Cars selling at MSRP is an outrage?
Mike Smitka
Retired Economist and Judge,
Automotive News PACE Awards for supplier innovation
This is an edited version of an overly long comment posted on "This Conversation With A Dealer Will Hurt Your Brain" on Jalopnik.com.
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I am shocked, totally shocked, that someone should be asked to pay MSRP for a car. Surely you all routinely negotiate a nickel off of every ear of corn you buy from Walmart or Food Lion?? – “I wanted one a little larger, but for a bit of a discount I’ll make do with this one.”
Now to the world of a dealership in August 2021 in the US.
- In many regions of the US there’s excess demand for certain vehicles at MSRP. With a phone call, they’d be able to sell every vehicle on their lot to another dealer within the hour, without discounting or having to take another, less desirable, vehicle in return.
- Most dealers are in business for the long haul and thus don’t want to sell over MSRP because it won’t generate repeat business or service business. (Note all of the 18,000 dealerships in the US are well-managed, so those most vocal in complaining about dealers are likely encountering an exception. Or are the sort of customer who, at the end of the day, has annoyed others right and left.)
- So you as a dealer want to sell to someone local, as you have decided NOT to charge what the market will bear, and not to empty your lot today of all cars.
- So asking someone to come in is both reasonable and fair. If you aren’t going to raise your price and thus must turn away customers, then turn away the one who isn’t local, because you certainly won’t get their service business and you’re unlikely to get repeat business. (The Jalpnik writer was complaining about not being given a quote over the phone.)
- But you still have excess demand and right now you can’t get another dealership to swap inventory. You can’t replace that F-150 on your lot. (Change the model name to match the local market.)
- So what are you to do? You favor someone who has used your dealership before.
- You also favor someone who gets financing through you. For my last two cars, I got a better rate that way, too. My local credit union and bank weren’t competitive. But despite the lower rate, the dealership still got a finders fee – and I’d rather they got a cut on the deal than my local bank getting to pocket everything. The dealership was active in the local community, supporting this and that. The owner lived locally, as do the employees. But my banks ... they all now have their own foundation, to let them fund “socially responsible” ventures that they can trumpet in their investor PR. No money for the local food bank, or youth sports team.
- You especially favor someone with a good tradein, because used car prices are at a historic high. Some models are hard to find at the used car auctions of Manheim and Adessa, leased vehicles are being kept by their owners, and rental car companies are holding onto their current fleet because they, too, have a hard time buying new cars. So you can more readily make money on a tradein, if it's anything decent. You can give a bit of a discount, you can pay a bit over KBB or some other used car price guideline on the tradein, and have a both a happy repeat customer and a bit of profit. (The price increase there is the biggest component of the recent uptick in inflation in the US.)
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Multiple comments assumed implicitly that dealerships don’t need to make money. Now in general dealerships don’t make money selling new cars. As a project for students I got a Honda dealership and a luxury dealership group (5 stores, 3 brands) to go through their financials with me and then the class. At best they earn enough to keep the lights on, even the luxury dealers. They survive because they operate multiple businesses under one roof – new (individual customers and local fleets), used (retail and wholesale), service (with "loaners" – effectively car rentals – as one component), parts (retail and wholesale), and finance and insurance, They need to run them jointly and competently if they are to stay profitable, as they all face competition. [As to the numbers: one was a local dealer with whom I had a longstanding relationship, who knew the numbers would stay confidential. The other was someone I knew from before he became a dealer, who also happened to have a son in my class that term. They brought inch-thick reports with them, the problem wasn't data accuracy, it was being overwhelmed by the data that comes with the complexity of a dealership.]
In normal times – Summer 2021 is NOT normal – US customers want a car, today. (In some countries, you have to order a vehicle, there’s no local inventory. Not here.) That means there’s a constant mismatch between what a dealer has on hand and what customers want. In normal times, dealers can swap new cars with other dealers to offset that, but it’s always better for them to sell what’s on their lot. (That’s on average, see my two examples below.)
Note, too, that on average MSRP is too high, because even if there’s high demand at launch, cars stay in production for 4 or more years, with a "refresh" at the midpoint. Over time a model has to compete with other, newer models that offer features unavailable at the relevant cost point when the model was engineered (think of things such as adaptive cruise control). Worse, after the first and especially the second year, it has to compete with used cars of the same model, as rental car companies "defleet," as leases expire, and as the more well-heeled customers decide they simply want something different. As a consequence, on average prices fall 9% per year. So -9% by the end of the first year, -17% by the end of the 2nd, -24% by the end of the 3rd, and a whopping -31% by the end of the 4th year. That's obscured because early vehicles tend to be fully loaded, and so well above base MSRP. Over time packages get made standard, 0% financing kicks in, and more vehicles are closer to base. Finally, as the replacement model launches and dealers work to clear their lots, we get the more visible discounts. Oh, and remember that you've never owned a new car: the moment you take possession (which, in some states, happens when you sign the last piece of paper, it's a used vehicle, and can no longer be sold as new.
Again, there's the average, and none of us is ever quite average. My last 2 new car purchases provide a case in point. For my wife’s CR-V, that was not a problem, as Honda only offered 3 trim levels and we didn’t want an unusual color. We were also local. [Unfortunately our trade-in was on its last legs and it died on the dealer’s lot. If only it had waited one more day...] For my Chevy Cruze, I wanted a stick shift, and across the entire region there wasn’t much inventory, so I had to pay a bit more [mainly in time and travel], and compromise on color. You all can think of your own variation, the closer your “drive” is to the high-volume commodity end of the market, the less varied the pricing. The more idiosyncratic, the wider the price quote and the more painful the purchase process – for me and for the dealer, who may only discover after the fact that by not giving me a good price, they ended up with that stick shift on their lot for another 9 months, which with floor plan and insurance and other incidentals put them into the red on that particular vehicle.
Finally, this world is shifting with online retailing. In some states, but not all, fully contactless sales are possible, there’s no notarized document that has to be signed in person. So as noted, new car sales aren’t profitable (given overhead), and the margin on used cars has been compressed, with wide variation because it’s a much harder business to manage. Service volume is declining, and has been for two decades as intrinsic quality is increasing. With increasing complexity, however, dealerships aren't losing market share. EVs won’t change the trend: with 280+ million registered vehicles in the US, even strong sales won’t quickly shift their share of of the “parque”. Walmart, Costco and others are entering the market, and certainly they can bring scale and online skills to the sales end. I don't view that as a threat to dealers. Why? – it's a thin margin business, full of hassle. Walmart is of course used to thin margins. I believe, though, they're in for an unpleasant surprise on the hassle. Meanwhile, the number of dealers in the US will continue its slow decline, as the less well-managed exit. Again, that's obscured by the way things are reported: the number of stores isn't falling very rapidly, but the number of stand-alone stores is, as 5- and 10-car dealership groups become more common.
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