Coming clean

There is an article posted on my blog dalepollak.com from November 12 entitled, “What the best of the best do when they make a mistake.” This post profiles the shared experience of two of the best used car operators I know, John Chalfant of Edmark Superstore, Idaho and Roy Greenblatt of Matt Blatt Dealerships, New Jersey.

Each of these operators tells the story of how their used car inventory and operational results have suffered in the third quarter of 2009. Chalfant and Greenblatt both expected to continue their big sales volumes through the end of the year, not withstanding the historical slowdown that generally occurs. Both of them acknowledged having made a mistake, finding themselves with more inventory than they needed to maintain their usually 15 to 18 annual turn rate. To their credit, they both pursued an aggressive strategy to “come clean” by quickly reducing their overstock of vehicles at the expense of gross profit.

Their decision to dump excess inventory rather than to hang on with the hopes of the New Year producing rebounds in values and volume stands in stark contrast to the approach taken by most traditional dealers. Chalfant’s and Greenblatt’s quick liquidation with little regard for current profit will allow them to free up the necessary capital to reinvest in fresh inventory in the remaining weeks of the year. This fresh inventory will undoubtedly be purchased at seasonal lows and will position them to recapture lost profits in the first quarter of 2010 while their traditional counterparts will still be stuck with the higher cost inventory from the summer and fall.

This “coming clean” strategy is counter to every instinct of a traditional dealer. To “come clean” as these two velocity dealers have done forces them to produce monthly financial statements that show exceptionally low gross profits. Most dealers would rather maintain their respectable average, albeit selling many fewer units. What these traditional dealers do not confront is the negative equity that is accumulating. Because automotive accounting does not require assets on dealers’ balance sheets to be marked down to their true market value, the cost of hanging on to the inventory doesn’t immediately evidence itself.

Even if market values rebound in the first quarter of 2010, these traditional dealers will find themselves competing against guys like Chalfant and Greenblatt that took their medicine early, replenished inventory at lower cost, and ultimately can dominant their competitors with vehicles at more competitive prices and healthy average profits.

It’s also time for me to “come clean” and acknowledge that Chalfant’s, Greenblatt’s and other velocity dealers similar experiences were inevitable. The extraordinary sales and profit performance commonly experienced by velocity dealers can sometimes produce an intoxicating perception of invincibility. In hindsight, what Chalfant and Greenblatt should have done would have been to forecast on a seasonally adjusted basis as do sophisticated new car manufacturers. The velocity strategy will undoubtedly enhance the performance of any dealer in any economic environment-however, the macro environment does define the boundaries of opportunity.

Now it’s your turn to “come clean.” The test is the trend of your used vehicle aging. Most dealers, to the extent that they are measuring this, are reporting an increase in the average age of their vehicles. If this is occurring at your dealership, it’s a tell-tale sign that you are hanging on rather than proactively taking charge and looking ahead. Although this strategy avoids immediately confronting the errors and pains of your forecast, it will undoubtedly produce a penalty in the months to come. The penalty will be the slow and low profit bail-out of your inventory in early 2010 while the velocity competitor is jumping out to an insurmountable advantage.