing operation until it reaches a point where the cash flow is large enough to take care of the expense.

The cash flow situation ties directly into your banking relationship or arrangement. Whatever the arrangement, you must be competitive in your own market, not only in terms of the rate of interest that's charged, but also on the rate of payback. Many times the bank requirement for principal payback plus the cost of interest will exceed the customer payment to you. If this occurs, you will then have negative cash flow plus have nothing left to pay overhead expenses. I recommend that a dealer review his bank line very carefully with his banker and office manage before jumping.

Of course, the relationship a dealer has with a bank through his dealership is an important one and should serve to give preferential service over an independent leasing company. That's another reason, by the way, to consider running your own leasing company over brokering your leases as we discussed earlier.

Every dealer should watch out for trying to be too competitive, especially if he's not properly capitalized. In other words, don't try to set monthly payment rates too low. What can happen if he gets into this situation on an open end lease is that the car may be brought back with, say a balance of $1,800 and the true market value may be only $1,500. I can't stress too much that the key success in leasing is your repeat and referral business. If you hit a customer with a big deficiency he's not expecting at the end of a lease, chances are you'll lose him. Be honest up front with him. Tell him a person quoting a lower monthly rate is going to create money problems for him at the end of the lease. Honesty and integrity are critical.

The last thing I can think of, but it's probably the most important, is how well the dealer has thought out and understood every detail of leasing before he goes into it. It's obviously not an easy subject and can involve a sizeable investment. I guess I'm kind of conservative about things, but I personally studied leasing for nine months before I even considered making a decision to go into it. I took courses, read everything I could and talked to as many people as I could who really knew something about it. For me, I think it's paid off. I recommend this approach for any dealer. At first, I ran the leasing company myself until I had about 150 leases on the books. Then I started searching for a manager that I thought really had the savvy to run my operation the way wanted it run. When I found him, I made him spend the next 90 days following me around until I felt confident that he would think exactly the way I would when it came to a decision. Whether my decision was right or wrong, I wanted it done this way. In my opinion, the stakes are too high not to operate this way.

You've emphasized studying and getting to know the leasing business. Where could a dealer go to learn more about it?

Miller: Sam Lee, Vice President of First Leasing in Beverly Hills is an expert on the subject. They publish a monthly news letter called LEASE NEWS which can be requested through First Leasing. Lee has also published a book called The Basics of Leasing which I think is an outstanding book that gives a real in-depth study of the whole leasing subject. I also recommend joining a leasing association which usually publishes some helpful information. One of the biggest is CATRALA. They're all over the country, so chapters should be accessible to most dealers. Dealers should also try to attend any association seminars they can ... these are put on regularly by the NADA or CATRALA.

If you had one parting shot, what would be the most important thing for dealers to consider about leasing?

Miller: Study it and really understand it with the ultimate thought in mind of taking a conservative approach to leasing. Be careful; don't get caught in full battle competition and wind up pricing yourself out of business. In my opinion, sensible leasing is not a numbers game, it's a profit game. But for that matter, what isn't?