Dedicated to Chris Irwin
What is a car worth, take two?
In January and February, dealers rushed to the auctions and purchased vehicles with frothy enthusiasm. Because of this, many people around the industry were quick to tell me that my prediction of used vehicle deflation in the first quarter was wrong, dead wrong. While my prediction did turn out to be incorrect, I am not so quick to admit wrong thinking.
My prediction last December of low wholesale demand in the first quarter was based on the belief that there would be nothing positive in the retail environment in the first half of 2009 to support a robust wholesale marketplace. And, as of February, the economic outlook, both near and intermediate, continues to be dismal. So what accounts for the bounce in wholesale market values? I say that it is wrong minded thinking on the part of what I call “the herd”.
“The herd” is the used car buyers that believe a vehicle’s worth is what it brings in the lane. While I might have agreed with this premise in the past, I say today it is wrong, dead wrong.
Before the Internet, the used car market was inefficient. This means that buyers had a difficult time finding two used vehicles similar enough that they could shop and compare one against the other. Dealers had much better knowledge of a vehicle’s value than did shoppers and that’s why shoppers often paid more than they would have if they’d only known where to buy others like it around town for less. Under these conditions, a vehicle’s retail value was largely driven by its wholesale value and its wholesale value was primarily driven by “the herd” in the auction lane
Today, however, a used car shopper can take any used vehicle, go on the Internet and find dozens if not hundreds that are virtually identical. They know where they all are and how they are priced. Rational human behavior pushes shoppers towards those vehicles that are priced most competitively. Therefore, it is no longer rational for dealers to believe that shoppers will pay them much more than they would pay someone else to purchase the identical vehicle
For example, imagine that you are a seller of an ’07 Ford Explorer Eddie Bauer 4×4 with an automatic transmission. In your market, there are 42 of them that are identically equipped with very similar mileage. Based on a ranking of price, yours happened to be 38th highest out of 42. The likelihood is very small that a shopper for this type of vehicle will appear at your store. If, however, your price rank was in the top 10, the likelihood of seeing a shopper would be much greater. If you agree with this premise, then you’re halfway towards understanding why the wholesale buyers of used vehicles in January were dead wrong.
The rest of the reason that the wholesale buyers were wrong is pure math (I didn’t say there wouldn’t be any math!) These wholesale vehicles were being purchased in the high $17,000 to mid $18,000 range. So let’s suppose that you paid $18,000. After transportation of $300, reconditioning of $700 and a mere profit of $1,500 you would have had to ask $20,500. The problem is that the average retail price of the 42 identically equipped similar mileage vehicles in your market was $19,200. This means that your asking price is already $1,300 over the average retail price, putting your competitive ranking at the 38 out of 42 vehicles we talked about above. As a reminder, considering the fact that there are 37 identically equipped similar mileage vehicles in your market available for sale for thousands less, how likely is it that you would sell this vehicle quickly? Not too likely. If you wanted to position yours in the 10th position, you would have had to have it priced at $18,464 – a $536 loser after transportation and reconditioning.
So I ask you, was the vehicle that you purchased worth $18,000? Well, yes, if you believe that a vehicle is worth what someone is willing to pay in the wholesale marketplace. I say, on the other hand, clearly no if you have the more enlightened view that a vehicle in today’s transparent and efficient marketplace will only bring what the retail market will bear.
I have watched thousands of buyers purchase tens of thousands of cars January through early February with the old mentality that a car is worth what it brings in the wholesale marketplace. These buyers have since gone home with their conquest purchases and have begun the task of digesting what they have consumed. Sure, you can argue that the retail market price will likely rise as a result of all of this new high priced inventory with higher wholesale values. However, the problem with this logic is that once the wholesale herd has filled its quota, the wholesale prices will begin to normalize and ultimately fall as the weeks and months progress. Therefore, enlightened buyers that had the patience and discipline to wait for the herd to pass will have the ability to purchase the same vehicles at considerably less and be able to price their vehicles at significantly lower retail prices.
The lesson to be learned is that the “wholesale herd” is now dangerous to follow. This group of buyers is one that has not yet come to terms with the fact that it is now the “retail herd” that rules the frontier. Simply stated, if you value a vehicle based on a very competitive retail price (eg 10th best), you will be more attuned to the true wholesale value of a vehicle. For example, if it takes $18,464 to be number 10 and you know that you want to make $1,500 profit and will spend $1,000 between reconditioning and transportation, the right amount of money to pay is:
$18,464
-$1,500 profit
– $1,000 reconditioning and transportation
$15,964
I know what you’re going to say…”but I couldn’t buy any vehicles for that price,” and I say “so what?” You’ve avoided a purchase that would have to be priced so high that it would undoubtedly become aged and you would have lost money. To this I say, “I am so sorry.” So was I really that wrong?