The news splashed across the page read, “J.D. Power Reports More Vehicle Owners Are Purchasing Service Contracts.” The story noted a new-vehicle penetration rate of 25 percent in 1999, up from an all-time low of 20 percent in 1997. So it appears service contracts are notoriously good sellers in the pre-owned decade of decline between 1987 and 1997, J.D. Power reported.

So what about used vehicles? Service contracts are notoriously good sellers in the pre-owned sector, where vehicles are older and factory warranties come with an end in sight. “Penetration, from numbers I’ve seen, is up from last year, which is a reverse of the trend that’s been in place for the past five years or so,” said Ted Thompson, vice president of sales for GE Auto Warranty Services. “The trend for the last five years has been more toward the pre-owned and program cars, so actually, it has probably enhanced sales.”

Industry experts agree that used-vehicle penetration is stronger than new-vehicle penetration for a number of reasons, primary among them being high volumes of off-lease vehicles that have flooded the market in recent years. “The sales of off-lease cars will continue to fuel service contract sales until we reach the tail end of the leasing boom,” said Sam Haik, of Wynn Oil Company.

Ed Bradley, vice president of JM&A Group, echoes Haik’s comment, noting the strong supply of used vehicles that are prime for service contract sales. “There is a great supply of clean, low-mileage, off-lease vehicles on the market that are fairly easy to sell service contracts for,” Bradley said.

Larry Altman, vice president of Interstate National Dealer Services, sees softening leasing levels as another reason for improving penetration. “Penetration levels have increased ever so slightly, I think, because leasing levels have dropped off ever so slightly,” he said.

Rising Sales

The Internet has also fueled service contracts’ rising penetration numbers, Thompson said. Consumers can research vehicles in depth before visiting dealerships, so they’re better equipped to negotiate lower prices than five years ago. That cuts away profits, according to Thompson. “That means grosses on new cars are being squeezed because people can research cars online before buying then, and now they can even buy them online,” he said.

So Thompson said many dealers try to resuscitate those profits through the F&I and service departments. That translates to a stronger push for service contract sales and keeps penetration levels higher. Bob Corbin, senior vice president of sales for CAN National Warranty Corp., sees another reason for stronger overall penetration – decreasing margins on new car sales. “Business is very good,” he said. “We’re adding new dealers to our ranks, and F&I penetration is up because margins on new car sales are waning for dealers.”

Disposable income and quality products led service contracts’ resurgence in 1999, said Pamela Hill, customer satisfaction research manager at J.D. Power and Associates. “The strong economy of recent years and attractive service contract products have been key factors contributing to the sale of service contracts,” Hill said. “When customers have more disposable income and the dealer is offering appealing service products, a good salesperson is better able to turn the sale.”

Perhaps awareness is the simplest explanation for rising service contract sales. People seem to know that a service contract can be a lifesaver when buying a used vehicle, according to Haik. “Today’s consumer is more sophisticated than ever before, and thanks to strong advertising for certification programs, they almost expect to get a warranty at the time of purchase,” he said.

Altman added that a new generation of products like “guaranteed price refund programs” spurs strong contract sales. Refund programs let buyers opt for warranties that last about five to seven years, and if they never use warranty services, they get a full refund minus interest. And if buyers end up using the warranties, they made good investments, Altman said. “This was around occasionally throughout the years, but there’s a big push now because penetration dropped so much in the past five years,” he added. Positive outlook strong penetration numbers mean strong sales, and a lot of service contract providers seem to be having a good year.“We just got our volume numbers back for the first quarter of 2000, and they’re up 107 percent over the first quarter of last year,” Thompson said, “The car business as a whole was very good last year and still is this year, and we expect to have a very good year.”

Confidence is also high in Deerfield Beach (FL), home of JM&A Group. “Business is great at JM&A,” JM&A President Lou Feagles said. “The first quarter showed 25 percent compounded annual growth in the service contract area. Car sales are good, and the reconditioning business is robust.” And no one seems to think that service contract sales have crested. They’re only now heating up, according to Haik. “We see the service contract as one that still has tremendous potential,” he said. “There is a lot of room to grow and thrive. I think it’s going to continue to expand because there’s more headroom for penetration.“This is a market that is not mature yet. When you see penetrations reaching as high as 80 percent, then it can be considered mature.” Until then, you might see service contract sales in a state of defrosting. “The entire industry rebounded last year, and now we have to discover if it’s a trend upward or an anomaly,” Bradley said. “We certainly hope it’s a trend.”

Weaker Sales in Past

Since the mid 1980’s, service contract sales have fared poorly. Altman credits that trend to the rapidly growing popularity of leasing throughout the 1990’s, where customers kept their vehicles for only a few years and saw no need to invest in service contracts. But he believes dealerships’ waning investments in their F&I departments contributed to the decade-long weakening. Hill stated that an aging U.S. population also affected penetration throughout the decade. Older owners are less likely to purchase a service contract than are younger owners, the survey stated. Automakers’ recent taste for shorter lease terms – as few as two years – has also weakened penetration, Corbin added. “Lease incentives have always had an effect,” he said. “They negatively affect service contract penetrations because, if you have a two- or three-year lease and a two- or three-year warranty and only plan to keep that vehicle for that period, you don’t want to buy a four-, five- or six-year contract.”

Confusing policies also kept some buyers wary of buying contracts, Altman said. If on Jan. 1, 1998, you buy a vehicle that came off the assembly line on Jan. 1, 1996 and opt for a six-year service contract, your coverage starts the day the car was sold, he said. That’s two years after you bought it. Dealers had to explain that a six-year contract was really a four-year contract with new-vehicle perks, and it just didn’t make sense, Altman said. About half of used-vehicle service contracts now start on the date of resale, he added.

Buyers Expect Value 

A key to improving penetration is tapping into what buyers want. Altman says today’s buyers want security and value. They expect a contract worth about five percent of the vehicle’s value, which he says is difficult to find now that vehicles are to technologically studded. Altman said that vehicles made two years ago consisted of two percent technology and that vehicles made today are 45 percent technological. “That makes it more difficult to repair a vehicle,” he said. “Instead of replacing a $5 dollar part, you often have to replace large, expensive components.” That technological dependence makes it even more important for a consumer to buy a service contract, according to Thompson. “Cars are much more complex now than they used to be,” he said. “For a long time, people felt confident enough to repair all of the minor and a lot of the major problems themselves, but with advanced technology, it’s next to impossible to do the repairs yourself.” Corbin says used-vehicle buyers who opt for service contracts want protection from previous owners’ problems. Service contract buyers also want coverage as close as possible to factory warranties.

It’s also important for sub-prime buyers to consider service contracts for their used vehicles, which tend to be older and higher-mileage, Haik said. Those vehicles are more likely to need costly repairs, and buyers without contracts sometimes have to abandon vehicles not worth the expense. Haik applied the same strategy to two-year-old, off-lease vehicles. A service contract helps buyers avoid depreciation and an increasing risk of big repair bills, he said.

Concerns

While the skies seem a little bluer today than several years ago, contracting companies still have concerns. “Clearly, the biggest issue for dealers today is, ‘What is the strength of continuity of the insurance backing of the company?’” Corbin said. Knowing that is akin to confidence that the contract provider stands on firm ground, and with that, he says dealers can sell a high-quality product. Corbin also says dealers need to be confident their warranty companies are working for them and not competing with them. Warranty companies need to sell their contracts only through dealers, because a customer that buys a service contract at a dealership and then finds the same contract offered directly from the company at a lower price will feel cheated.

Warranty companies also need to take steps to ensure growth in contract sales, says Greg Laube of The Paint Bull, a reconditioning company that offers excessive wear and tear lease protection. “For strong growth and stability in contract sales, two events must occur,” he said. “First, the integrity of the product has to be maintained. Customer retention and satisfaction are the driving force of a dealership’s success. Nothing less than a superior protection plan will survive the buyer’s scrutiny. “Second, a new generation of vehicle protection products must emerge, specifically in the leasing market.” That kind of product must “provide a new profit center” and offer better service and retention, Laube added. Paint Bull Plus, a three-stage plan debuted by The Paint Bull in March, fits the prototype, he said. Paint Bull Plus manages the vehicle service contract through it’s full cycle by:

--processing the initial sales information and creating a customer service file for each contract.

--performing the termination inspection.

--providing a certified vendor to perform services needed to fulfill the contract.

Laube thinks the market is ripe for success in warranties and service contracts but adds that only the strongest programs will thrive. “I think dealer confidence is getting high,” he said. “It’s survival of the fittest, shall we say?”