Can you turn inventory too fast?

September 15, 2008

Recently, I received the following note by an individual working for a captive finance company.

Hello Dale,

I now work for a captive finance company and manage a sales force that offers and sells used cars at physical auctions.  My background was primarily working at auctions in general management and operations capacity for approximately 20 years so I’m no stranger to this type of marketplace. We remarket approximately 50,000 units a year for 2 different brands. We as a company realized some time ago that the used car market wholesale and retail have become much more efficient and adjusted strategy accordingly. Our strategy in a nutshell is to offer our cars to the customer first, the grounding dealer second and then onto an internet site for franchise and independent dealers. If the car does not sell then car then moves to physical auction. So we utilize the internet as one of our top venues for offering and selling our cars which controls or modulates vehicles hitting physical auction and reducing supply. Once at auction the cars again get lifted onto the internet and sold live during scheduled monthly auction events.

With that, our company has really started to fixate on the turn time of selling off the used inventory at auction due to the fact that vehicles are depreciable assets and there is an average per unit holding cost. So much in fact, we have targeted our overall yearly objectives based on this metric. The idea is the faster you sell the less of a negative impact or loss on depreciation is incurred. My concern and fears are that we might be throwing the baby out with the bathwater so to speak since our sales force is trying everything within there power to move off the inventory quickly. No longer is the floor price imperative at auction but the days in inventory has become the pivotal decision point. So my question becomes do you believe that turn time is this critical and that there is an inflection point where you can sell too quickly and reduce resell retention? In your opinion which would carry more weight in resell retention; days to supply or days in inventory? Does quicker sale speed really drive success?

Your many years at the auction have served you well. The answer is yes, there is a point of inflection where velocity can actually work against you. Interestingly, your dilemma is 180 degrees diametrically opposed to most of the industry. What I mean is that your company is obsessively focused on dumping inventory as quickly as possible, while the majority of the retail industry remains obsessed with getting “the big grosses.” I spend most every hour of my waking day convincing dealers that time is no longer the friend of the used car department. What I mean is that we should no longer operate our business on the premise that somebody will come along and take cars off of our hands for too much money. Rather, the proper assumption is that a car will bring what the market will bear.

Having said this, there is validity to the fact that most cars decline in value every single day. This condition sets up the challenge of balancing the conflicting interest of getting out of the vehicle quickly and maximizing its profit opportunity. Your company happens to be singularly focused on the former, while the general retail industry comes down squarely on the latter.

As your own question suggests the right answer to find the proper balance between fast turn and high gross lies in the market day’s supply of that vehicle, in that market, that moment with its exact equipment. Specifically, today the used car market is an efficient market. An efficient market is any market where buyers and sellers have relatively equal knowledge of their choices and alternatives. The internet has made almost all used car buyers knowledgeable about competing vehicles and prices in their local market. Any efficient market is governed by the principles of supply, demand and price sensitivity. This principle is as time tested as markets are themselves.

The reason that no one in the used car industry has ever had to concern themselves with a vehicles market supply and demand is that it wasn’t relevant when the used vehicle marketplace was inefficient. These principles simply don’t apply to inefficient markets. Even if someone did recognize the need to pay attention to market day’s supply on a used vehicle, until recently there was no technology to quantify these important metrics. Today, however, technology makes it possible and the efficient market deems it to be necessary.

So, have some patience with your employer because they simply have not yet understood what you and I know about the efficient market. That is that some vehicles that have a very high demand and a very low supply deserve more time at higher prices than those with unfortunately high market day’s supplies. Take some comfort, however, that while they are not maximizing their investment return, they are at least minimizing their losses. This stands in stark contrast to the alternative, where a company tries to maximize its return thru the ill fated belief that time will produce buyers who are willing to pay too much money.