Understanding New Car Dealers
In business, in life, and in the car business, good negotiators like to "get into the heads" of their opponents and learn as much as they can about how they operate, how they do business, and how they plot their negotiation strategies. In this segment we're going to show you the world from the dealership's perspective in the belief that the more you know about the car business, the more prepared you'll be to deal with their tactics.
Identifiying the Enemy
"They have identified the enemy and he or she is you." (Or at least one of the enemies.) From a car dealer's perspective (and fortunately this is not universally true) there are two kinds of enemies:
Enemy #1. Those customers who have taken the time to do their homework, who refuse to accept less than the true wholesale value for their trade-in, and have established a budget beyond which they will not go. These people are also the type who maintain a pleasant, even attitude-no sign of anger or malice in these folks-and they make it clear they are prepared to walk out and shop another dealer if they don't get what they want. Salespeople will, in private, also reveal their feelings about customers with the expression: "Buyers are liars." In truth, sometimes they are. As you learn, there are times when a white lie-or at least an avoidance of the truth-works very much to your advantage. (More on this later.)
Enemy #2. Any and every competitive dealership. Most salespeople are firmly convinced that a competitive dealership will all but "give away their vehicles" if that's what it takes to "steal" a customer. Make note: This very real and often fierce competitiveness is one of your best weapons.
Floor Planning
The manufacturer sells its vehicles to dealers at set invoice prices. But since most dealers don't have the kind of money it would take to buy and hold a full inventory, they enlist the help of their bank or other financial institution. This is called "floor planning."
For the purpose of this explanation, let's assume the dealer uses his local bank. The bank lends the necessary invoice price to the dealer and then charges the dealer interest (usually prime rate plus points) for that period between when the dealer takes delivery of the vehicle and when he sells it to the customer. When the car is sold, the dealer repays the bank the invoice cost, settles the interest due, and keeps the remainder as profit. The longer a car sits on the lot, the greater amount of interest it accrues. That's why dealers want to move cars as fast as they can and why they prefer to sell you a car or truck from their stock rather than having you request one that must be ordered from the manufacturer.
Dealer Markup
You will find that there are two sets of markups on most cars. One markup is the profit on the base car. That is, the car without any of its options. The second markup, which is frequently higher, is for the options. For example, you'll find that the markup for a Chevrolet Corvette is 15'/2percent for the base Corvette. The options are marked up 17 percent. You should consult a consumer guide like Edmund's New Car Price Guide to identify the base vehicle and option markups for the car of your choice.
Front End Prorfits
The amount of profit from the sale of the vehicle is called the "front end" of the deal. From this they have to pay the salesperson's commission and contribute to the dealership's overhead. Clearly, the new vehicle sales side of the dealership's operation is successful if they can:
1. Sell cars or trucks in volume
2. Earn a good gross profit on each vehicle sold
Back-End Profits--Profits after the Sale
If a dealership had to exist on the front-end profits alone, most would probably be out of business in short order. For that reason they will work very hard at selling "add-ons" after you've agreed to buy the car or truck. These include rust protection (which they sell to you for $150 but which costs them less than $10), extended warranties, and life, accident, and health insurance. All of these are major profit sources for the dealer. They will also try to convince you to finance your car through them. That becomes another source of profit.
Sometimes, car companies offer financing rates that are better than those you will find at your bank or credit union. This low APR (annual percentage rate) is usually part of the manufacturer's effort to move an oversupply of inventory. While we recommend that in most cases you say no to dealer-offered life, accident, and health insurance, there are some situations in which these add-ons can be of value: specifically, if you are elderly and in poor health and find it difficult to get insurance.
Dealer Hold-Backs
Currently, most manufacturers are "holding back" from the dealer anywhere from 2.5 to 3 percent of the markup in their cars. In other words, if a car has a list price of $17,100 and an invoice of $15,000, that is a 15 percent markup. What the manufacturers do is hold back 3 percent of the profit-in this case $450-so that the dealer can, if he so chooses, show an invoice of $15,450 to a customer to prove how "close we are to tissue." Once the car is sold, the manufacturer sends the dealer a check for the "hold-back."
One of the interesting side notes on this "hold-back" process is that it has negatively impacted many sales commission checks. Usually the salesperson earns a commission based on the total profit in the deal. Even though the "hold-back" is, in fact, profit, many dealers are not figuring that into the salesperson's commission. Needless to say, this does not sit well with the salespeople
Your Trade-in as Dealers Profit Source
If the dealership has a used-car operation, your trade-in can also rep¬resent a source of additional profit. Let's say that a new car has a sticker price of $18,000 and that the dealer's price, or invoice, is $16,000. Further, let's assume that the buyer trades in a car with a wholesale value of $8,000 and that the dealership agrees to put that $8,000 of used car equity against the new car. The buyer turns over the used car and a check for $10,000. The dealership now has to pay off a floor plan on the new car. The floor plan would be the invoice plus whatever interest has accrued.
For simplicity, let's say that the dealer's payment to the bank or financial institution amounts to $16,200-the invoice plus the floor plan interest, which will round off to $200. Because $8,000 of the deal is in the equity of the trade and $10,000 is in cash, the dealer has to make up the $6,200 difference. That "difference" will come from the used car. If he has given the customer $8,000 as a trade-in allowance, it's probably because he knows that the car will bring at least that and probably more at auction. However, if it's a nice car, he may sell it him¬self in order to improve his profit on the transaction. It would not be unusual for him to put the car on his used-car lot with a price of $10,995, which is about a 37 percent markup. If he sells it for $9,995, that means he has received $10,000 in cash and a trade-in, which as a result of the resale grossed him $9,995 for a total of $19,995. Subtract what he paid the bank for his floor plan-$16,200-and his total profit on the new car transaction is $3,795.
Now, factor in the back end of the deal, hold-backs, and possibly even a factory-to-dealer incentive payment, and the total gross profit to the dealership could be several thousand higher. You see? There is a reason why car dealers live in big houses
