Double Discounting Is Hurting Dealerships

So far I’ve discussed two factors that are putting gross profit margins under pressure: market-based pricing and the impending increase in the supply of used cars. There’s a third element to this equation—the fact that dealers have fundamentally changed their pricing strategy without also changing their sales and marketing approach. That’s led to a disconnect that we call the “double discount.”

“Double Discounting” Defined
The first discount used to be taken at the desk with the “first pencil.” But now with market-based pricing and the transparency of the Internet, the first discount is actually taken with the Internet price before the consumer even gets to the store. Then when the consumer is negotiating the car deal, salespeople are often programmed to try to close by discounting price, leading to a double discount.

That’s because salespeople have been trained to negotiate to close the sale by discounting and consumers have been conditioned not to buy unless they negotiate a significant discount. This has put dealers in a bind. Either they double discount on price and erode their margins, or they refuse to negotiate on price and discount their closing rates.

The Need to Adapt
So what’s the solution? Increase your close rates without discounting. Or at the very least, minimize the discount offered when already priced to market. How? By adapting the way you market and sell your cars.

That’s easier said than done, of course. But the bottom line is that dealers have fundamentally changed the way they price their inventory without adapting the way they market their cars online or sell them on the lot. In the long run, that’s an unsustainable situation.

Over the next few posts, I’ll describe how dealers can avoid the double discount problem by changing their sales and marketing strategies.

The Bubble Is Bursting: Gross Profits Are Headed for a Fall

In my previous post I discussed why pre-owned profit margins are under pressure. The factors driving this trend include transparency from the Internet, market-based pricing, and rising overhead costs from new dealership buildings. And that’s not the bad news—the bad news is that the problem is only going to get worse over the next few years.

The NADA average gross profit of about $2,300 likely represents a bubble in used car profitability. Why? It’s a simple matter of supply and demand.

The Rubber on the Road

New car dealerships sell the bulk of late-model used cars, typically aged one to five years. That means the number of new cars sold in a particular year impacts the supply of late-model used cars over the next five years.

During the financial crisis from 2008 to 2010, new car sales fell dramatically. That means the supply of late-model used cars plummeted over the last three to five years, as depicted in the chart below. In the wake of the recession, consumers’ increased frugality also led to an increased demand in used cars at a time when there was less inventory available.

 

So in the last five years, while the supply of used cars decreased compared to the prior five-year period, demand was on the rise. As a result, used car prices have climbed. And because supply and demand moved in opposite directions, that led to an increase in the average gross profit per vehicle.

 

But over the last couple of years, used car units in operation have been on the rise and will be peaking over the next three to four years, climbing to levels last seen in 2006. Back then, according to NADA, the average gross profit per vehicle was less than $1,800—more than $500 less than 2013 average gross profits. Are you ready to take that kind of hit to your profit margin on every pre-owned vehicle you sell?

 

The good news is that there is one thing every dealer can fix to avoid eroding pre-owned gross profits.  In my next post, I’ll detail what that is.

Two Main Reasons Why Gross Profits Are Under Pressure

One of the greatest challenges facing dealerships right now is that profit margins are increasingly under pressure. Several factors are at play, but it’s clear that the Internet is making it increasingly difficult to earn strong retail gross profits per vehicle.

NADA reports that the average retail gross profit for used cars in 2013 was $2,361, up 13 percent from the previous year. But dive a little deeper into the numbers and you get a different picture. When you look at six of the top publicly owned dealerships, gross profits at five of them fall between about $1,470 and $1,900 per vehicle. Only Lithia beats the NADA average at more than $2,500 per used car.

Market-Based Pricing
What’s notable about those figures is that the five public dealership groups with average gross profits below NADA’s reported average are disproportionately concentrated larger in metropolitan areas—Lithia is the exception, with more stores in smaller markets. When I ask larger metro dealers why they are seeing margin pressure, I consistently hear about Internet-driven price competition from “market-based pricing.”

Market-based pricing is certainly a necessity given consumers’ unprecedented visibility into pricing through the Internet.  With consumers able to compare prices across hundreds of dealerships during their online research, there is more pressure than ever on dealers to price their vehicles competitively.

Bad Timing
Unfortunately while market-based pricing and the internet are pressuring pre-owned margins, dealers’ cost structures have climbed. The dealership building boom driven by the factories has created beautiful facilities (ironically at a time when people stopped visiting dealers in person as much) but the result is a higher cost structure.

Furthermore, changing compensation for sales staff is also having an impact on dealerships’ cost structures. The average salary of a sales person was nearly $64,000 in 2013 vs. $46,000 in 2002.  With more expensive rent and higher salaries, less gross profit is getting to the bottom line.

And the really big news is that we are about to see a seismic shift in pre-owned profitability that every dealer needs to plan for.

In my next blog post, I’ll explain why.