Car Dealer Economics

Recently I purchased a car and came face to face again with the befuddling economics of car dealerships.  My brother, who is an expert car negotiator, helped me out a lot doing research and negotiating with them in the crazy, we-aren’t-ever-going-to-see-each-other-again style necessary not to get ripped off at the dealer.

The car dealership that we were working with had masses of cars on his lot.  A co-worker of mine said his buying power was increased because while he was haggling a big rig came onto the lot full of cars to unload and it was so packed that there literally was nowhere to put the newly arrived autos.

While every other industry in the world seems to be moving to a just-in-time model or some sort of centralized distribution warehouse (Amazon), the car dealer industry uses the sad, old-fashioned methods of packing their lots with autos and then cutting each others’ throats to get an incremental sale.  Rather than having the exact car you want by having you order it and wait for its arrival (BMW still does this, at least according to a friend of mine who recently bought one, and Scion does this, too) – my dealer just tried to sell me the closest one to what I wanted on the lot.

My brother, being a crazed car buyer, actually uses the technique of 1) determining the car you want 2) asking for a different, similar car to what you want that you KNOW the dealer doesn’t have on the lot 3) threatening to walk away because they don’t have the car that you knew they didn’t have in the first place and instead having to “settle” by having them offer you to take the car you wanted in the first place, for a discount.

One major problem with this methodology is that the car buyer (me) leaves this experience with a terrible feel for the brand rather than a positive view, based upon interaction with the dealer.  This sort of marketing is suicide given that a repeat customer is critical to the long-term success of a car brand.  The second major problem is that having all this inventory on the lot causes all the dealers to drive down prices since they need to move these cars quickly which isn’t the most profitable outcome.

In today’s Wall Street Journal there is an article about car dealers and the tough times that they face today called “Driven To Despair“.  The article discusses how dealers are trying to stay afloat when sales are down and it is more difficult to finance all the inventory sitting on their lot.  Then they interviewed a Chrysler dealer named Mr. Bragg:

Mr. Bragg then did what many dealers have been forced to do: “I took my own money out of the bank and bought cars with it,” he says, “I was out of options”.

You can see that easy financing at low rates was prompting much of this economically insane behavior.  Many other businesses would not see it as a “last resort” to finance inventory out of their own cash flow; only in the car industry was it viewed in this manner, because distorted economics shielded dealers from the obviously depreciating assets gathering dust on their lot.  Maybe if dealers had to finance the inventory they’d only keep a few demonstration vehicles on hand, and then customers would need to order to obtain what they’d need, or just keep popular models in popular configurations immediately available and special order the rest.

Cross posted at LITGM

8 thoughts on “Car Dealer Economics”

  1. The first problem is that the OEMs have always accounted a unit as sold when it was delivered to a dealer, even when the OEMs captive finance unit was floor-planning the car.

    Second, Dealers have been protected by state laws against the rationalization of the business by the OEMs. They have something like tenure and cannot be terminated. Further they often have the right to block other dealerships of the same brand in their area. Finally, the contracts appear to prevent anyone from conducting a true sale of obsolete inventory. There are still “new” 2007 and 2008 MY cars out on dealer lots. Even the ch 11 of GM and Chrysler did not cause real inventory clean out.

    I have tried tough as nails tactics on Dealers, with limited success. Using the internet, and the CarMax written offer on a used car, has been some help. Even then, it is a tough way to buy anything.

  2. The central problem is that car dealers are an organized and effective constituency at the state level. Everyone wants to cut out the middleman, except middlemen.

  3. I agree that the primary problem with car dealers is the decades long accumulation of state and federal law that locks everyone into the model that reached its optimum in the 1950s. It’s a classic case of government distorting the market and freezing innovation.

    In order to try something new, you have to start and entirely new company. Existing companies cannot modify their operations at all. It’s bizarre in the extreme. I don’t know of any other industry in which innovation and change in existing companies is essentially outlawed.

  4. My brother did a lot of the things in that post, he emailed a lot of them, did a bunch of research, and set up visits. If it was up to him I’d still be negotiating away, searching for that last $500 off.

    One thing I did was pick a stripped down car with cloth seats and a V4 engine and the base stereo package. That saved thousands right there. Plus no extended warranty.

    I could have saved more by buying used but since I drive them until they are quite old (had my last one over 11 years) that basically accomplishes the same thing.

    Plus I ‘under invest’ in my car relative to my income :)

  5. I’m driving a 15-y/o Mercury I bought used seven years ago. The odd thing is that this same car, on the current used car market in my area, costs more than I paid seven years ago. I gather (thought I’d be happily educated if this isn’t the case) that the glut of new cars has pushed up the price of used cars.

    I’ll be driving my car for at least the next couple of years, barring a PowerBall win.

  6. Carl, I’m glad your brother helped. I don’t believe there are any V-4 engines available in the US today – what did you buy? Point being, maybe you aren’t the most auto-knowledgeable, and I suspect you know it. No insult intended.

  7. Clearly what Carl meant was an inline four or I4. He’s hardly alone in making this error; I’ve heard dealers actually come up with it, despite the fact that we haven’t had any actual V4-powered vehicles show up in the States in decades. (Last one I remember was a Seventies Saab, which borrowed Ford of Germany’s V4.)

    Nothing, of course, says we won’t have V4s in the future.

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