COMMENTARY: A look into the future of auto dealership inventory management
For the past few years auto dealers have enjoyed unprecedented market conditions with record profits in both new- and used-vehicle sales. However, excluding a brief reprieve in February and March, the tightening of the consumer market and the subsequent drop in wholesale values has created a dynamic where many operators are struggling to turn a profit.
As Sir Isaac Newton said, “What goes up must come down.” In the last several years, the precipitous rise and fall of vehicle values driven by increased consumer demand would seem to confirm that quote. As the consumer frenzy stalled due to rising interest rates and affordability challenges, the average age of inventory sitting on dealer lots across the country started to increase in the second half of last year.
As a result, vehicle values started to rapidly decline as dealers slowed inventory acquisition and price competition increased. As auto dealers, the challenge shifted quickly to moving stale or excess inventory off of lots rapidly before it wiped out your profit.
The good news…
The market has stabilized a bit. The average used car is still worth substantially more than it was pre-pandemic.
However, there is an argument to be made that a more normal operating environment is ahead of us as elevated vehicle values are more in line with the exorbitant inflation rates being felt in most industries. The idea that there’s more room to go, especially as supply normalizes on the new car side, is certainly true, but there is reason to be less fearful.
A new dynamic in the used-car market
That being said, there is another unusual dynamic playing out in the current used market. Because of the slowdown in vehicle production caused by the pandemic, there is lower-than-normal availability of late-model vehicles, specifically any model year produced in 2021, 2022, or 2023.
Because of the supply constraints in those production years, far fewer of these vehicles were sold new. As a result, fewer late-model vehicles are available for dealers to buy off lease, as trade-ins, or in the wholesale market.
Compounding the problem is the fact that many of the new vehicles that were sold to consumers in those years were sold at or above normal pricing (MSRP or above) and financed. This has led to above-average loan balances and more negative equity than ever before, making it harder to pull consumers out of a trade-in. This is significant because late-model trade-ins tend to be one of the most profitable inventory sources for a used car operation and are in many ways the engine that keeps your used car department running.
These are the used-car managers’ bread and butter. They drive used-car sales, lead to more trade-ins when sold, generate income in the finance office, lead to future service work, and are important to retain customers that are loyal to your brand but may not be in a position to purchase a new vehicle at the moment.
Therefore, there is still this underlying scarcity in the market.
Adding to this market challenge is the chip shortage, which altered how some cars were built, along with low parts availability. All this can affect vehicle values and impacts the world that the used-car manager inhabits right now. How they choose to manage this moving forward and still make money is no easy decision.
Dealers are well-known for being smart and resilient. That being said, it is important to adopt strategies that work best for your market conditions. What can you do differently right now to be successful in the current climate?
Adopt a strategy of discipline
If I were to sum it up in one word, I think the key thing is discipline. It’s having the discipline to know and establish what your core inventory is — meaning, what do you sell well? If you are a Toyota store, you know that customers come to your store to buy Toyotas.
But you should also take a more analytical approach and analyze the data based on your sales history, market data, and more. If you are in a rural part of Texas, there is a good chance you can sell a truck. And your sales history and/or market data will help you see the things that you intuitively know, as well as some things that you didn’t.
Don’t let fear drive decisions
Of course, you can’t sell what you don’t have — you still have to buy vehicles and have inventory. If I am a grocery store manager, I have to have groceries on the shelves if I want to operate my business.
So as a used-car manager, you have to have used cars on the lot. You cannot be so cautious that you don’t go out and buy used inventory. This is a mistake I see too many used-car managers fall victim to.
You also need to know what sells well, be smart about what you buy and what you pay for it, and manage your stocking levels. It’s not enough to just know, “Here’s what I buy, these are the cars that I sell well.”
You need to go deeper and think, “These are the cars that I sell well, but I also need to think about how to price them, how many I have, and how I manage them if they age.” Have a robust and defined pricing and aging strategy. Maintaining discipline and executing that strategy matters.
The fine art of vehicle pricing and valuation
When considering how to price a vehicle online, most used-car managers look at a vehicle and think, “OK, I am going to find similar vehicles in my market and see how my car stacks up against the competition in a few ways: a) is this vehicle more or less attractive than average? b) Does it have more or less equipment than what’s on the market? c) Is this vehicle under or over-supplied in my market? And d) Does it have a better history than the average car on the market?”
Every used car is unique. Each has a story. You have to take a real look at each one. There are so many things to consider. Is it the most or least desirable color? Does it have the most or least desirable interior? Is it well equipped? Is this the package the buyers want? What condition are the wheels in? And much more.
There’s a little bit of an art to it. But it is really just calibrating to the average — is it better or worse than the average? And then based on that assessment understand the strategy that almost everyone uses. Look at what vehicles sell for in your market.
If the average Toyota Corolla sells for $20,000, compared to that, is yours an average car? An above-average car? Is it a well-above-average car? Is it a below-average car?
Price to win, not to lose
Structure your pricing strategy to what you think that car is worth. You’ve got to be right about that. And then have a structured markdown strategy. If you price it from day one to lose money — guess what? — you are going to lose money!
Price it at first to make more than you think it is worth. And, be disciplined in your approach. Let’s say you want to turn all of your vehicles over in 60 days. If you need that car gone in 60 days, the first 15 you are going to swing for the fences because you can’t strike out in 15 days. So, you set the price higher. And guess what? That most in-demand inventory is going to go.
Now, from 15-30, you mark it down a little bit. From 30-45, you mark it down a bit more. And from 45-60, get aggressive and get rid of that car. Depending upon how that vehicle shifts, you may need to change some of your assumptions about if it is in fact an above or below average car.
The inventory balancing act
From a selection standpoint, select the right cars based on your sales history and market data, but then also by understanding your current inventory position in similar cars.
This story is a great analogy. We were in Hawaii, and we went on this road trip to Hana. It’s a daylong affair, only one road in and out. You get to this little town with a population of perhaps 750 people.
There is just one game in town. This one guy has a lunch place, and he also sells shirts and hats and all this stuff. That guy has X number of visitors that come to Hana every day, stop at his lunch spot, and buy his stuff.
If that guy were to say, “Hey you know what — I am selling these shirts like crazy, they are flying off the shelves. I sold 20 yesterday alone! I am going to buy 10,000 of these shirts.”
All of a sudden, he has 10,000 shirts in stock. He is not going to sell more shirts, necessarily, than he would have previously. If he were understocked, he might. However, if he were overstocked or even perfectly stocked beforehand, he is not going to sell 1 more shirt. In fact, if he doesn’t start selling more than 20 shirts a day, he will be sitting on 500 days’ worth of t-shirt sales.
The effects can be disastrous — chances are some of his inventory will get damaged or go missing, the shirts may go out of style, and holding that inventory will tie up a bunch of his cash that he could have spent in other parts of his business to make a profit now.
Well, cars are no different. If I am a Lexus dealer in a large metropolitan area and Lexus RX 350s are flying off the shelf, there is certainly an argument that I might be understocked and need to acquire more inventory to stock up. Just be mindful of your daily sales rate and how many days’ worth of sales (your days’ supply of inventory) you want to keep in stock.
Don’t look at just your inventory as a whole, but go down to the model level, at least. Some used-car managers take that analysis to price bands, model years, package, color, and more.
It is very easy to be overstocked. Just because you found a car at auction and the price was good, does not mean you should buy that car. If you sell 10 Toyota Corollas a month and decide you want to have 50 in stock — you now have five months’ worth of sales in inventory.
And, at the rate cars decline in value, most agree that it is tough to turn a profit on a car when you hold it for more than 60 days. Because of recent depreciation rates, I believe that the profit window closes closer to day 30 or 45. So, as a used-car manager there is this delicate balance of having enough, but not too much.
The challenges used-car operators will face throughout 2023 are varied and numerous, but they can be overcome with the right planning and execution. Those who have consistent, well-defined strategies and stick to them will be the ones rewarded in all markets.
Without discipline, a clearly stated pricing strategy and inventory management strategy, and an awareness of market conditions, it is tough to survive in this climate. However, as I previously mentioned, dealers are well-known for being smart and resilient and have survived and thrived under similar conditions in the past. With the right strategy, you can thrive despite the many challenges you face.
Nick Gerlach is executive vice president of operations & product Strategy at CarOffer.