Addressing Increased Used Vehicle Supplies, Depreciation

October 26, 2015

You might say that the blessing we’ve enjoyed in used vehicles is running out of gas.

The blessing has been a relatively stable balance between used vehicle supplies and demand. These market forces have helped to subdue the effects of used vehicle depreciation for much of the year.

But industry analysts predict a continued rise in used vehicle supplies—driven by increased trausedcarde-in units, off-lease units and fleet sales—is reaching the point where depreciation is becoming more pronounced. A report by Black Book and Fitch in late August suggests that the annual depreciation rate will reach 15 percent in 2015, up from 12 percent in 2014.

For dealers, the market dynamics create an operational challenge: What’s the best way to minimize your exposure to depreciation and maximize your profit opportunity?

To answer the question, I recommend three best practices:

A balanced, market-wise mix of inventory: The profit-sapping effect of used vehicle depreciation isn’t uniform across all vehicle segments. Some segments, like compact cars and sedans, tend to suffer more than SUVs and trucks, where consumer demand helps to mitigate value declines even as supplies increase. In this environment, it can be tempting for dealers to place their bets on the least-risky segments, stacking their inventories to take advantage of better-performing segments.

The problem: This approach is akin to “putting all your eggs in one basket.” It over-exposes dealers to volatility—particularly as more dealers pursue the same segment-specific strategy or, other factors, such as gas prices, shrink demand.

Generally, I recommend that dealers base the composition of their inventory based on market insights. By doing so, you’ll spot opportunities to step up or step back in specific segments, as market conditions change. In addition, this strategy, by design, helps you build a balanced inventory that minimizes over-exposure to volatility in any one segment.

Minimize inventory age. With projections of an ever-increasing supply of used vehicles, dealers will face greater pressure to retail used vehicles in less time. This best practice follows the basic economics of supply and demand: As fresher vehicles enter the market, they create competitive choices for buyers that diminish the value of older units they’ve already shopped.

To combat these market forces, I recommend that dealers follow two standards: Strive to maintain at least 50 percent of their inventory under 30 days of age, and stick to a maximum 45-day retail window. Together, these operational standards breed a culture where time is money, and a greater share of vehicles retail while they’re fresh and grosses are better.

Price for profitability, not solely front-end profit. This best practice reflects the reality of today’s well-supplied used vehicle market: Some cars are true-blue winners from a front-end gross perspective. They face fewer competing units, and you can price them above the competition and expect buyers to pay your asking price.

Unfortunately, such vehicles do not represent the majority of most dealers’ used vehicle inventories. While most units have the potential to generate a decent front-end gross profit, their real value to the dealership extends beyond the sales desk. Each of these units, when retailed efficiently and quickly, creates additional opportunities to generate F&I and service income, acquire a trade-in, and repeat the reconditioning/retail cycle all over again. As dealers embrace this philosophy, their used vehicle pricing helps execute a “turn and earn” inventory management strategy that minimizes depreciation and maximizes the “total gross” of the dealership.

It’s worth noting that dealers who embrace these best practices don’t worry too much about rising used vehicle supplies and increased depreciation risks.

“The market is what it is, and it will do what it does,” says the CEO of a California-based dealer group. “In used vehicles, our goal is to create the most opportunity with every car. When we do that successfully, the worst case scenario isn’t as bad for us as other dealers.”