3 Best Practices To Beat Back Used Vehicle Margin Compression

It’s like a leaky faucet.

Drip by drip, the retail profit you make on used vehicles goes down the drain.  

But unlike a leaky faucet, the fix for margin compression in used vehicles isn’t as easy as calling a plumber.

That’s because, more and more, ongoing margin compression in used vehicles is the nature of the business.

According to the National Automobile Dealers Association (NADA), used vehicle gross profits as a percentage of transaction prices has been shrinking, bit by bit, for nearly the past decade.

NADA data shows that in 2009, used vehicle gross profits ran 14.3 percent of average vehicle transaction prices, compared to 12.1 percent in 2016. This diminished return may not seem like much, but it’s a significant difference when you consider the average used vehicle transaction price has grown by nearly $4,700 (from $15,210 in 2009 to $19,886 in 2016, a 31 percent increase).

The challenge, and opportunity, for dealers rests in how you contend with margin compression.

The fix isn’t as simple as selling more used vehicles. In a margin-compressed environment, you have to sell more used vehicles more efficiently to maximize an ever-smaller return on an ever-larger investment.

To achieve a higher level of operational efficiency and sales, I recommend the following best practices for dealers:

A consistent sourcing pipeline. You can’t retail vehicles you don’t have in stock. More and more, dealers are employing full-time, technology-enabled sourcing specialists to maintain a steady supply of incoming auction inventory. The specialists free up managers who previously found themselves lacking sufficient attention and time to selectively acquire the right auction vehicles, with specific Cost to Market and Market Days Supply metrics, to fill inventory needs. It’s not uncommon for these time-addled managers to just buy cars because their inefficient sourcing methods lead to frustration and less-than-optimal decisions. Similarly, the specialists give managers more time to oversee appraisals and maximize every trade-in opportunity.

Faster retail-ready turnaround. It’s still fairly common for used vehicles to spend five, seven or even 10 days in service before they are reconditioned, detailed, photographed and posted online. A Midwest Chevrolet dealer found that by trimming three days off his dealership’s eight-day retail-ready average, he realized an additional $300,000 in front-end gross profits. The dealer is now working to consistently meet a 36-hour turnaround, and anticipates the improvement will generate an additional $200,000 in front-end gross.

The example highlights the “time is money” axiom of retailing vehicles in today’s margin-compressed market. I would also note that top-performing dealers set aggressive benchmarks of 24 hours or less to complete detail and reconditioning work—a goal that typically requires automotive RO approvals when repair estimates fall within expected ranges, and dedicated recon teams in service.

Reduced inventory age. I currently recommend that dealers strive to retail at least 55 percent of their used vehicle inventory in less than 30 days. Dealers who achieve this objective, which requires a Velocity-oriented pricing strategy, are doing all they can to minimize margin compression and take advantage of retailing vehicles when they are fresh and stand to deliver maximum gross profit. To understand why reducing the days to sale of used vehicles is so important, I encourage dealers to do a quick study of the gross profits they achieve on vehicles retailed in less than 30 days compared to vehicles retailed after 30 days.

In most cases, the results show the average front-end gross profit declines by at least 50 percent once vehicles cross the 30-day line. If you segment vehicles retailed after 45 days, it’s not uncommon to see a roughly 50/50 split between vehicles that make a little money and those that lose a lot more.

This analysis often leads dealers to agree with my assessment that any vehicle that you don’t retail within 45 days represents a failure of management. For some reason, right or wrong, someone turned their back on these units, when they should have been working harder to sell them.

It should be noted that none of these best practices represents an easy fix. Each requires dealers, managers and team members to think and do things differently, sometimes in a manner that’s contrary to what they’ve been taught.

But dealers who get past these hurdles find their reward. It comes in the form of improved used vehicle performance and profitability in an era where neither can be taken for granted.