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Thursday, March 4, 2010

The Internet and Dealership Fixed Ops

"Pre-owned sales should be driven by a high rate of inventory turn rather than being based on gross profit per retail transaction," says Dale Pollak, CEO of vAuto and the author of the hot selling book “Velocity, From the Front Line to the Bottom Line.” Pollak conducted sold out workshops at the NADA convention this year. The vAuto booth was packed every time I tried to get near it. Pollak’s “velocity” concept is based on the fact that the Internet has changed the way people shop for pre-owned vehicles. When doing an online search, consumers get to a point when they are looking at too many vehicles for them to conveniently digest. They will then select a sorting parameter and in the vast majority of situations they select “Sort Lowest Price First.” Anyone who has ever purchased a pre-owned vehicle online, used Priceline.com, Hotels.com, or the search and sort feature on most online shopping sites knows this process. Pollak maintains, as do his advocates, that it is essential to make sure one’s inventory is priced in such a way as to show up in the first pages of the search, if not the first page. If a unit is priced substantially higher than the lowest priced vehicle of its type, consumers will probably never see it in a multi-page search hierarchy. The monitor of the consumers’ computer is the dealer’s display lot in this new internet driven era. If dealers and their inventory do not show up well on the web they will never see the consumer at their physical location. With dealers in the position of having to compete against their competition in an online scenario, downward pressure has been placed on transactional gross profit. It is truly the market at work and this new trend doesn’t favor auto dealers' traditional business model.

Dealers who use available technology like Pollak's vAuto will gauge their own pricing against their competitors before arriving at a posting price for their own inventory. They have found they can more than make up for the lost gross profit per unit by achieving a high turn rate. This practice also increases the number of F&I “turns” and trade ins taken. Practitioners of the “velocity” model experience astounding inventory turn rates and more than make up for the lower average gross profit per vehicle with overall departmental gross and net profit.

But this column is not about Dale Pollak or vAuto. Their theories are being proven every day in the market place. Dealers who aren’t on board with the theory are getting their butts kicked every day by those who are. This column has to do with the fact that since the pre-owned business is no longer based on a "cost plus" model and is driven by the fact that online traffic on inventory is generated based on pricing that will maximize the number of “hits”, there is a new reality in how dealers charge themselves for internal reconditioning.

In the late 1970’s, state and federal law mandated that auto manufacturers compensate dealers based on their retail customer pay rate for warranty work. Dealers, including myself, rushed to increase their “door rate” to capitalize. It was thought that discounted “menu pricing” would prevent consumers from fleeing to lower priced independents. We can look back with the clear vision of retrospect to see what happened. The increase in warranty reimbursement more than offset any loss of customer pay revenue in the beginning. Fixed Ops became the cash cow of the dealerships. But over time, new vehicles were built to increasingly higher standards and the warranty reimbursement vehicle dropped, along with the recent drop in total volume of new vehicles. Pricing cover was created for the proliferation of independent competitors in both the parts and service space.

At about the same time, it also became popular for dealerships to charge themselves internal rates for pre-owned inventory based on their new higher retail door rate. Instead of using the warranty compensation time schedule, they used full retail for both parts and labor. Previously, most dealers used an internal formula based on what they might provide any other large volume customer, like perhaps a fleet or municipality customer. Labor based in the range of 67% of retail rate and cost plus 25% on parts was typical. Not only were many dealers charging themselves additional mark up with the hopes of retaining at least that amount when the vehicle was sold, but many vehicle departments were forced to do everything “in house.” I’ll leave it to the reader to decide whether or not the retail recon concept has worked out overall. It certainly doesn’t make sense to do internal work at “cost.” It makes no sense to send work outside the dealership if the job can be done competitively “in house.” It is obviously a question of balance, and the debate is over where the balance point lies.

The “retail recon” theory was predicated on that premise that sales people and their managers sell from cost. This premise assumed that a “little extra cost” didn’t make much difference and that consumers would pay based on what the sales staff had the guts to charge and lenders would finance accordingly. The Internet has turned pre-owned vehicles into commodities. Dealers who post uncompetitive asking prices based on their old “cost plus” theories will find themselves on the back pages of the consumers’ Internet search and generate a fraction of the inventory “hits” as their “velocity” competitors. And in today’s environment, getting lenders to advance financing based on what is convenient for the dealer is problematic at best.

The policy put many used car managers in the position of having to recondition based on uncompetitive pricing. As an example, I’ve seen dealers force their pre-owned departments to buy tires at retail from their own parts departments when the same tires were available at half the price from Costco or Sam's Club. Some dealers went as far as to ban the touch up specialists and the “dent doctors,” requiring the work to be done in the body shop. Even sublet tickets have been marked up.
Many used vehicle managers used counter productive methods to deal with some of the impact of the “retail recon” policy on the wholesale side. Some would attempt to “steal" fresh trades to “package” with over age and over the market units to hide losses exacerbated by the extra internal profit that had been penciled onto their inventory. Wholesale buyers didn’t care how much money a dealership had in a unit, it was worth what current market dictated. So how do you measure the lost business from standing down from trades and including potentially high gross profit quick turn units in packages to hide losses?

In my own experience I watched a dealer tell his used car manager he could no longer do paint jobs on older “affordable” price category vehicles with a local MAACO shop. He was forced to do the paint jobs “in house” at a cost $2000. higher than the department had been paying outside. The dealer lived by the adage, “You can’t manage what you can’t measure.” How do you measure what you should have had, could have had, but didn’t get? There were no paint jobs for the dealership’s body shop to do because those vehicles now had to be wholesaled. The dealership lost the 12 – 15 “a month “affordable” price vehicles sales it had previously achieved. “Retail recon” forced other vehicles to be wholesaled instead of reconditioned and retailed. It forced appraisers to look at appraisals in a more conservative way. Fresh sales were lost as well as the trade in and F&I opportunities that would have gone with them. But the internal account on the financial statement looked nice and fat! The service manager got a nice commission check. And the lost opportunities were like they never happened.

Given the current and future pre-owned inventory shortage, many “retailable” vehicles in the “affordable” price category will need to be “made” via reconditioning rather than purchased at wholesale or traded for in near lot ready condition. Will traditional dealers leave those opportunities to competitors whose internal reconditioning structure allows them to “make” these units?

The original “cost plus” theory also included the notion that “fixed op”compensation was generally predicated on a lower percentage than “front end” compensation. "Penciling" gross profit from the sales departments to fixed operations leaves more dollars to fall to the bottom line. Some have mentioned this as one of the factors that has driven more and more sales talent from the auto business.

Will the future bring a more balanced approach to dealer pre-owned reconditioning? If your competitor is a "Velocity Dealer," he or she doesn't want you to change a thing you’re doing!

Written for Wards Dealer Business

David Ruggles is a former dealer-owner, partner, GM, and consultant with 43 years’ experience in the auto industry. He has conducted an annual seminar on auto dealership issues and processes in Japan since 1993, and helped develop specialty software focused on pre-owned leasing. A contributing columnist for Wards Dealer Business and Auto Finance News. Member of the International Motor Press Association. He can be reached at ruggles@msn.com.