It’s fair to say the auto retail business has changed more in the past 10 years than in the previous 75 years combined.
Much of the change owes to the rise of the Internet and new technologies, which have transformed the way consumers shop for used vehicles and how dealers manage their inventories.
But one thing hasn’t changed: You still make your money in used vehicles when you buy a vehicle “right.” When this happens, you’ve got a sufficient margin between your costs to acquire, recondition and retail a vehicle and its eventual transaction price to achieve your front-end gross profit objectives.
To help dealers consistently purchase used vehicles “right,” I’ve advocated that they use each vehicle’s Cost to Market metric to help them understand and manage each vehicle’s profit potential, from the moment it’s acquired. Similarly, I’ve urged dealers to assess and manage the Cost to Market ratio for their entire inventories—a higher-level view to help dealers ID purchasing/cost trends that can erode the profitability of their used vehicle department.
But there’s some misunderstanding among dealers on both fronts—dealers often aren’t clear about how to effectively apply the Cost to Market metric as they acquire vehicles at auctions and trade-ins. Similarly, dealers often don’t recognize the Cost to Market metric’s value as a trend-spotting tool.
Before we dig into the misunderstandings, though, let’s quickly review the elements that make up the Cost to Market metric itself. In short, the metric measures the “spread” between the amount a dealer pays to acquire and recondition a used vehicle and the average retail price for the same/similar vehicles available in a market (see box, this page). The metric excludes the discretionary packs some dealers apply to their used vehicles.
Now, let’s address the Cost to Market misunderstandings:
Cost To Market should be a guide, not necessarily a rule. In general, I urge dealers to maintain a maximum 84 percent Cost to Market average for their overall used vehicle inventories. As an average, this benchmark means that some cars in a dealer’s inventory will carry a Cost to Market metric above the 84 percent threshold, while others will fall below it.
But some dealers view the 84 percent Cost to Market benchmark as a hard-and-fast rule as they appraise and acquire used vehicles. They refuse to buy any used vehicle with a Cost to Market metric above the 84 percent ratio.
The problem? These dealers inevitably exclude too many vehicles from their purchasing consideration and, in turn, lack the inventory they need to maintain used vehicle sales volumes and profitability. Even worse, these dealers are often passing by highly desirable, in-demand vehicles that, by their nature, require more money to acquire and recondition them.
I should add here that the maximum 84 percent Cost to Market benchmark is especially important in today’s era of high wholesale prices and retail price pressure. In this environment, most used vehicles transact at a 90 percent Cost to Market ratio, which translates to a mighty slim 6 percent margin—hardly enough for a dealer to pay a commission and make a profit.
Use Cost To Market ratios to diagnose profitability problems. It’s common for dealers to say “I’m not making any money in used cars.” When I hear this statement, I look close at a dealer’s Cost to Market ratio for their used vehicle inventory.
In many cases, the dealers aren’t paying close enough attention—their inventory Cost to Market ratio hovers well north of 90 percent and they wonder why front-end margins are suffering.
Besides the inattention, the root causes of the margin trouble often owe to a lack of discipline or effort on the part of dealers to find and acquire vehicles with more favorable Cost to Market metrics, and/or the dealers spend too much time and money to recondition the vehicles they do acquire.
Once dealers address these controllable cost-related issues, they are much better able to achieve their front-end gross profit goals (assuming they don’t give up gross margin at their sales desks).
Finally, it’s important for dealers to also recognize that Cost to Market is just one of three critical metrics to improve profitability in their used vehicle operations. You’ve still got to get the “right” cars (e.g., Market Days Supply) and price them in a manner that assures their quick sale to maximize front-end gross and minimize age issues (e.g., Price to Market).
In addition, today’s market requires that dealers sell more used vehicles in less time. This operational necessity means that dealers should, at all times, maintain at least 50 percent of their overall used vehicle inventory under 30 days of age.