The car business is a high stakes gambit. The average consumer believes manufacturers just build cars and dealers sell them – simple as that. But it’s actually a complex franchise system with millions of moving parts that are difficult to control. From every manufacturer and supplier, to the dealers, their managers and team members, it’a giant machine with not much wiggle room between breakeven and profit, so even the slightest pull back in consumer demand can cause panic.
I was reading Glenn Mercer’s Car Charts newsletter recently, Breaking Down Breakeven about how manufacturer and dealer profits are normalizing, with inventories increasing again. Covid and the chip shortage were supposed to have taught us a lesson but Mercer’s insights bring home how things are even more precarious than I thought.
Controlling expenses is the #1 concern for dealers. Get your FREE DEALER SELF-ASSESSMENT to see how you measure up against manufacturer-specific benchmarks. Get it today!
What is breakeven?
At its simplest, breakeven is how much money you need to make to cover all your expenses before you start making a profit.
The dealership breakeven point is where the total revenue equals its total costs. This means the dealership has sold enough cars, service and parts to cover all its expenses, including both fixed costs (like personnel expense, rent, semi-fixed and fixed expenses) and variable costs (cost of sales, selling expenses). Beyond this point, any additional sales contribute to profit.
Breakeven is a crucial concept that helps determine the minimum level of revenue required to cover all fixed and variable costs.
The breakeven point tells you how much revenue you need to cover all your costs and begin making a profit. This analysis provides valuable insights for the following:
- Pricing strategy: It helps determine the minimum price that should be charged to cover costs and generate a profit.
- Sales targets: By knowing the breakeven sales volume, businesses can set realistic sales goals to achieve profitability.
- Cost management: Breakeven analysis highlights the impact of fixed and variable costs on profitability, allowing businesses to identify areas for cost reduction.
- Decision-making: It aids in evaluating the viability of new products, expansions, or investments by analyzing the required sales volume to break even.
- Performance evaluation: Comparing actual sales to the breakeven point helps assess the company’s financial performance and profitability.
Dealership breakeven
This got me thinking about dealership breakeven and though it’s not a typical metric that dealers track, it’s worth reviewing as part of an overall financial analysis. Performing a break-even analysis allows you to determine when you will likely begin generating a profit and where your sales levels need to be to maintain profitability on a monthly basis.
I have worked for and/or known only a handful of ‘good car guys.’ These are men and women who possess a gift for running car dealerships. Each one of them could calculate breakeven in their heads. They may not have known the proper accounting terminology but when it came time to close the books for the end of the month, their numbers and mine were very, very close.
The “corporatization” of dealerships
Most of those good car guys came from a world before the “corporatization” of auto retail, where owning one dealership was considered a triumph and a way to cement their legacy. Today, it’s about constantly owning more, “building shareholder value”, and cutting costs to the point where the customer and employee experiences suffer greatly.
In this move to corporatization, it’s difficult to avoid homogenizing dealerships and their management. As I’ve seen so often, in the process of making all dealerships conform to a uniform way of doing business, very often leads to lower profits, higher employee turnover, lower morale and ultimately, lower customer satisfaction.
Breakdown of dealership profitability by department and how they perform.
Dealerships consist of four departments: New Car, Used Car, Service and Parts (some have body shops, which would be another department). Each department has its own sales, gross profit, expenses and net profit. Each is its own section on the monthly financial statement and then all are combined for a total store section.
New Car Department
Contrary to popular belief, the New Car Dept rarely shows a net profit on its own (total sales minus cost of sales minus expense = net profit). However, the system is designed for these cars to return to the dealership for service, again and again. The idea is to setup future revenue for the service department in repairing the vehicle. Then, service consistently delivers excellent customer experience thereby retaining loyalty, making the dealership the first choice for the customer’s next vehicle purchase. This is part of the logic I covered in The $517,000 Customer post.
New Car profit margins, or lack thereof.
Profit margins on new cars are often negative because today’s new car profit calculations are extremely complex. They are a combination of the actual profit (or loss) a dealer makes on each car deal plus any “factory money” ie: compensation from various incentive programs, subsidized advertising, bonuses, subvented consumer financing, and special discounts. Dealerships often have to employ a designated person to manage all the incentive programs to make sure monies owed from the manufacturer are collected.
Keep in mind, dealerships are franchises, which means there is a vested interest for the franchisor (the manufacturer) to incentivize their dealers to sell cars. Every manufacturer is different, some incentive programs are more complex than others, but most dealership New Car Depts are not profitable without the manufacturer’s incentives.
I could write a whole book about how we got to this place of incentives being the “make it or break it” factor in dealership profitability. For now, let me just say that I’ve been the business long enough to remember when there was a net profit in the New Car Dept. without incentives. Ah, the good ol’ days.
The goal of the New Car Dept. is to sell new cars.
By the time the cars arrive at dealerships for sale, the manufacturer has made their profit and their desire is to sell as many cars as possible to get their vehicles out on the road for others to see and hopefully want to buy.
How the factory (manufacturer) gets paid: When the car lands at the dealership for sale, the manufacturer is paid for the vehicle via something called Flooring, which is a short term loan on that vehicle until it’s sold. An invoice is created for the vehicle, then a copy goes to the flooring bank to initiate a loan and another copy goes to the dealer. Flooring interest is paid each month, which, especially with higher interest rates, makes is one of the a largest monthly dealership expenses.
Both the dealer and the factory share the goal of “moving metal.” At the dealership level, it’s critical to manage/control how cars are sold, how they are financed, and how quickly the dealer obtains funding for car deals so they can pay off the flooring on each car. This is why superior inventory management is crucial to a successful operation.
The Used Car Dept. can often make a net profit.
I’ve always maintained that a good used car manager is worth their weight in gold. I’ve seen and experienced the difference when an expert is at the helm, and believe me, it’s pretty enjoyable, not to mention profitable.
Used Car Dept profitability is entirely dependent on two main things:
- A Used Car Manager who knows what they’re doing.
- An effective management and control review process with metrics such as days supply, inventory mix, inventory management including aging of vehicles, wholesales, and expense control.
It’s very easy to lose a lot of money on used cars, especially in volatile markets like we’ve been in during the past several years.
Fixed Operations (Service and Parts Depts.) is the actual profit center of a dealership.
According to the National Automotive Dealers Association (NADA), fixed ops accounts for an annual average of 12 percent of a dealership’s revenue, 60 percent of a dealership’s net profits, and approximately half of the gross profits.
“We are in the wrong business.”
I was part of a 6-franchise dealership group in Beverly Hills. It’s super hard to stay profitable in BH. The rents are off the charts, the City is always after you for something (example: they don’t allow balloons anywhere that the public can see them), and the customers are, shall we say…unique.
The dealership’s landlord was a guy who sold high-end rugs. His office was in the Pacific Design Center and one day we had a meeting with him to button-up negotiations on the lease renewal. Somewhere during the conversation, we got to talking about profit margins and we learned that he was making roughly 60% margin on every rug he sold.
I looked at my colleague and joked, “We are in the wrong business.”
Profit margins are nowhere near that selling cars and service. However, most of us love the car business, and would likely not enjoy selling rugs.
Auto manufacturers and breakeven
In Glenn Mercer’s post, he makes the point that the problem is that the auto industry is a high-breakeven-point industry, meaning that the urge to produce is very strong. He asserts that for the industry as a whole, profits don’t emerge until capacity is 80% or even 90% utilized, because the fixed costs are so high. Assembly plants cost billions to build, suppliers of components cannot be easily turned on and off, R&D budgets dedicated to finding cheaper battery technologies or safer autonomy software are enormous, etc.
The obvious problem with enormous pressure to produce and sell is that it kills profitability. As cars keep coming off the factory line faster than Lucy and Ethel can wrap the chocolates, the urge to cut price becomes overwhelming and factories and dealers alike slide into lower profits or even losses. We have seen this at the publicly-traded dealer groups such as Lithia and AutoNation, whose new-car profits are rapidly regressing back to the mean of 2019 or earlier.
If the supplier and OEM breakeven point is 85% of capacity, even the slightest pullback in customer demand will cause panic in the executive suite.
- Triggering discounts (“If we cut price they’ll buy more”)
- Inventory builds (“If we give them more choices they’ll be sure to find something they like”)
- Financing subvention (“Just pretend the residual value is higher, that will bring the lease payment down”)
- Other bad behaviors.
It was refreshing to hear Mr. Mercer share this, if only to validate my own assumptions and provide more context to how this lack of sustainable profit has permeated throughout the industry over at least three or four decades.
Time for a more equitable, sustainable model
My car business career began very early in my life and I can remember when the New Car Dept made a pretty decent profit. I’m not naive about how things have progressed to the stage we are now. The relationship between the manufacturer/franchisor and dealer/franchisee was once a solid bond forged by a common goal. Sadly, that’s been chipped away at, and now both sides are susceptible to panic with even slight market fluctuations.
I do wish the entire industry could make efforts towards a more equitable, sustainable place. When panic is baked into the entire machine, it’s tough to move beyond it. In the meantime, keep an eye on your breakeven!
If you’ve gotten this far, you might like my Kruse Control Newsletter. Get my latest business tips, exclusive content, and a bit of fun straight to your inbox. Sign up now – it’s free!