It’s not uncommon to hear dealers say, “Our grosses are too low,” when they adopt the Velocity Method of Management™ principles for their used vehicle department.
The reality, however, is that gross profit margins are under pressure for every dealer — irrespective of whether they use Velocity® principles or more traditional approaches for managing used vehicle inventories.
NADA reports that the average retail gross profit for used vehicles was $2,161 last year, a 2 percent drop from $2,214 in 2010. This dip is indicative of broader industry trends where high wholesale prices and price-conscious buyers combine to narrow dealer margins.
As I’ve noted here before, I believe this margin compression is the “new normal” for dealers. Dealers who believe they should achieve $3,000 or more in gross profits on every deal are clinging to unrealistic expectations in a market that simply doesn’t pay out like it used to.
In this environment, I remain convinced that the Velocity approach to managing used vehicles — where dealers and their inventory management processes are keenly attuned to market dynamics — are best positioned to maximize the profit margins today’s market will allow and thrive as successful 21st-century automotive retailers.
But the promise of profitability and success isn’t automatic. Nor is it likely to arrive when dealers approach the Velocity Method of Management™ principles in a piecemeal fashion. This is because the used vehicle lifecycle at a dealership involves a series of decisions and processes that are both individual and interconnected — if you touch one, you touch them all.
As I’ve discussed the problem of low gross profits with Velocity® dealers, I typically find the root causes of their difficulties result from a breakdown in the application of Velocity® principles to their used vehicle inventory management processes. When we examine these shortcomings in detail, it’s not uncommon for dealers to see the light: They’ve effectively left gross profit potential on the table because one or more of their used vehicle management processes are out of sync.
Here are four key Velocity Method of Management™ problem spots and the corrective steps needed to maximize the profit margin potential on every used vehicle:
1. Focus on fresh inventory.
The most successful Velocity® dealers keep at least 50 percent of their used vehicle inventory under 30 days of age. They do this because they recognize the potential for gross profit margin is greatest when a unit is fresh and depreciation has had less time to erode the spread between their investment in the vehicle and its market value. This focus on fresh inventory requires an emotion-free breed of discipline that’s different from the past; we’ve been conditioned to believe “a little age is OK.” This mindset is corrosive for Velocity Method of Management™ strategy and it will quickly result in aging vehicles with diminished gross profit potential. In an environment where every sliver of margin is essential, “a little age is not OK anymore.” Dealers and their managers have to learn to dispassionately dispatch the vehicles they’ve allowed to become a drag on their gross profit margins.
2. Manage acquisition costs.
The single-most important driver of a vehicle’s gross profit potential is the amount you pay to acquire it at auction or via a trade-in. To their credit, many dealers and used vehicle managers have become more market-astute and disciplined about the wholesale prices they’ll pay at auctions. Trade-ins, however, are another story. When I examine inventory acquisition costs with dealers concerned about low profit margins, we’ll often find that these dealers are not monitoring the look-to-book and cost-to-market ratios of their appraisers on a regular basis. In fact, some of the biggest inventory “misses” we find result from an appraisal that effectively killed a unit’s gross profit potential before it even had a shot in the market. This is the equivalent of a cardinal sin in automotive retailing: Appraisal processes must be more disciplined and structured to leverage the fact that trade-ins offer us the absolute best opportunity to acquire a vehicle and reach its profit potential.
3. Rethink reconditioning.
While dealers understand reconditioning costs can drag down a used vehicle’s gross profit potential, some do not actively manage this investment risk as well as they should. For them it’s more reflexive than reflective. They keep paying the cost because it’s considered necessary without asking if they may be investing too much for too little return. I’ve worked with Velocity® dealers who have improved their gross profit margins by aggressively changing their reconditioning process from one that fixes all flaws to one that efficiently and cost-effectively addresses the absolute necessities.
4. Prove your retail pricing.
When dealers get worried about used vehicle gross profits, they often play an old card; they simply raise their prices and expect their salespeople to hold gross. The problem here is that higher prices are a death knell for showroom traffic. Today’s buyers won’t look twice at vehicles they perceive as priced too high for the marketplace. Likewise, today’s buyers have a better sense of a fair deal than yesterday’s buyers. In turn, buyers today have less of an innate need to negotiate if they find used vehicles priced in line with what their own online research suggests would be a fair price.
Velocity® dealers have embraced these dynamics as they seek to maximize their gross profit potential. They’ve replaced negotiation with documentation as their chief means to hold gross in a deal. Next, they actively monitor and manage how well their sales teams convey the credibility of their retail asking prices with buyers. The end result: These dealerships close most of their deals with less than $300 in discounts from their asking prices, and they create an in-dealership culture that resonates with today’s buyers.
Dealers who have successfully addressed these trouble spots love to hear about other dealers complaining of “low grosses.” Why? Because many recognize their former selves in the comments and know that these dealers haven’t yet evolved all of their used vehicle management processes to compete more efficiently and effectively, maximizing their gross profit potential.