What makes a car dealer make money? (6 Ways)
What’s the first thing that comes to your mind when you think of a car dealer? Imagine a modern, sleek showroom where shiny display cars rotate slowly on a rotating turntable. Are you more excited about your first impression? This could be an old, dusty area next to the highway run by a man in a trilby cap and bad tie.
The car dealer is as common as ever, regardless of how you look at it. There are special laws in America that restrict car makers from selling directly to consumers. These laws ensure that nearly all customers will have to deal with a dealer. In today’s post, we’re looking at how car dealers make their money. Which are the secrets to their success? Are they simply selling more cars?
How car dealers make money
You might find this a bizarre concept. You would think that car dealers earn their money selling cars to customers. Well, yes, that’s definitely true up to a point, but it’s actually quite a lot more complex than you might think.
The National Automobile Dealers Association shows that new cars are responsible for approximately 58 percent and only 26 percent respectively of gross profits at typical car dealers where there is both used and new vehicles. Even though 26 percent of total sales is accounted for, it's only a fraction. The rest is additional products that we’ll introduce more below.
When it comes to pre-owned cars, these account for something like 31 percent of a dealer’s total sales, according to the same data from NADA. This is despite the fact that used car sales account for 25 percent to 25% of dealer profits. If you put this number with new cars, then you have 51 percent of a dealership’s profit. But what about the remainder? We’ll get into that further below, first let’s study car sales.
1. Car Sales
You might think that more than the lion’s share of profits at a car dealership would be garnered from car sales, but this is not the case at all. As mentioned, 51 percent is a small percentage of total profits. The unit sales of the cars themselves don’t even make up that amount of money.
You spend $20,000 to buy a sedan car, such as a Toyota Corolla. That price might be the invoice price — the amount that the manufacturer charges the dealer for the unit — in which case the question arises: where does any profit come from? You would be accused of serious problem in your business ethics if you bought a car at $20,000 from a supplier and later sold it for $20,000
2. Dealer Holdback (New Cars)
This is also known as dealer holdback. The dealer holds back a bonus equal to 1 to 2 percentage of each vehicle's invoice. This would translate to $200, or $400 in the example of our Toyota $20,000 model.
Dealers benefit from this arrangement because they are able to sell cars at a lower invoice price while still making some profit. This arrangement is not common for all manufacturers.
3. Dealer Cash (New Cars)
Another revenue stream for dealerships is “dealer cash” which is a bonus paid to dealerships, sometimes at the end of the year, for help in shifting a particular model that the manufacturer wants to boost in sales. It’s not an advertised practice, but it’s well known among those in the industry.
4. Trade-Ins (Used Cars)
Part-exchanges are another way to make money in car sales. The dealer will always try to get the lowest price possible for the vehicle and expect the customer to react in one of these two ways. Either they will be motivated to get rid of the car as fast as possible for whatever price, just wanting to avoid all the hassle, or they’ll be dazzled by a partial discount on a car they really want. The person who trades in their car fails to realize that the dealer is the winner.
The dealer earns money in the above transaction by two things: first, on car financing taken from the customer and secondly on sale of the vehicle. The dealer might realize a $5,000 profit in just one transaction.
5. Car Finance Products
There’s a reason that car dealerships push financing options when it comes to selling their cars. The dealership will only benefit if the customer pays cash. Except for accessories, they will have very low profits from you. NADA numbers show that around 90% of new vehicle sales are financed. For used cars, the figure is 73%.
In a similar style to the trade-in model, dealerships rely on customers’ desire for convenience. Many finance deals are attractive because they can offer lower interest rates, low deposits or longer terms to repay the loan. These offers are all designed to make you pay more. The car, finance, and lease deal all come together in one package. This makes it seem more attractive, even though private financing would be less expensive elsewhere.
Dealers sell financial products such as extended warranties and insurance in addition to car financing. Because everyone requires insurance, dealers can sell it. They also have the ability to get clients to spend more because they are able do everything under one roof. Because so many cars can be financed dealers make money from selling special insurance such as gap coverage.
Extended warranties are even more lucrative. Warranty provider endurancewarranty.com estimates the average cost of an extended car warranty at $1,800. This will usually convince buyers to fork out $1,800 instead of $3,000 or more in replacement costs if an engine needs to be replaced. Each sale represents a tremendous profit margin, since only a fraction of these warranties is ever actually used.
6. Service and parts for your car
Finally, we get to parts and servicing, which is the mysterious “other half” of a car dealer’s profits. Parts and servicing accounts for 49 percent, which includes:
- Annual car servicing
- Other maintenance and repairs for cars
- Realignment of ADAS
- Detailing and car washing
- Accessory for your car
- OEM parts for cars (as opposed to aftermarket) are branded.
Blue-chip companies like BMW, which are known for their strong customer service policies, have shifted to service and parts because they know how profitable it is. Particularly when it comes down to after-sales service. If you’ve ever encountered one of the “Product Geniuses” of BMW, you’ll know that they’re more than just salespeople. You can rely on them to be your contact person at BMW for any questions or concerns.
If you are having a problem with BMW's, call your genius. This list could go on. Tesla offers a similar product with its Sales Advisor position. They increase sales through providing unrivalled continuous service.
Conclusion: The Game of Car Dealership Profits is Complex
In the end, we reach the conclusion that car dealers can indeed make a great deal of money, but it’s just not all from the sale of cars. The purchase of a vehicle from a dealer may be just the first step in what will become a profitable and long-lasting relationship.