In the past several weeks, I’ve met with dealers to discuss front-end gross profit problems in used vehicles.
The gross profit problems, it should be noted, are not due to low sales volumes. Often, these dealers are selling more used vehicles than they used to. The issue is that front-end gross profits are not meeting dealer expectations.
To root out the source(s) of the trouble, I will closely examine the factors that make up the cost-to-market metric for a dealer’s inventory. This number shows the relationship between the total costs for a vehicle (acquisition, fees / transportation, reconditioning, packs, etc.) and the prevailing retail prices for the same or similar vehicles in the market.
Typically, I look for an 84 percent cost-to-market average for a dealership’s inventory. This figure says that, on average, the used vehicles in a dealer’s inventory offer a 16 percent spread for the sales team to secure front-end gross profits. Example: If a vehicle’s total cost is $13,500 and its cost to market is 84 percent, the retail asking price is $16,070 and the spread is $2,570.
Not surprisingly, the dealerships where front-end gross profits are a problem typically have cost-to-market ratios near 90 percent. For a $13,500 used vehicle, a cost-to-market metric of 90 percent translates to a spread of $1,500. This is the profit margin the sales team has at its disposal to close deals.
When I see this, I’ll drill down to figure out why the cost-to-market is higher than it should be. I often find a problem in one or more of the following three areas:
1. Vehicle reconditioning costs
In my day as a dealer, we didn’t worry too much about over-doing the reconditioning on a car. We knew, more or less, that if we invested $1 in reconditioning, it would return $1.25 for our effort and time. Today, however, I’m not convinced this ratio holds true as a general rule. It certainly does for some vehicles in some markets. For others, it’s more of a crapshoot. We can’t really know with certainty whether our decisions to replace tires, install new brakes or fix small dings on windshields and upholstery make a critical difference with today’s buyers.
For these reasons, I recommend that dealers with gross profit concerns should re-evaluate, and potentially re-invent, how they handle reconditioning. They should recognize that these costs have a direct impact on a car’s profit potential — and they should take steps to mitigate these add-on costs wherever possible. Such mitigating steps might include reducing the retail rates charged to the vehicle for reconditioning parts and labor in service. Other steps include ongoing efforts to manage or reduce the scope of reconditioning work approved for every vehicle, the use of non-OEM, warrantied parts when appropriate, and centralized operations.
2. Vehicle packs
Some dealers add as much as $1,000 in cost to used vehicles through packs. I’ve found this practice can shrink a dealer’s used vehicle margin spread in three ways.
First, a pack adds cost to a vehicle. The greater the pack, the greater the cost, the smaller the margin spread. It’s as simple as that.
Second, the presence of packs often spurs reflexive pricing decisions. Dealers will price vehicles above the market to make up for the pack cost they’ve added to a car. This reduces the unit’s appeal to online buyers and contributes to aging issues that reduce profit.
Third, packs can create a chilling effect on appraisers. They end up low-balling trade-in offers to account for the dealership’s pack. In turn, the used vehicle department acquires fewer cars at the front door, and spends more time and money buying vehicles at auctions. Poof! A little more of the spread disappears.
3. Sales process transparency
In a recent discussion with a five-store dealer group in Wisconsin, the gross profit troubles were not caused by cost-to-market or aging inventory issues. This dealer group was a textbook Velocity® dealer. They did an incredible job preserving the spread for every car — until it hit the sales desk. There, sales managers were discounting cars to close deals. Put another way, they were handing over the spread to customers.
This group took immediate action. They implemented training to help create a transparent sales process that calls for salespeople and sales managers to directly discuss the group’s market-focused approach to pricing — what I call “documentation as the new negotiation.” The result? They’ve added an average $200 in gross profit per copy in just three weeks, and the number’s still climbing.
I should note these three problem areas are not the only factors that can reduce a dealer’s gross profit potential in used vehicles. They are, however, the ones that appear to be the biggest current contributors and that merit immediate scrutiny for dealers who seek improved used vehicle profitability.