How new car dealers make the big bucks

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How new car dealers make the big bucks
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Most of us probably believe that dealers laugh all the way to the bank on the profit they make when they sell us a new car. 

That belief stems importantly from the high prices of those vehicles. Today the average transaction price for a new car or truck is close to $34,000, excluding taxes and registration fees.

That opinion is reinforced by the negative attitude we have about the car-buying process. Most of us would rather have all our molars pulled than walk into a car store to haggle the price. Whatever the outcome, we end up feeling we’ve left beaucoup profit dollars on the table. And several Internet sites bolster that mindset by playing the car buyer’s victimization card over and over again. “Watch out for this trick!” “Don’t pay that fee!” etc.

It’s time to debunk those ways of thinking by exposing the truth about how smart dealers earn the bulk of their profit dollars — focusing on cold, hard facts, not long-outdated conventional wisdom and victimization clichés.

Read more: The true cost of owning a car is a lot more than you think!

A look at the country’s largest automotive retailer

Meet AutoNation, the country’s largest automotive retailer. At the end of 2015, this company owned and operated an “automotive mutual fund” of 342 new vehicle franchises, selling 35 different brands from 254 stores, predominately in major markets in the Sunbelt region.

On January 1, 2016, there were 18,058 new-car dealerships in the U.S., so AutoNation doesn’t dominate anything. But its management team is probably the smartest in the business. They buy profitable stores that are well-known in their key markets. They then leverage their significant scale and cost structure by centralizing and streamlining store-level accounting and administrative activities. Their objective is to be the best-run, most profitable automotive retailer in the nation.

Most important, AutoNation is a unique source of facts about the new-car business because it’s a publicly traded company, a component of the S&P 500 Index. So it must publish its financial numbers quarterly. Fortunately, the company’s annual reports go well beyond what the law requires. They’re a primer on how a well-run retail auto business really makes a buck. The 2015 report starts with pie charts that show the financial size of each major sales element and its percentage contribution to the company’s gross profit (total revenue minus the cost of goods and services sold). Feast your eyes on these enlightening numbers:

  % of Revenue    % of Gross Profit
New Vehicle Sales 57.5% 20.6%
Used Vehicle Sales 22.9% 10.8%
Totals     80.4%   31.4%
     
  % of Revenue   % of Gross Profit 
Parts & Service 14.8% 41.0%
Finance & Insurance 4.2%   26.6%
Totals  19.0% 67.6%

The sale of new and used cars accounted for over 80% of AutoNation’s revenue, but delivered less than one third of its gross profit. Parts & Service plus Finance & Insurance, under 20% of its revenue, contributed the balance. And these are the smartest operators in the business.

Then there’s the company’s “overhead,” the ongoing expense of operating any business. (Accounting, administrative salaries, insurance, legal, rent, utilities, depreciation, etc.) The gross profit must be adequate to cover this stuff and provide a net pre-tax profit that gives the company an adequate return on its substantial investment.

So how much gross profit does this automotive retailer make on a new car sale?

In 2015, its average revenue per sale was $35,375, including the selling price and all the secret factory bonus money earned for reaching sales and other targets. The gross profit per sale was a modest $1,985 — just 5.6% of the revenue. (On used cars, those numbers were $1,577 and 8.2%, respectively.) But AutoNation’s overhead expense was 12.2% of its revenue.

So if they only sold cars, the best management team in the new-car business would be out of business.

AutoNation’s fiscal year 2015 pre-tax income was only 3.5% of its revenue. For perspective, Toyota’s was 10.6%, Ford’s 6.9%, GM’s 6.3% and Subaru’s 9.1%.

It’s not easy to make a profit in a retail business where there are only 39 brands, but 31,734 franchises for those brands sold through 18,058 retail outlets. As one of 3,097 franchisees, a Ford dealer’s biggest competition isn’t Toyota or Honda, it’s those other 3,096 Ford dealers.

Which brings us back to this core message I keep preaching:

  • You are shopping for a commodity. The car you want, configured as you want it, is the same car with the same price structure at every dealership selling that brand.
  • There is never “a right price” or “a good price” for any commodity. That thinking is based on the assumption that you know what the seller paid for it (aka, nonsense).
  • Your sole objective should be to get “the best price available,” and your sole leverage for accomplishing that comes from having several dealers compete for your business. There’s zero leverage in walking into a car store and haggling the price. And zero fun.
  • Given how most dealer cash incentive programs work today, based on monthly or multi-month total sales targets, it’s common to have a $1,000 or more difference in the price proposals from nine or 10 dealers on a mid-priced car. And this month’s low bidder might be next month’s high bidder, depending on where that dealer stands vs. next month’s target.
  • Best of all, by having dealers compete for your business, you’ll be in total charge of the process.

I just ran out of smart things to say.

For more on new-vehicle purchasing and leasing, you might like to check out a few of this consumer advocate’s other submissions on Clark.com.

Read more: See more of James Bragg’s stories

Check the safety of your teen driver’s car at this website


Author’s Note: After decades as a corporate consumer marketing executive, I decided to start an information service for new-car buyers because: (1) it was consumers’ most hated purchase process, (2) there had to be a better way to shop smart for a new car, (3) I had real doubts about the conventional wisdom that had underpinned the shopping advice for decades and (4) I wanted a job in which the only jerk I had to deal with was the guy whose face I shaved.

Specifically, it made no sense to me that we bought hundreds of products and services every year, and no one could tell us the seller’s cost for any of them. But somehow, we were willing to believe that a family with the intelligence, experience and financial resources to own a new-car dealership would let us know what they paid for those cars. That was nonsense on stilts!

In late 2012, at USA TODAY’s invitation, I proved to senior executives of Kelly Blue Book, Cars.com, Edmunds, TrueCar and Consumer Reports that “the dealer invoice price” has had no relationship to any dealer’s cost since the Internet arrived in 1995. And that, as with everything else we buy, there was no way to learn that cost. (I wasn’t their favorite participant.)

As a result, Consumer Reports has dumped its New Car Price Service — a major cash cow since 1983 — because: (1) its “target price” advice was based on that very nonsense, and (2) its two-decade failure to recognize that obvious fact was a major embarrassment. (As George Orwell said, “To see what is in front of one’s nose requires a constant struggle.”)

This piece is another step in my ongoing mission to make you a smarter new-car buyer by digging out and telling you the truth that you’re not getting elsewhere. All I want in return is your promise to visit me when I join the witness protection program.

 

 

 

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James Bragg About the author:
James Bragg has been a full-time consumer advocate/activist for over 20 years as the day-to-day, hands-on founder/manager of FightingChance.com, a national information service that’s helped over 130,000 consumers buy or lease a new vehicle for the lowest price. His latest book is a revised edition of Letting the Cat out ...Read more
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