Temptation Abounds. Will You Bite?

by dpollak on 01/30/2018 · 0 comments

‘Tis the season for temptation in used vehicles.

It’s that time when some dealers stock up on used vehicle inventory in advance of the annual rite of spring-fed retail sales.

I got a note today, in fact, from a dealer who’s contemplating bulking up his inventory even earlier this year, given recent softening of wholesale prices.

I had to ask the question: “How did that work out for you last time?”

The answer wasn’t surprising. Last year, the dealer began acquiring more inventory late January to ensure he had enough vehicles to meet anticipated demand in early March. But, “by the end of February, the wholesale market had increased and we were selling aged units for less than it cost us to acquire inventory,” he says.

The dealer’s experience is not unlike those I’ve gleaned in conversations from other dealers. To an individual, they all admit that previous attempts to speculate on an expected uptick in retail sales often don’t pan out the way they thought they would.

Take this experience from a Texas dealer, who bulked up his inventory in anticipation of selling more used vehicles to replace those lost in Hurricane Harvey.

Indeed, the dealer sold more retail units, but he also suffered a hangover effect—a preponderance of 70-day and older vehicles he was forced to list at “fire sale” prices at the end of the year to get out of them. The upshot: The losses on the aged units effectively wiped out any gains the dealership realized from succumbing to the temptation to speculate.

“We thought the buying frenzy was going to last longer than it did,” the dealer says. “The projections of 750,000 to 1 million totaled cars wasn’t. Right now, we have 30 units on fire sale to get out of them. We just projected wrong.”

Such experiences have led me to conclude that dealers simply aren’t as good at gambling or speculating on future retail sales as they think. In fact, I’d assert that these attempts to play the market only pay off about 50 percent of the time.

Unfortunately, dealers often don’t remember the 50 percent of the times their speculative efforts don’t work, especially when they’re facing a fresh temptation to repeat the cycle.

On some level, the inability to resist this temptation is understandable. Dealers and used vehicle managers are typically individuals who like to gamble and take risks—witness the shoulder-to-shoulder blackjack tables after hours at any NADA convention in Las Vegas.

But I would suggest that dealers should strive to resist the temptation to speculate for the following reasons:

  1. Your past success. Like the two dealers mentioned above, it’s a useful, albeit sobering, exercise to honestly evaluate whether bulking up their inventory or holding on to vehicles really paid off in the past. How many of those vehicles sold quickly when the appointed time for their retail sale arrived? How many aged past the point where they delivered a sufficient return on investment? What was the average front-end gross for all of these vehicles (including any retail or wholesale losses)? In my experience, dealers find that their attempts to speculate panned out worse than they remember.
  2. Your holding costs. In many cases, the decision to stock up on inventory comes 45 to 60 days in advance of anticipated retail demand. This means if you acquire a vehicle for $15,000, you’re automatically saddling it with holding costs (assuming a $30/day average) that range from $1,350 to $1,800. This cost burden, which I recognize many dealers and used vehicle managers don’t regard as “real money,” makes it extremely difficult in today’s highly competitive market to realize a sufficient return on investment when the vehicles finally retail.
  3. Your crystal ball. In all my years, I still haven’t met anyone, in the car business or elsewhere, who can consistently and accurately predict the future, especially in an environment as competitive and volatile as today’s used vehicle market. We’ve all seen sure-fire winner vehicles turn out to be losers, which is a lesson worth remembering when the temptation to speculate strikes.

The bottom line is that the best dealers today are used vehicle retailers, not speculators. They don’t consider hope as a viable strategy for success. Rather, they focus their efforts on retailing everything they can in the current market. This strategy puts them ahead of competitors who can’t resist the temptation to speculate and too often get bogged down with the bad results.

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A new year brings much discussion about goals, resolutions and to-dos.

That’s certainly the case with a lot of dealers, judging from conversations and e-mails the past few weeks.

Collectively, the dealers are perhaps more clear-eyed about the year ahead in used vehicles than they have been in previous years. First and foremost, margin compression is no longer an abstract concept. Many dealers closed 2017 retailing more vehicles than they have in the past. Yet, the return on the effort and investment proved far from satisfying.

This recognition is important as many dealers are placing a higher priority on their used vehicle operations this year. They understand new vehicle sales volumes are likely to soften, while used vehicles will be good, if not better. They know that rising interest rates and credit challenges will probably put new vehicles out of reach for some buyers.

Some dealers are doubling down on used vehicles. They sense more opportunity and plan to follow the path of some public groups and open standalone used vehicle stores to further their growth and profitability goals.

Across this spectrum, I gleaned four resolutions that dealers believe will drive more productive and profitable used vehicle operations:

  1. Reduce acquisition costs. There are three elements to this imperative. First, dealers are aiming to press down the average cost of their inventory—a nod to the recognition that, for many buyers, affordability will be critical to making a sale. In recent years, the average inventory investment has crept closer to $20,000, a reflection of an emphasis on late-model units. Second, dealers will be focused on Cost to Market, working with more discipline and diligence to maintain an average 85 percent Cost to Market ratio for their inventories. Finally, dealers are also aiming to reduce acquisition costs through increased efficiency. I’ve heard more dealers say they will more aggressively and intently on online auctions, rather than physical sales, to acquire the wholesale inventory they need. They are looking for cost and time efficiency through technology, while sending managers and buyers across the country less frequently, if at all.
  2. Book more trades. The thinking here goes beyond the time-honored reality that dealers can generally acquire trade-ins more cost-favorably than they can from other sources. It’s also about inventory diversity and affordability. As one dealer put it the other day, “The trades are often older, and may need more work than we’d like, but they’re selling well.” To be successful, this effort often requires a greater level of oversight and training (or re-training) to ensure appraisers consistently meet your look to book and Cost to Market objectives, and recognize you might retail vehicles you didn’t take in the past.
  3. Reduce aged inventory. Data-minded dealers and used vehicle managers have noticed a disturbing trend—their vehicles are often running out of retail juice by the time they hit 30 days in inventory. The realization has led some dealers to move the goal posts. If they allowed vehicles to stay on their lots for 60 days, the new threshold is 45. A few dealers are even more aggressive, setting 30 days as their viable retail window. These adjustments typically require fine-tuning of your merchandising and pricing strategies to spur a faster pace of retail sales. Even I now offer a more time-sensitive recommendation: I now urge dealers to maintain at least 55 percent of their inventory under 30 days to mitigate margin compression and market volatility. My prior recommendation was 50 percent.
  4. Minimize speculation. In my conversations, I asked dealers where they went wrong last year. In many cases, the “big misses” owed to speculative bets that involved loading up on inventory in anticipation of future demand. These bets occurred when you might expect—in advance of the spring selling season, or in the wake of a natural disaster. The problem: Dealers, like anyone else, can’t reliably predict the future. They often find their bets play out right about half the time. Unfortunately, the losses on the other half of their bets often wipe out whatever gains they thought they realized. I like how a used vehicle manager in Phoenix plays his hunches. If he’s buying 10 vehicles at auction, eight or nine of will be dead-ringer acquisitions based on market data. The remaining units reflect the manager’s desire to take an occasional shot at playing his best guess.

I applaud the dealers for recognizing that margin compression is a very real and troubling risk to their used vehicle business. They deserve credit for resolving to do something about making the bottom line better.

But I also remind them of reality: Resolutions aren’t really worth anything until you bring them to life in your dealership.

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Velocity

by dpollak on 01/24/2018 · 0 comments

It’s not complicated.

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