Car Buying

How Car Dealers Operate

What goes into getting cars, customers and even employees

Cars are a huge part of the lives of most Americans, and as a result, we've all likely spent more time than we'd like at dealerships, shopping for the new car that best meets our needs, satisfies our wants all with the best price possible. But very few car buyers give much thought to the car dealership as a business. So we spoke with some experts to find out how modern car dealers operate: how do they make money, how significant is employee turnover, how are decisions made when it comes to ordering inventory and how important is the parts and service department to the overall revenue?

When it comes to making money, and what departments provide most of it, it varies, but used cars and parts and service are a major part. New cars on the other hand, don't play as big a role anymore. That may come as a surprise to some consumers who have spent a considerable time either haggling over the price of a new car or stressing over the decision.

In the past (during more flush and/or less competitive times) profits as a percentage of new car sales were much greater than they are now, said Paul Taylor, chief economist for the National Auto Dealers Association (NADA), based in McLean, Virginia. Due in part to aggressive incentives, recent stats show a significant number of car dealers actual lose money on new car sales. "During difficult years for new car sales," Taylor said, "profits from used car sales and from parts and service are what keep the dealership in business."

Many consumers may wonder exactly where most of the vehicles on a car lot actually come from. If a car is on a lot, it's because the car dealer wants it there, because he thinks he can sell it. Car dealers order their inventory based on their reading of the marketplace, how well certain models have sold in the past, on feedback from consumers and – of course – what the OEM (Original Equipment Manufacturer) wants them to order and keep in their inventory. It can get tricky with models that are in high demand, especially if the model is a surprise, out-of-the-box success, and the manufacturer doesn't have enough models to meet that demand. It can also get sticky if a model quickly loses favor, or an outside issue (such as Volkswagen's emissions scandal – ed.) puts sales of that model into a nosedive.

Then there are used cars, the inventory of which is typically related to how many new cars a dealer is selling. "A high volume of new car sales brings a high volume of traded-in used cars for the dealer to choose from for their used car operation," Taylor said. "Trade-ins that come into the dealership as part of the new-car purchase are the source of about one-third of the used cars and light trucks in a franchised dealer's inventory. And trade-ins on a used car upgrade account for about 18 percent of used cars in the franchised dealership's lot," he said.

"Additionally, if used car demand is strong, the franchised dealer will obtain cars from used car auctions, accounting for roughly one third of used light vehicles. And dealers buy some cars directly from the public in what are called 'street purchases', accounting for eight percent of used cars," Taylor noted. "These are consumers looking to sell their current cars even if they are not buying a new car from that dealer. Other sources, such as purchases from other new car dealerships, account for about 12 percent of used cars and light trucks."

How do car dealers pay for the new cars on their lots? Car dealers often use financing to make their car purchases, much like individuals do. They purchase the cars from the manufacturers via an instrument called floorplan financing. "Generally, all new vehicles are financed through the manufacturer, and dealers pay interest monthly on that loan," explained Wayne Phillips, a former dealer who now works for the NADA. "Dealers have to pay off the [original equipment manufacturers] immediately on new vehicles, but many turn around and finance them through the OEM's finance arm. Most used vehicles are also financed this way, although some dealers own their used cars outright."

One of the rules of any business is that, if the business doesn't grow, it stagnates. So car dealers are always looking to attract new customers, not just to procure those extra sales dollars, but to secure another ambassador for the dealership. New business often comes in the door by word of mouth. Attracting new customers, however, has been more of a challenge both during and after the recession. Typical causes include slumping regional economies, a sluggish new housing market (builders and tradesmen are big buyers of light trucks) and the challenge of a domestic industry (Ford being the one exception) coming out of bankruptcy. And there is also the obvious: there are simply too many cars in the marketplace. Fifty-plus years ago General Motors held 50% of the domestic market; today it would be a huge win to attain – among its four brands – just 20%. As manufacturers roll out more new models every year, the industry becomes more fragmented. So, it's now more difficult than ever for a carmaker and its dealers to maintain or increase their foothold in the consumer marketplace.

"The two biggest obstacles to attracting new customers are a marketplace that's more crowded with competitors and a slowing (or sluggish) economy," Taylor said. Just as they work to attract new customers, it is equally imperative that car dealers retain existing customers. Repeat business is consistently a major contributor to any car dealer's annual revenues and its reputation. Many – if not most – car dealers conduct customer satisfaction surveys to determine whether current customers are happy with the quality of service.

"Customer satisfaction surveys provide very useful feedback, and dealers use that information as an opportunity to continually improve that customer satisfaction," Phillips said. "Dealers put a lot of emphasis on continuously improving their processes." That is, of course, key to keeping current customers returning over the years, hopefully to buy that second, third and fourth vehicle. Today the challenge is in maintaining brand loyalty, especially among younger buyers less fixed on a specific brand and often more focused on specific features.

An ongoing issue dealers and dealer groups face has been a relatively high rate of employee turnover. Salesmen and various department managers leave or are dismissed for various reasons: Perhaps they underperform and maybe they're underpaid. Retail hours play havoc with what is a generally acceptable home life, and while more dealer groups move toward a pay structure with some base salary, many sales people are still paid on straight commission. And if that commission is a percentage of a declining profit picture so, then, is the compensation package in decline.

"The salesperson-turnover rate at the typical new-car franchise dealer has remained on the high side," Taylor noted. "Although formulas for turnover rates vary, the simple formula most often utilized, and the one used by NADA, is calculated as the number of employees who voluntarily quit or were fired in a given year, divided by the firm's total number of employees." With the reduction in the number of family-owned stores and the multiplication of publicly traded dealership groups, employee 'churn' remains an integral – and unfortunate – aspect of the retail environment. Positions are typically more secure in the back end (service/parts) of the business, but it remains an industry long on jobs and yet – from a perception standpoint – short on careers.

What does all of this mean to you, the car buyer? Knowing more about how car dealers are operated – knowing that dealers face many more challenges than they did just a few years ago, even in a growing economy – helps make you a more informed consumer. And that puts you in position to either get a better deal on your next new car purchase, or – at the very least – have a better idea of what that 'better deal' constitutes.

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