Velocity Management Challenged and My Response

August 14, 2009

Recently, a story was told to a dealer by a salesperson representing a company which sells a traditional used vehicle inventory management systems. The salesperson spoke of a particular dealer that left the traditional core inventory management approach in favor of one based on the velocity method of management. The salesperson said that the dealer had lost $150,000 of gross in the first three months of his velocity experience. The implication was that dealers choosing to employ a velocity approach to used vehicle management will suffer a reduction in used vehicle gross profit. As an advocate of the velocity method of management, I think that this story warrants additional consideration and discussion.

First, it is important to note that the transition from yesterday’s traditional core inventory management to a real-time market velocity approach is a journey with many ups and downs. One of the first experiences of a velocity dealer is the report of unprecedented levels of traffic and sales. This phenomenon results from the dealer’s first-time ability to price vehicles in accordance with their present market supply and demand dynamics. In other words, vehicles with high supply and low demand begin to get immediate attention when the offered price matches the market’s expectation.

Unfortunately, however, along with the almost immediate improvement in traffic and sales comes vehicle transactions at a price point that produces less than expected average gross profits. To be clear this initial negative result is not due to improper pricing, but rather is caused by the sudden movement of older and overvalued inventory. So yes, the PVR in the initial phase of the velocity dealer’s journey will likely dip, but the negative equity in their inventory is being reduced. This is the rest of the story that the salesperson neglected to report. In fact, along with the immediate pickup in traffic and sales, velocity dealers routinely report that their aged inventory and negative equity has rapidly disappeared.

Now, while this initial experience is unpleasant, it is absolutely necessary in order for the dealership to perform profitably in the current market. Continuing to operate with aged and over valued inventory is equivalent to a drug addict that doesn’t want to face the reality of the addiction. The inventory solution salesperson’s account of the dealership’s loss of gross profit without reporting the fact that the inventory is being cleaned up, is like reporting a rehab patient’s initial sickness as a result of coming off of the drugs. You simply can’t get healthy until you experience the painful removal of the evil drug.

Once the velocity dealership has experienced the expected and inevitable cleansing process, they are now ready to shift to the next phase of their velocity journey. With fresh inventory and a firm resolve never to repeat the sins of their past, the velocity dealer begins to acquire fresh inventory that has high demand and low supply. Such vehicles are less sensitive to price competition and therefore will produce rebounding PVR’s. But, probably not the old PVR’s of the past. So there’s a statement that if taken out of context, can also be used by the self-serving interests of the old traditional guard. To this extent, allow me to explain.

When velocity dealers report that their rebounded PVR’s still don’t achieve the heights of their old ones, I ask them the following question: If we took your old PVR and washed against it the negative equity in your inventory and your wholesale loss before you applied credits, do you really think that your old PVR would be the same? The answer is, of course not. But unfortunately the hidden negative equity doesn’t show up on the balance sheet nor does it show up in the income statement from which dealers and managers judge their performance. If automobile dealers were held to the same standard of public companies requiring them to mark their assets down to true market value on a regular basis, then dealers would be forced to recognize that their old PVR’s weren’t really as good as they thought.

So what we’re really dealing with here is that the inventory management salesperson in question, through either ignorance or self-serving motives, is attempting to dissuade the industry from moving to a model of health and vitality that is being demanded by the efficient marketplace.

I encourage those who agree and disagree with this posting to identify yourself by name and professional association and tell us all what you think.

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