A Strong Market Exposes Gross Deceptions in Used Vehicles
In my latest book, Gross Deception: A Tale of Shifting Markets, Shrinking Margins and the New Truth of Used Car Profitability, I address several “gross deceptions” that have long been part of the business of retailing used vehicles.
For example, the book discusses the gross deception that every “fresh” car deserves the same chance to find a buyer. This belief often translates to dealers pricing every vehicle in essentially the same way—start with an asking price that will give you the gross profit you expect, and then reduce the price as the vehicle ages.
In the book, I describe the problem with this gross deception. The problem is that no two “fresh” vehicles are ever the same in terms of their ability to deliver a return on investment. In fact, as the book details, we found that a sizable share of dealers’ used vehicle inventories consists of vehicles that had little or no investment return potential when they came in as “fresh” units.
I’ve been thinking about this and other gross deceptions as I reflect on conditions in the current market. Today, we’re in a place where the age-old problems of too much inventory and too many aged cars aren’t chronic issues. The principal problem right now is that dealers can’t get enough inventory to sell all the retail customers who want their cars. I honestly can’t recall a time when dealers have had such a strong retail run despite the economic and social challenges posed by the COVID-19 pandemic.
But the market is also delivering another blessing to dealers, although I’d submit the blessing isn’t readily apparent to everyone. The blessing is that the market is exposing the fallacy of several gross deceptions that have gone unacknowledged or unnoticed for a very long time.
Here are three gross deceptions that current market is laying bare for everyone to see and understand:
You need to stock more cars than you sell to find success. In Gross Deception, I make the case that the pace of margin compression in today’s market has effectively shortened the viable retail shelf life of most used vehicles. It wasn’t all that long ago that dealers could expect to see a 60-day-old unit deliver at least some front-end gross profit. Today, the viable shelf life has shrunk to 30 days—a fact that I believe necessitates dealers maintain their used vehicle inventories in accord with their rolling 30-day total of retail sales. If you carry a 45- or 60-day supply, you’ll inevitably end up with cars aging past the point that they provide a positive contribution to your used vehicle department’s bottom line.
This guidance has met resistance from dealers who believe that if they don’t stock more cars than they sell, they won’t have enough cars to attract and close customers.
Today, I’d encourage these dealers to consider what’s been happening over the course of the last nearly three months. Across the country, dealers have maintained lighter inventories than they’d normally carry this time of year. Cox Automotive data puts the days supply at 34 days, compared to its normal 45-day mark. Even with fewer vehicles, many dealers enjoyed record-breaking used vehicle sales in June and July. I know many of these dealers believe they would have sold more inventory if they had more cars.
But dealers should also recognize what current conditions allow them to achieve: You didn’t need an out-size inventory to achieve a stellar sales volume. It’s my hope that this recent run of inventory investment efficiency offers a lesson for dealers about what the “right” level of inventory truly needs to be to find success.
It’s better to walk away than over-pay. I’ve talked to more than one dealer who laments that the only people making money off auction vehicles are the sellers and the auction houses. The wholesale market is extremely hot right now, and we’ve seen average sale prices ride above MMR for several consecutive weeks. This situation has turned some dealers away from auctions, while others are walking away from auction cars rather than paying what they believe is too much money.
But as I note in the book, the problem isn’t over-paying for a vehicle your inventory needs and your market wants. The problem, and the gross deception, is how you handle the vehicle once you own it.
In fact, the current market is helping dealers correctly handle the vehicles they paid up to acquire. Retail demand is helping these vehicles sell quickly, allowing dealers the opportunity to at least make some gross profit from reconditioning and F&I sales, even if front-end gross profits are anemic (or worse) due to high acquisition costs. The lesson is that if you must over-pay for a vehicle, it’s retail exit should occur as quickly as possible.
“I can’t replace the car for what I’ve got into it.” When I wrote the book, this statement almost always came from dealers or used vehicle managers as a justification to keep a vehicle, often one priced above its competitive peers, past 45 or 60 days in inventory. The statement is a gross deception because the replacement value of the vehicle is completely irrelevant to the problem at hand—which is that you’ve got a vehicle that hasn’t sold and has lost its ability to make a positive financial contribution to the department’s bottom line.
The current market is showcasing the fallacy of the “can’t replace the car” gross deception. Across the country, dealers are retailing vehicles and replacing them with units that, if they’re acquired from auction, tend to cost more than the one they just sold. In most cases I’ve seen, everything works out just fine. Dealers make money on the car they retailed, and they make money on the one that replaced it, irrespective of its acquisition cost. I dare say this has been the recipe for dealers who have found the greatest success in the current market.
In my book, I write about how the gross deceptions of the used car business often lead to sub-optimal results in dealers’ used vehicle departments. When the gross deceptions prevail, dealers ultimately sell fewer cars and see less return on their used vehicle investments than they otherwise would.
Strangely, the current market doesn’t seem to be exacting this price from dealers who allow gross deceptions to drive their used vehicle management decisions. It’s like the market is offering dealers a moment of clarity and grace to see the gross deceptions for what they are and work to get past them for good.
I’ve been actively encouraging dealers to take advantage of this rare opportunity before the market returns to its normal, less-forgiving self.