stocks. They are considered depreciating assets. New, as well as some used units are financed or “floored” through the dealership’s bank. Some examples of flooring banks would be Ally Bank, formerly GMAC, Ford Motor Credit or Toyota Motor Credit.
These flooring banks finance the units for the Dealer. Usually there is a grace period, such as sixty days, where no payment on inventory is due. This gives the dealer time to sell the unit, realize a profit, and pay off the flooring bank when the unit is sold.
If it goes beyond the sixty days, used in this example, the Dealer pays a flooring charge against that unit. This would reduce the amount of profit the Dealer was anticipating. Whether it is a new or used unit, this cycle continues month after month, flooring charges being applied to that specific unit that continues to sit on the lot, all due to a rise in gas prices in this example.
But that’s not the only thing that occurs. Remember, vehicles are depreciating assets. As time marches on, and the unit continues to remain on the lot, it loses value. This applies to new units as well as used units. If you were the Dealer, would you be motivated to find a buyer for that unit? Would it be safe to say you might take a loss on that unit to avoid a potentially larger loss down the road? We will discuss this subject in detail in a later chapter.
The Parts Department has generally three profit centers. The first one is retail sales of parts to the general public, or over the counter sales. The second profit center is the wholesale side. The Parts Department supplies parts to independent auto mechanics, auto parts stores and some municipalities. The third profit center is supplying parts to the Service Department. Parts are usually supplied at wholesale to the Service Department, and marked up on the customer repair orders.
The Service Department’s main source of revenue comes from warranty work. This may include new car warranty work reimbursed by the manufacturer or through an extended warranty sold through the Sales Department on used cars. There is also revenue generated through “customer pay” repair orders called “R.O.’s.” Customer pay R.O.’s may include work not under warranty, oil changes etc.
The objective of the Service Department is to build a repeat clientele. The Sales Department is a huge player in building that clientele. Customers, as a rule, usually have warranty and repair work done where they purchased the car. This creates a continuing stream of income from that customer and also retains the customer for the dealership for future car sales.
Now that you have a general understanding of how dealerships operate and create profit, let’s take a detailed look at how the Sales Department generates profit. In the next chapter, you will learn about the various selling systems, tactics and practices dealerships use to sell you a car and create profit.
The Sales Department
Now that you have a general overview of how dealerships, as a whole, operate to create profit, lets break it down and get specific on how the Sales Department functions and creates profit. It’s important to understand how the Sales Department generates revenue.
When you understand the “how,” it becomes easy to comprehend “why” it’s possible to buy a car below cost. This is crucial to your success in negotiating your car deal. How we will apply this knowledge to put you in control of the selling process will be discussed in a later chapter.
Let’s start with some of the general areas of profit the Sales Department is responsible for, and then discuss each one in detail. The first area of profit is the car deal itself. The car deal is broken down into two distinct groups of profit known as “the front end profit” and “the back end profit.”
Front end profit is generated based on the selling price of the car, less its cost. This is also known as the “front end gross.” The back end profit is usually generated by the Finance Department. Back end profit or “back end gross” is generated by the profit from extended warranty sales, GAP insurance and an array of other products and services offered by the Finance Department. The items that were purchased are then added into the contract.
The Finance Department also generates revenue by securing financing on behalf of the customer. That profit is known as “reserve.” Back end profit will be discussed in greater detail in the next chapter.
A second area that the Sales Department generates profit is on programs put out by the manufacturer. Some of the programs may include “dealer cash,” “stair step incentives,” or contests. These programs are designed to target and incentivize a dealerships performance in areas the manufacturer wants to promote growth or move inventory that has become “aged,” or in stock for a long time.
These programs are not normally advertised to the general public, nor should they be confused with rebates or consumer cash. The programs are usually not long running, and are available to the Dealer until the manufacturer’s objective is meant.
Let’s look at dealer cash for a minute and how this might benefit you as a buyer. Dealer cash is usually provided to dealers to move “aged” or stale inventory. First, I would like to point out something I think is very important. This is the Dealer’s money! Not the customers. They may use this money in a number of ways. They can keep it all, when they sell the qualifying unit, they can use it to discount the unit, or bury negative trade equity with it.
In my career, I have witnessed dealer cash amounts as high as $4,500! Imagine a Dealer discounting a new pickup truck $4500 plus the available rebate for the customer of $3,500! The objective is to identify those units where the dealer cash may be available. I’ll discuss how to do that in a later chapter as we start putting everything together that we’ve learned.
Now, let’s take a look at “stair step incentive money” and how this might be advantageous from the buyer’s perspective. I will try to keep this as simple as possible. Let’s say a manufacturer notices a lack luster sales performance in one of its vehicle lines. In this example I’ll use a Ford Focus. They have quite a few units sitting at their storage facility, and the dealerships have too many in inventory.
The manufacturer announces a program that states for every Ford Focus sold in this month, the manufacturer will reimburse the dealership $200 per unit. If the number of units sold in that month exceeds 20, the reimbursement becomes $300 retroactive to the first unit sold. If the total units sold reach 25, the retroactive amount would be $350 per unit, $500 for 30 units, and so on.
How do you think this would affect your Focus purchase if it were the 29th of the month and your purchase would be their 30th sale? Let’s do some quick math. 29 units at $350 per unit equal $10,150. 30 units at $500 per unit equal $15,000. So do you think they might dump the price on your Focus to make an extra $4,850?
When it comes to used vehicles, there are no manufacturer programs that support them in this way. The only exception to this is the Certified Pre-Owned programs. Those programs usually offer incentivized interest rate financing and a small extension of the manufacturer’s warranty. The selling price is usually increased to cover the additional expense in “certifying” the used vehicle.
However, there are other opportunities. The Sales Department is also responsible for cutting their losses when a vehicle becomes aged. You may recall from the first chapter, I stated that vehicles were depreciating assets.
Most used vehicles on dealership lots were purchased at the auction. They were transported to the dealership, reconditioned, and placed on the lot for sale. As time goes by, and they remain on the lot, the vehicles value continues to drop. The auction prices can determine the value a Dealer might receive if they were to re-auction the vehicle. If the time has been 60 to 90 days since it was purchased, there could be a significant loss to the Dealer plus re-auction fee’s and transport
