It’s probably not the best time to talk about problems in the new car business.

After all, dealers have been enjoying what may go down in history as unprecedented success in new vehicles. Sales have been on steady uphill climb since 2008, and Ford Mustang classic muscle cars 300x210 3 Reasons Efficiency Will Ultimately Drive New Car Profitabilityeveryone expects the current year to end on the same, if not better, note than last year.

But the buoyancy around the industry’s performance tends to mask three underlying fundamentals that I find disturbing:

Margin compression: While dealers have been selling more vehicles, they’ve effectively been making less money on a per-car basis. Stats from the National Automobile Dealers Association (NADA) show that gross profits as a percentage of sales prices have declined 31 percent since 2009 (from 3.6 percent that year to 2.5 percent in 2014).

Part of this decline owes to rising transaction price transparency. It’s easier than ever for today’s buyers to learn how much they should pay for a vehicle online. The decline also owes to factory pricing decisions. This spring, Fiat Chrysler became the latest to shave a percentage from the margin between the dealer invoice and the manufacturer’s suggested retail price (MSRP).

The cyclical nature of car sales: Dealers should know better than anyone else that ours is a cyclical business. We’ve enjoyed a really good run the past several years as new vehicle sales have satisfied demand that effectively disappeared during the economic downturn.

But this market demand simply can’t last forever, particularly when the past few years of sales have been marked by ever-longer finance terms. Analysts may disagree on the timing, but most concur that sales volumes will eventually level off, if not decline, from current levels.

Increased reliance on “below the line” monies: I recently spoke to a Chrysler dealer who has all but given up on front-end gross profit in new vehicles. The reason: The dealer’s determined that it’s in his best financial interests to essentially give up front-end gross profit in favor of retailing more cars to meet factory stair-step incentive targets.

This dealer’s decision is increasingly common. In the face of an ever-smaller pool of front-end gross, who can blame a dealer for chasing the bigger pot of gold? The problem, of course, is that the “below the line” money carries conditions, some of which erode the entrepreneurial nature of being a car dealer.

Likewise, the “below the line” money isn’t guaranteed. While factories are pretty flush right now, it’s not irrational to consider that bonus program rewards will diminish as sales volumes decline.

Taken together, the underlying new vehicle market fundamentals suggest a darker horizon for dealers. The next question becomes: What can dealers do today to prepare for conditions that may create a perfect storm of problems in the not-so-distant future?

The answer, at least to me, rests in increased efficiencies. Dealers will simply have to retail a greater volume of new vehicles at a lower cost per unit, and in less time, than they’ve been accustomed to in the past.

Some dealers have already embraced this efficiency-focused operational standard. Their emphasis on efficiencies typically manifests in three ways:

  1. Stocking the right new vehicles. The dealers use new technology and tools to consistently align their inventory mix to current market demand. The strategy builds volume while reducing time in inventory and related carrying costs. The dealers essentially create an advantage over other dealers who are less adept at mining market data to make inventory decisions.
  2. Pricing to meet customer expectations. Just as we’ve seen in used vehicles, more and more dealers are adopting a “near one-price”-type approach to pricing their new vehicles. That is, their asking prices include incentives and other discounts to advertise prices that fit the range of transaction prices today’s buyers can easily find online. These dealerships also adopt pay plans that reward sales associates for selling more cars and minimizing discounts.
  3. Reducing transaction times. Progressive dealers are embracing a goal of a one-hour-or-less average transaction time for new vehicle customers. To achieve the goal, the dealers employ e-commerce-type tools to effectively complete a deal before customers arrive at the showroom for a test drive. The ultimate goal: A faster, more satisfying in-dealership experience that seeds repeat/referral business.

I realize some dealers likely won’t appreciate my frank assessment of the future new car market. But, as my Dad has always said, “the worst days aren’t quite as bad if you see them coming.”

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Following is an email from a friend and customer about increasing his inventory as we enter the summer slowdown.

Good afternoon Dale. Hope all is well with you. Last month was a down month for my used car department. Sold 62 at $1200 per copy. I had around 15% of my used inventory as trades and the rest were “p” cars that I know I’m paying up for. Anyway the turned dropped from 18 to 10. I’ve identified some changes I need to make and will spare you the details. My pay plan is maximized at 80 used so my thoughts are taking the inventory up from 88 used in stock to 120. So even at a 10 times tchrysler When Should You Increase Your Inventory?urn I still end up at 85. I’m simply adjusting my math. I killed it March and April, breaking store records selling around 85 cars at $1700 front end per copy. But I also had trades coming in. It’s tough when you have to pay up at auction but necessary to generate an opportunity.

So my questions are what are your thoughts going into the second half of June and the rest of the summer? It seems there are less “right” cars on Smart Auction and people are less willing to deal on them. I’ve been the used car manager here since mid-February so I’m still trying to dial in the right inventory. They previously carried 110 cars and sold 48 on average. It also seems the used car business is slow in this area. What are your thoughts on the overall used car market now? Thanks in advance for your time.

 Here is my reply:

WARNING, WARNING, WARNING. DO NOT INCREASE YOUR INVENTORY

You’re about to make one of the most common mistakes in the used car business. Specifically, you do not ever increase inventory for the purpose of selling more cars. The only proper justification for increasing units is to slow your turn. Once your retail turn reaches 15-16 turns, you have the right to either raise your prices slightly and generate more gross or add a few more units to your inventory. Either approach under such conditions is prudent so long as you do not fall below 12 retail turns per year.

This advice is especially critical at this particular moment of time. This is because the values in the wholesale market have already peaked and will only be declining for the balance of the year. Your approach is also ill-advised because of the large quantity of late-model expensive off-lease cars that are due to be returned to the market in the coming months. If you go out and buy a whole bunch of used cars now you will surely have an excess amount of over-valued inventory in the coming weeks and months.

Think about the analogy of operating a fish market. If your current sales were below your expectation, would you go out and buy more fish with the belief that it would generate additional sales? The answer is obviously no. Sell what you have in stock as it already represents more units than you should have.

In other words, what you have on your hands right now is a sales problem, not an inventory problem, and therefore, you should address it as such.

 

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It’s becoming more critical for dealers to pay close attention to the average cost of their used vehicle inventory.

I say this for three reasons:

concept car 2 300x155 3 Ways To Turn Your Average Inventory Cost Into AdvantageFirst, today’s market can lead dealers to believe that managing your average used vehicle cost isn’t important. After all, cars are more expensive and, if you want to play in today’s highly competitive used vehicle market, you’ve got to pay.

Second, even if a dealer recognizes how/why a lower average inventory cost helps a used vehicle department reach its peak performance potential, it’s easy to look the other way when buyers or managers consistently pay too much for trade-ins or auction purchases.

Third, dealers who do proactively manage their average used vehicle inventory cost tend to sell more cars in less time than dealers who don’t. Among the best-performing dealers I know, the average cost of their inventory is a topic of conversation and investigation every day. They live and breathe the metric, and their results prove the benefit of their cost-minded commitment.

One of these dealers is Bradley Williams, general manager for Rivertown Buick GMC in Columbus, Ga. His take: “The further you drive down your cost, the quicker your inventory turns. Increased volume should follow.”

Some dealers may question this thinking but, if you step back, it makes sense. There are far more potential buyers for lower-priced vehicles, and these units also typically pose less depreciation and valuation risk than their higher-priced counterparts.

The key question then becomes, “OK, Dale, what’s the best way to set and manage our inventory cost targets?” Here are three best practices I’ve gleaned from Williams and other dealers:

1. Recognize the relationship between average new/used vehicle costs. I like Williams’ formula: He strives to maintain his average used vehicle cost at 50 percent of his average new vehicle cost. For example, if his average new vehicle cost is $26,000, his average cost goal in used vehicles is $13,000.

This goal serves two key purposes. It helps create an inventory mix that delineates the value proposition between new and used vehicles for customers and, if managed correctly, can mitigate the preferences of individual buyers/managers, who like stocking higher-cost cars.

2. Evaluate your inventory turn by cost segment. For Williams, this analysis taught him that lower-cost cars turn more quickly. “As I managed my $13,000 cost target, I could usually expect an increase in monthly volume of one unit when we landed $100 below the goal,” he says. “I could also expect a reduction in unit volume as average cost increased.”

Other dealers arrive at the same conclusion as they evaluate inventory age by cost segment. In many cases, the oldest vehicles are also the most expensive and, in turn, they often suffer from the most significant price (and gross profit) reductions as dealers do their best to retail them.

3. Be realistic, and not too rigid, with your average cost target. The best used vehicle retailers recognize that managing your inventory to meet your average cost target is a balancing act. If you’re too firm, you’ll pass up retail-worthy vehicles that happen to fall outside your cost parameters. If you’re too flexible, you run the risk of burdening your inventory performance with too many expensive cars.

“You have to be realistic,” says the used vehicle director for a six-store group in the Midwest. “There are times when I’ve relaxed our cost targets to make trades and fill inventory gaps. But when I do, I know I’ve got to focus on retailing those higher-cost cars quickly to keep our turn and grosses in line.”

In closing, I should note that I’m writing this article as the spring selling season is coming to a close, and analysts indicate used vehicle values in most segments are on the wane.

My prediction: This seasonal volatility will prove far less problematic for cost-conscious dealers who, through their ongoing diligence and discipline, will have the advantage of less inventory water to bail as summer arrives.

 

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A Case Of One Step Forward, Two Steps Back

05.29.2015

Mistakes happen in used vehicles. Simply put, there are too many things that could go wrong, for everything to always go right. That’s what makes the following story from a used vehicle manager so troubling. Last December, the manager made a decision to stock up on inventory. He had no choice but to acquire the [...]

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3 Ways To Boost Used Vehicle Profitability While Selling More Cars

05.28.2015

  In its 2014 report on dealership financial performance, the National Automobile Dealers Association (NADA) highlights a disturbing trend in used vehicles. The NADA report notes that franchise dealers enjoyed a 6 percent increase in used vehicle sales compared to 2013—an increase similar to what dealers saw in 2013, compared to 2012. Yet, net profits [...]

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A Quick Look At Closing Ratios And “Closers”

05.22.2015

I’ve been asked recently for benchmarks on closing ratios for dealers. The frequency of the question, I suspect, follows the fundamental change in the way today’s new/used vehicle shoppers zero in on a potential purchase. As most dealers are aware, shoppers do the bulk of their homework and research online. On average, they visit fewer [...]

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3 Ways Packs Prove Problematic For Dealers

05.15.2015

  There’s no question that dealers like packs. But packs have become increasingly problematic for dealers, sometimes in ways they fail or refuse to see. I recently asked a group of dealers to share how much they packed their used vehicles. The responses ranged from $0/per car to $1,200/car. I then asked the dealers at [...]

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Dealer Enjoys Early, E-Commerce Success

05.08.2015

General Manager Todd Long dares to be different at O’Neill Honda in Kansas City. Before he took the job in December 2013, Long mystery-shopped the competition. “It was the epitome of the ‘90s all over again,” he says. “Nobody’s outside. Nobody’s helping you. No manager TO. The MSRP is the price. His findings convinced him [...]

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3 Lessons From Top-Performing Used Vehicle Retailers

05.04.2015

I was struck by several take-aways from Automotive News’ Top 100 Dealer Groups Ranked By Used Vehicles report published last week. The dealer groups’ collective performance keeps getting better. The report says the groups saw a combined 9.9 percent gain in retail used vehicle sales in 2014, 4 percent better than the industry as a [...]

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3 Ways To Eliminate The Used Vehicle Manager’s “Double Curse”

04.29.2015

Some used vehicle managers carry a double curse. The first curse is their absolute focus on average front-end gross profit. They’ll say, “I can’t change this price because there won’t be enough front-end gross,” or, “I can’t buy this auction car because there won’t be enough front-end gross,” or, “I can’t offer the customer what [...]

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