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Yesterday I participated in an Automotive News webinar with Tom Kontos, the Economist from Adesa Auto Auction. This seminar can be purchased and downloaded from the Automotive News website. I think that you would find it informative and instructive. I have a few thoughts from the seminar that I’d like to share.
First, I concur with Tom Kontos’ prognosis that dealers will experience further tightening of used vehicle supplies in the coming year. Further, prices will continue to be strong. Obviously there will be some ebbs and flows throughout the year in specific segments based on fleet and lease maturities. There are also always risks of the unknown based on volatile factors such as oil prices, weather patterns and similar phenomenon’s. Further tightening of supply and continuing high wholesale prices will create stress for dealers in two respects. First, they will find it difficult to purchase vehicles for prices that allow for a traditional profit margin. This is because I don’t expect retail rates to rise equally with the wholesale increases. Banks are ever conscious of their LTV advances. So what does this mean for wholesale buyers of used cars?
It means that many buyers will return from auction without purchasing vehicles that they badly need. Their conclusion will be that prices are too high to make any money. This is largely based on their expectations of buying vehicles for prices that allow them to make traditional gross profits in addition to a traditional pack.
Alternatively, other dealers will buy vehicles and be wiling to accept less than traditional profit margins and perhaps less, if any dealer packs. While this alternative isn’t ideal, it does address the realities of the moment of the market. After all, what are your choices? Either you don’t buy, which I think will ultimately starve your operations for badly needed variable and fixed gross profit, or you buy with a willingness to temporarily accept lower margins. If this alternative strategy is adopted along with a high turn velocity mentality, it is possible to reclaim the loss margin through additional volume.
I don’t however, want to be casual about the statement that volume alone can compensate for lost margin. The difference between volume and velocity are three conditions that must be present in order to have volume with the prospect of profitability. So what are these conditions?
First, you have to have the ability to identify and source the right vehicles. Today, the right vehicles are not necessarily the vehicles of your new franchise brand or the ones that have performed well in the past. Such vehicles may no longer be right for today’s market and/or they may not be available for purchase at the right price. Rather, the right vehicles are the ones that your current market is craving with high demand and short supply (i.e. low market day’s supply). The marketing cost to attract buyers on such vehicles is much lower and these vehicles are much less sensitive to price competition pressure.
The second condition is to price vehicles properly. As I’ve stated many times in the past, this doesn’t mean all high or low, but “know” which ones can and should be priced high and dropped slowly if necessary and which ones should be priced low and dropped rapidly. Your ability to know depends on a physical assessment of the vehicle as well as its replaceability and its supply and demand. Simply stated, cars with high supply and low demand need to be priced aggressively from the start, while cars that have high demand and short supply will command generous gross profits without too much hindrance from competitive offerings.
The third necessary velocity condition is to own your vehicles right. You’ll never make any money in the used car business unless you own your cars right, and you can’t manage your cost of ownership unless you measure it. Today, dealers should not own their vehicles fully reconditioned for any more than 85% of cost to market (unit cost divided by average retail market asking price).
The next observation from yesterday’s seminar is that you must know the price at which you can sell a car in order to know how much to pay for it. In yesterday’s used car business the retail price was determined largely from the wholesale price, and today the retail price drives a proper wholesale valuation. If you know (and you should) what it will take to sell a car, simply back out your cost and your expected profit, and that represents the proper target acquisition price. If you have to pay over that amount to acquire the vehicle, then you must be prepared to accept less profit, otherwise don’t pull the trigger.
During yesterday’s call, someone asked whether recent events have caused me to reconsider this position on purchasing vehicles. The answer is absolutely not, and in fact I would like to hear from the individual that asked the question. I don’t know what recent conditions they’re referring to that may have caused me to reconsider.
The bottom line is that next year will be a challenging year from the standpoint of purchasing, valuing and pricing vehicles. I would strongly recommend that your dealership invest in technology and develop processes to ensure that the velocity conditions are created and maintained. If management is successful in creating the conditions favored by the market, then success becomes a natural and predictable outcome.