Buying a car is a significant financial decision, and understanding how dealerships make their money can empower you to negotiate a better deal. Many believe dealerships rake in massive profits on every sale, but the reality is more nuanced. This article delves into the various factors influencing a dealership’s profit margins, revealing the truth behind the numbers and equipping you with the knowledge to become a savvy car buyer.
The Myth of the “Huge” Markup
Often, the perception exists that dealerships mark up cars exorbitantly, leading to enormous profits. While markups certainly exist, they are not as high as many consumers imagine. The automotive industry operates on relatively thin margins, especially on new car sales. A significant portion of a dealership’s income comes from other avenues besides the initial sale price.
Invoice Price vs. MSRP: Understanding the Difference
To understand dealership profits, it’s essential to grasp the difference between the invoice price and the Manufacturer’s Suggested Retail Price (MSRP). The invoice price is what the dealership pays the manufacturer for the vehicle. The MSRP is the sticker price, the price the manufacturer suggests the dealership sell the car for. The difference between these two figures is the potential gross profit the dealership could make, but it’s rarely that simple.
The invoice price isn’t always a fixed number. Factors like manufacturer incentives, volume bonuses, and holdbacks (a percentage of the MSRP that the manufacturer refunds to the dealership after the sale) can affect the actual cost the dealership pays. Dealerships often aim to sell cars for close to, or even slightly below, invoice price to meet sales quotas and secure manufacturer incentives.
The Reality of New Car Profit Margins
New car sales often have surprisingly low profit margins. Dealerships may only make a few hundred dollars in profit on a new car sale, especially on popular models. This is because competition among dealerships is fierce, and consumers are often well-informed about pricing, thanks to the internet.
Dealerships rely heavily on volume to generate revenue. Selling a large number of cars, even with smaller profit margins per vehicle, adds up to a substantial overall profit. The pursuit of manufacturer incentives further drives this volume-based approach. Failing to meet sales quotas can cost a dealership significantly, making them more willing to negotiate on price to close a deal.
Where Dealerships Really Make Their Money
While new car sales may not be the primary profit driver, dealerships have other revenue streams that contribute significantly to their bottom line. These sources are often where the real profit opportunities lie.
Used Car Sales: A More Lucrative Avenue
Used car sales generally offer higher profit margins than new car sales. This is because dealerships have more control over the pricing of used vehicles. They acquire used cars through trade-ins, auctions, and purchases from individuals. The cost basis is more flexible, allowing for a greater markup.
The key to success in used car sales is accurate valuation and effective reconditioning. Dealerships assess the condition of the vehicle, make necessary repairs and improvements, and then price it competitively based on market demand and condition. A well-managed used car operation can be a significant profit center for a dealership.
Finance and Insurance (F&I): The Profit Powerhouse
The Finance and Insurance (F&I) department is often the most profitable area of a dealership. This department offers customers a range of products and services, including auto loans, extended warranties, gap insurance, and other add-ons.
Dealerships make a commission on the sale of these products. The markup on these items can be substantial, making F&I a crucial revenue source. While these products can provide genuine value to customers, it’s essential to carefully consider your needs and compare prices before purchasing anything in the F&I office. Negotiating the terms of your financing and insurance is just as important as negotiating the price of the car itself.
Service and Parts: A Consistent Revenue Stream
The service and parts department provides a steady stream of revenue for dealerships. This department handles everything from routine maintenance, such as oil changes and tire rotations, to major repairs.
Dealerships make a profit on both the labor and the parts used in these services. While independent repair shops may sometimes offer lower prices, dealerships often have specialized equipment and factory-trained technicians, ensuring quality service and expertise. Building a relationship with a dealership’s service department can be beneficial for maintaining your vehicle’s performance and value.
Factors Affecting Dealership Profitability
Several factors influence how much profit a dealership makes on each car sale and overall. Understanding these factors can give you insight into a dealership’s negotiating position.
Location and Market Conditions
The location of the dealership plays a significant role in its profitability. Dealerships in high-demand areas with less competition may be able to command higher prices. Conversely, dealerships in areas with numerous competitors may need to offer more aggressive discounts to attract customers.
Economic conditions also impact profitability. During economic downturns, car sales tend to decline, forcing dealerships to lower prices and accept smaller profit margins. Conversely, during periods of economic growth, demand for cars increases, allowing dealerships to increase prices and improve their profitability.
Dealership Size and Overhead Costs
The size of the dealership and its overhead costs also influence its profitability. Larger dealerships typically have higher overhead costs, including rent, utilities, and employee salaries. These costs must be covered by sales and service revenue.
Smaller dealerships may have lower overhead costs, allowing them to operate more efficiently and offer more competitive prices. However, they may also have less inventory and fewer resources than larger dealerships.
Manufacturer Incentives and Rebates
Manufacturer incentives and rebates can significantly affect a dealership’s profitability. Manufacturers often offer incentives to dealerships for meeting sales targets or promoting specific models. These incentives can be passed on to customers in the form of discounts or rebates, or they can be retained by the dealership to improve its profit margins.
Rebates are typically offered to customers directly, but dealerships may also offer their own discounts and incentives to attract buyers. Understanding the available incentives and rebates is crucial for negotiating the best possible price on a car.
Negotiating for a Better Deal: Tips and Strategies
Now that you understand how dealerships make their money, you can use this knowledge to negotiate a better deal on your next car purchase.
Research and Preparation are Key
Before you even set foot in a dealership, do your research. Know the invoice price of the car you want, as well as any available incentives and rebates. Get pre-approved for a car loan from your bank or credit union. This will give you a baseline interest rate to compare with the dealership’s financing offers.
Be Willing to Walk Away
One of the most powerful negotiating tactics is being willing to walk away from the deal. If you’re not comfortable with the price or the terms of the financing, don’t be afraid to leave. Dealerships are often more willing to negotiate with customers who are prepared to walk away.
Focus on the “Out-the-Door” Price
Don’t just focus on the price of the car itself. Be sure to negotiate the “out-the-door” price, which includes all taxes, fees, and other charges. This will give you a clear picture of the total cost of the vehicle.
Negotiate Financing and Insurance Separately
Don’t bundle the financing and insurance with the price of the car. Negotiate each item separately to get the best possible deal. Shop around for auto insurance quotes before you go to the dealership, so you know what a fair price is.
The Future of Dealership Profitability
The automotive industry is constantly evolving, and dealerships are adapting to changing market conditions. The rise of online car buying platforms, the increasing popularity of electric vehicles, and the growing demand for subscription services are all impacting dealership profitability.
Dealerships are increasingly focused on providing a seamless customer experience, both online and in-person. They are also investing in new technologies and services to attract and retain customers. The dealerships that thrive in the future will be those that can adapt to these changes and provide exceptional value to their customers.