How car dealers make money

So, how do car dealers make money?

You have probably heard your car salesperson say to you “You seriously got a great deal” or “We are selling this vehicle for a loss”.  Are they telling the truth?  Did you hook them up to a lie detector test?

Probably not huh???Honest Car Dealers Test

So how do car dealers survive if what the salesperson said was true?  There are a few profit centers in the dealership and they each have their own department: Sales, F&I (Finance and Insurance), Service, Parts, & Body Shop.  Some dealerships also may have an after market department too, but for this example let’s concentrate on the most common.

  1. Sales–  Sales makes money on the difference between what the dealership owns the car for and what you paid for it.  Dealers often add “pack” money on used cars which varies from $500-$1200 dollars.  Pack money is nothing more than baked in profit designed to ensure the dealership will make something and to also ensure that the sales people DON’T get paid on it.  So, a salesman is paid AFTER pack money.  On new vehicles the “pack” money is typically $0 or $100 dollars but again on a used vehicle it’s a bit more.  On used vehicles dealers cost vary QUITE a bit which I will explain in a later post.  So, it’s really hard to tell what the dealer owns it for without looking at the books.  Why such a variance?

Here are a few reasons why used car prices can vary so much:

  • If the vehicle was a trade, did the dealer have to “step up” to make the deal happen?  Therefore, putting more money in the car than the appraiser recommended?
  • What were the reconditioning costs?  This is largely determined by how the previous owner cared for the vehicle and the vehicles original mechanical condition.
  • If the vehicle was bought at the auction, did the dealer pay too much?
  • What time of the year is is?  Seasonality largely effects used car pricing so depending on when the car was bought or traded the value may be higher or lower.  (In the month of December used car values diminish drastically)

How much money does a dealer make on a NEW car:
Check out the following link to another post on HONEST CAR DEALER explaining what New Car Dealer Cost is and how dealerships make money on new vehicles.

So here’s a look at the potential profit of transactions:

2007 Honda Accord- EX( just traded in)

  1. Dealership gives the customer $13000 and the “black book” and auction values states that is average condition.  This is a fair value.
  2. The Honda gets inspected where the dealership had to put $750 dollars to recondition the vehicle (subtotal- $13750)
  3. The office or accounting department adds $1000 of pack on the vehicle ($14750)
  4. While on the lot the salesperson recognizes a few scratches and the management team agrees to fix them for $250 ($15000)

The dealership then looks online to see what the other 2007 Honda Accord EX’s are priced at.  The dealership notices the competing dealers in the area have a very similar vehicle priced at $14400. In order to be aggressive the dealership prices their vehicle at $14300 which would constitute SELLING THE VEHICLE UNDER COST!

Customer calls and asks for the Internet price and gets $13900 then decides to stop in.

Customer takes a test drive and offers the dealer $13800.

The dealer accepts.

Did the dealer lose money?  Well….

1.    Sales department profit worksheet:

Selling price $13800

Cost of $15000

Profit -$1200  (Before you argue this is how the sales department will calculate it and NOT the dealership)

Salesperson commission (typically 30%) of -$1200- a nice flat commission of $100

TOTAL NET PROFIT: -$1300

2.    F&IThe F&I Department is another HUGE profit machine for the dealership.  Please read the following post for tips on the BEST WAYS TO FINANCE A NEW OR USED CAR.

On a selling price of $13800 the customer decides to finance with $0 money down therefore financing a balance of $15,000.
Customer gets a rate of 5.9% from the dealership and a buy rate (wholesale rate) of 4.9% earning the dealership $280 dollars.

Customer chooses to buy gap insurance for $800 dollars.  Cost on gap insurance is $400, Profit of $400 ($680) [Gap insurance costs vary on the term AND loan amount.

TOTAL F&I NET PROFIT: $680


3.    Service- The service department is the largest profit center in almost any dealership.  The service department makes money on the difference between the labor rate they charge which is typically $100-$150 dollars and they labor rate the dealership pays their technicians which can vary between $10-$40 dollars.  It’s really that simple.

The following is the potential profit using the same example:

Service department profit worksheet

    • Labor – LOF,  Inspection, and A/C line repair= $550 billed internally at $93.75 per hour which is the internal labor rate. –
    • Cost of Labor- 5.8 hours @ $20.00 per hour = $116.00

TOTAL NET PROFIT: $434


4.    Parts- The parts department makes their money on the difference between what they sell parts for minus the cost. Simple right?

Same example:

    • Internal price  of new A/C line, oil, and filters- $200
    • Parts cost- $100 (***After thought- The parts mark-up WOULD NOT be this much. Just a FYI- you get the point.  Parts margins are A LOT slimmer.***)

TOTAL NET PROFIT:  $100

SUMMARY

Therefore on this transaction here’s the balance sheet:

  • Sales department lost $1300 (-$1300)
  • Finance department made a profit of $680
  • Service made of profit of $434
  • Parts made a profit of $100
  • DONT FORGET that Pack money that would get added in accounting- $1000

TOTAL NET PROFIT: $914 dollars  (Keep in mind that dealers have carrying costs too and overhead not calculated in the costs here)

So, the next time a salesman tell syou that you received a good deal. Albeit that may be true but don’t feel bad.  The dealership did OK…

For all of your tips please visit the place where honesty is the the ONLY policy HONEST CAR DEALERS!

February 10, 2011 by Jamie Rettig