Of course, car dealerships, unless they are profitable, do not survive. How Do Car Dealers Make Money? To several, car dealerships appear as profit-making machines. Most people are worried that they will be taken advantage of when they go to buy a car, and that the dealer will make thousands upon thousands of dollars off of them. The fact is that car dealerships are a lot like grocery stores-they rely heavily on volume to make money, and on each transaction, they don’t make much.
So, how do car dealers make money? Three key areas of their business, Sales, Support, and the Finance and Insurance (F&I) divisions, make money from car dealerships.
Car dealers don’t make much money from selling cars
To say that car dealerships don’t make money selling vehicles seems counter-intuitive. If you don’t make money from selling your namesake vehicle, why get into the car business?
This is a legitimate query, and if you don’t know how car dealerships work, your answer is veiled in secrecy. The fact is, most car dealerships make no profit from selling vehicles. Some do, but most don’t make up the majority of the profit generated at a dealership, or at least car sales don’t.
Sales of vehicles can be broken into two categories: sales of new cars and used cars. There are two different areas of a car dealership where the dealer can make cash, regardless of the sale of a new car or a used car. The “frontend” and the “backend” are referred to as them.
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The front end of the deal is all that happens to the salesperson while you work. Everything that happens after the salesperson is out of the picture is the backend of the contract, and the Finance Manager steps into the picture.
In principle, with no front-end profit and a lot of backend profit, you can have a used car sale. Or with a lot of front-end benefits and no backend profit, you might have a new car contract. Vice versa, or.
When you hear a dealer say, “We are taking a huge loss on the frontend, you better make up for it on the backend of the deal,” you know that means they don’t make much (or any) cash on the car sale, and they need (or at least want to) make money on the F&I part of the sale.
Again, on the front end of their car sales, car dealers normally do not make much of any profit at the level set. It’s no secret that their inventory is marked up by the dealer, but even with this markup, margins are slim. Manufacturers, the firms that make the cars you see at the dealership, set proposed retail rates for each vehicle they manufacture. This is what we usually refer to as MSRP, the retail price suggested by the manufacturer.
So, do dealers selling new and used cars make a killing? The response is no, 99 percent of the time. Do any individuals overpay for a vehicle, and the dealer makes a lot of profit from the front end, sure. Does it happen? Oh, no. Here are the methods by which car dealers make money from.
The Role of Commissions
Traditionally, a car salesperson works on commission, above a minimum-wage base salary. A salesperson will usually earn a portion of the “front-end gross profit” as a commission from a car transaction. The difference between the dealer’s invoice and the sale price is commonly described as front-end gross profit. Somewhere about 20 percent appears to be the number. The salesperson would gain somewhere around $200 if a car was sold with a $1,000 front-end profit.
Finance and Insurance (aka the backend)
The Finance and Insurance Office is a growing area of interest for car dealerships. F&I has always been an important revenue source for car dealers, as it is affectionately referred to, but it is becoming a big driver of profit now more than ever.
Car Dealerships Markup Loans
First, it’s important to understand that they can make money on the loan if you fund the purchase through a dealership. Do not get mad about this.
Car dealerships sell something that you and I can’t; amount, to lending institutions. In general, car dealerships get access to loans at rates that individual buyers can’t. Then dealers mark up and resell these loans to customers.
Bear in mind that you don’t have to fund your car through a dealer. In addition to seeing what the dealer will quote you, the next time you purchase a vehicle, you can consider having a pre-approval on a loan from another lender.
Car Dealerships Markup the Money Factor on Leases
If you don’t buy a car and you lease it instead, there’s still a way for dealers to make some profit there. By marking up the cash factor on a loan, dealers make money. A cash factor of .00125 is paid by the lender to the dealer, and the dealer marks it up to 50, 75, or even 100 basis points. The distinction between the purchase rate (what the dealer charges the lender) and the marked-up rate (what you’re quoted) is the dealer’s additional backend profit on the lease.
Car Dealerships make Money Selling Warranties and More
Dealers make money by offering various insurance policies or warranties in addition to the profit created from financing or leasing a car: extended warranties, tire, and wheel security, etc. The dealer makes some profit for every selling of an additional item.
In the car industry, good finance managers are like gold, and dealerships like to keep them around. Dealerships are also keen to invest in software and technologies that raise their F&I margins.
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In the industry at present, many distributors invest in third-party suppliers to make the F&I process more pleasant for the customer. Solutions such as docuPAD have been able to make the F&I process simpler for the customer while increasing the gross profit distributors receive at the same time. Dealers know that they can sell even more goods during the F&I process than ever before by enabling the consumer to self-select the assurances, protections, and plans they want.
As a rule of thumb, dealerships on the backend of a car dealer will traditionally make much more profit than on the front end. A “healthy” deal for the car dealer would result in front-end and back-end gross profit combined between $2,500 to $3,500 depending on the dealer. Note that very little of this will come from the vehicle’s actual sale.
How Do Car Dealers Make Money: warranties
Parts & Service are the Real Moneymakers
So, How Do Car Dealers Make Money? You are beginning to see how car dealerships make their money right now. Selling automobiles is essentially a way of selling other goods and services, and dealers make their cash from those other products and services.
Look no further than their parts and service department for a plethora of options as far as goods and services a car dealership has to give. For all car dealerships, the Parts and Service department is their main revenue source (and benefits center).
Let’s begin with the Department of Parts. Several related products that go towards fixing, repairing, or upgrading a vehicle are kept in stock by the parts department at any car dealership. The parts department of a dealership would have hundreds, if not thousands, of unique products stored at any given moment, from tires to shocks.
The Department of Parts sells these parts to three clients:
1. Customers;
2. Plus various dealerships; and
3. Their own Department of Service.
How Do Car Dealers Make Money: parts and services
For car dealers, it’s all about service absorption
The Service department is where car dealerships make almost all of their profits. In the company, there is a term called “service absorption.” Service absorption is the proportion that the Parts, Service, and Body Shop operating gross covers of the sum of its entire consolidated department operating expenses PLUS the total of fixed expenses and dealer salaries.
Car dealers are striving for 100% (or greater) service absorption, while most hit 70%. If a dealer reaches 100 percent absorption of service, their Components, Service, and Body Shop can make enough profit to account for all the costs of the dealerships.
In the Service Department, then, how do dealers make money? By beating the time of the book associated with each vehicle going through the service lane.
It doesn’t matter whether or not a vehicle is under warranty for a service department (dealers would gladly send invoices under warranty to suppliers for cars), what is most important is that their mechanics can beat the stated book times for each job.
Car repairs are paid based on how long a job should take, compounded by the hourly rate of a store. If it takes four hours for certain work, and a mechanic can get it done in two, guess what the dealer would charge you for? Four operating hours. And, at their hourly rate, they’ll charge you (which is generally going to be quite high).
This is how car dealerships make their money, driving efficiently through their operation by processing repairs, maintenance, and more.
How Do Car Dealers Make Money: absorption
Owning the real estate that the dealership sits on
We’ve discussed the typical ways car dealers make money so far. There are a few non-traditional ways in which dealers can make money (and, more appropriately, their owners).
By owning the real estate that the dealership sits on, Smart dealers make cash from their dealership. This is another way that dealers can gain a lot of cash. Many dealers own the land on which they build their dealerships, and then they are paid rent every month by the dealer to work there.
How Do Car Dealers Make Money: real estate
Used Cars: Trade-Ins and Purchases
While used cars account for the smallest percentage of the gross profits of a dealer, the trade-ins may themselves be a “huge profit center for the dealer,” says Oren Weintraub, a former general sales manager at a top Ford dealership and now president of the Authority Auto concierge car purchasing service in Los Angeles. And those used cars are needed by dealers.
Used cars are more lucrative for a dealership than new cars. And since dealerships prefer to recondition in-house cars, the criteria for refurbishment also help to strengthen sales of parts and services.
#How Do Car Dealers Make Money: used cars
