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Everyone in the retail automotive industry is experiencing a case of whiplash from the starts and stops, ups and downs, and ins and outs of the used car market place. From the extraordinary volatility of gas guzzlers and compact cars to the seemingly irrational rise in the wholesale marketplace, even the experienced sages of the industry are scratching their heads when considering what to buy or how to value a vehicle. I contend that the volatility that we have experienced in the last half of ‘08 and first half of this year may actually be the “new order”.
In the past, the market’s preference for certain vehicles and the expected rate of their depreciation was fairly steady and predictable. This steadiness was a result of the old market’s inefficiency. Today, the used car market is an efficient market where information flows freely and quickly. Used vehicles are no longer one-of-a-kind but much more like commodities. The efficiency of the market and the commoditization of the used vehicle have largely been created by the transparency of the Internet. If you understand this, then you can understand why I say that volatility is the new order. Any efficient commodities market by its nature is volatile; consider the oil, metal, grain, or cattle markets. All such markets are subject to frequent and extreme volatility. I am not saying the used car market is perfectly efficient nor am I saying that used cars are true commodities; but the market is getting more efficient and used vehicles are more like commodities everyday. As the nature of the market changes in this way, volatility is to be expected.
The first indication that volatility is here to stay in the used car market is the retreat of finance companies offering leases. In order to calculate a lease, there must be predictability of a vehicle’s residual value. Today, financial analysts cannot find enough certainty in the future of a vehicle’s value or market preference to set a reliable residual value. The other key indicator that the volatility is here to stay is the decision by third party guidebooks to publish values on a more frequent basis such as weekly or even daily. These companies haven’t undertaken this task with the belief that volatility is temporary − they too know that it is the new order.
Once we come to the conclusion that the predictability of a used vehicle’s value and marketability is subject to much more volatility than it has been in the past, then some changes in practices and habits are in order. First, we must realize that volatility equals risk and risk often equals loss. The only way to minimize the risk in holding a used vehicle is to minimize its exposure to time. If the industry had any belief in the past that 60 days was the outside limit to hold a vehicle given the perceived risk, then I say that 45 is absolutely the new 60. This approach flies in the face of the traditional approach of trying to maximize average gross profit by trying to get the last dollar from every customer on every car. This simply takes time, and time equates to greater exposure of risk. The more enlightened approach to making money in the used car business is to worry less about your PVR and more about the velocity in the turn of your used vehicle inventory. Ironically the higher the velocity of your turn, the better your PVR will be!
Another needed change is to change to buying vehicles in lower quantities, but more frequently. Once you understand that market shifts in value and preference occur in weekly rather than monthly increments, you understand that you can more easily be caught long in any particular type of vehicle. True enough, if you were long on SUVs when gas prices dropped and then hung on to them long enough, you would have made a lot of money this spring. But it could have just as easily gone the other way. In other words, I think that you should make a fundamental decision as to whether you are in the business of speculation or retail sales. I don’t deny the attractive profits that can be derived from speculation but I also recognize that a lot of speculators go bust when they are wrong. The more prudent approach for dealers is to stay lean and right even if it means being light rather than long and very possibly wrong.
With volatility as the new order, prepare yourself to stay attune to the values and preferences of your live market. Let loose of the notion that what worked for you in the past will likely work for you in the future. Instead, take an approach that will keep your operations consistent with the new order.