Two Ways To Find The “Sweet Spot” For Your Inventory Turn Rate

May 9, 2014

You might call it an annual rite—just as the tulips start to bloom I hear from dealers excited about the start of the spring selling season.

This year is no different, as dealers wrapped up March with year-over-year records in used vehicle sales volumes and profitability and passed along their positive results.

Amid all this good news, I received an astute question from the chief financial officer (CFO) of a six store dealer group in the Southwest.

Like other dealers, the CFO was extremely pleased with the performance of his used vehicle managers. cool-old-trucks 3He shared stats from March that showed more than 60 percent of the used vehicles at his dealerships were less than 30 days old. Further, the average days in inventory ran less than 20 days across his stores, with some dealerships running less than 15 days. This performance translates to an annual inventory turn rate of more than 18 times.

Then came the CFO’s question: “Dale, is it possible that our average days in inventory can be too low, and our annual inventory turn rate too high?”

The CFO’s question reminded me how much the car business has changed in a very short time. Just a few years ago, most dealers paid little attention to their average days in inventory or, for that matter, their annual inventory turn rates.

Now, it’s a different story. Dealers are combing through their used vehicle inventory and market data, looking for ways to get better—with some like the CFO essentially asking if it’s possible to have too much of a good thing.

Unfortunately, there’s really no clear-cut answer to the CFO’s question. I’ve seen some dealers who turn their inventories more than 20 times without sacrificing any volume or gross profit. (Note: In some instances, these dealers have capital or space constraints that require this rapid pace of retail sales.)

I’ve also seen plenty of dealers who struggle to consistently maintain all the processes necessary to acquire, recondition and merchandise a sufficient supply of cars, and diligently price them all to the market, to maintain an inventory turn rate of 12 times a year.

I told the CFO that, in general, an annual inventory turn rate higher than 15 may suggest lost sales volume and profit opportunities. I suggested that the CFO consider two options that might ease his concern that his teams were selling too many vehicles too quickly.

Option 1: Add more vehicles to your inventory. The additions should be incremental, a few vehicles at a time. In the short run, this option will likely lower the turn rate as the used vehicle department takes on the additional inventory. Over time, though, the addition of a few more vehicles provides the opportunity to increase monthly sales volumes and improve profitability (assuming the additional vehicles don’t overly strain the people and processes necessary to acquire and retail them quickly).

Option 2: Be less aggressive with prices up front. This option almost automatically slows the inventory turn. But it also offers the opportunity for the dealership to increase front-end gross profit averages due to relatively higher retail asking prices. In most instances, this option requires dealers to slightly increase the Price to Market ratios on fresh vehicles (particularly those with dealer-favorable market data) and to be doubly diligent about pricing adjustments as the vehicles get older.

I encouraged the CFO to implement either option, or a combination of both, to help his managers determine the respective inventory turn rate “sweet spot” for their markets and performance objectives.

I also commended the CFO and his team for avoiding a common “spring fever”-induced trap that seems to get a good many dealers into trouble every year: As sales volumes increase, managers start to believe that they could close even more deals if they had more inventory to sell. They’ll then acquire truckloads of used cars, which they can’t efficiently retail in a timely manner. The end result is often a more difficult start to the already-challenged summer selling season.

The CFO promised to proceed with caution, and we agreed that we’d share his experience here in an upcoming column.