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What is the average profit for the owner of a car dealership?

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2008-04-07 17:09:04

What Dealers Won't Tell You About Car Prices In order to

understand what price you might expect to pay for your next car,

you must first understand how new car pricing really works. As you

know, pricing is very important whether you lease or buy. Different

customers can pay widely different prices - for the same car, at

the same dealer, on the same day - depending on each customer's

knowledge of how car pricing works. New car dealers expect most

customers to negotiate price. Unfortunately, negotiating is not

easy. Buying a new car is more like haggling for a donkey in

Marrakech than buying a refrigerator at Sears. Dealers are able to

quickly spot customers who don't have the knowledge to negotiate

well. Knowledge is key. Let's take a look at how dealer pricing

works. Manufacturer's Suggested Retail Price

First, for new cars, automobile manufacturers decide the retail

price that will be set on each model, each model variation

("trim"), and each option. Combined, these prices become the

Manufacturer's Suggested Retail Price (MSRP). These prices

can change from year to year for the same models, or can even

change one or more times during a model year. MSRP becomes the

"sticker price" - the price shown on the vehicle's attached window

sticker. There will also be additional charges for transport and

preparation ("destination charge"), and distributor/dealer

installed options. These charges are not technically part of the

MSRP, but are part of what you pay. Notice that the "S" in MSRP is

short for "suggested," meaning that a vehicle's sticker price in

only a recommended price. A dealer is perfectly free to charge more

or less if he chooses. For hot-selling new vehicles in high demand,

selling prices can easily be higher than sticker price. For

slow selling vehicles in good supply, selling prices will almost

always be less than sticker price. Invoice Price

Dealers are independent businesses, not owned by car makers,

which means they buy wholesale and sell retail to make money - like

any other business. Wholesale price, sometimes called "factory

invoice price" or "dealer invoice price," is the price that a

dealer pays the manufacturer for a vehicle. All dealers pay the

same price for the same vehicle. However, there are other factors

that determine a dealer's actual cost. We'll examine those in a

moment. Dealer Profit Margin

The difference between MSRP sticker price (retail price) and

invoice price (wholesale price) is a dealer's potential profit

margin, assuming vehicles sell at sticker price - ignoring other

costs, charges, or rebates he might receive. This dollar margin, as

a percentage of sticker price, is not the same on all vehicles.

Some vehicles have a very high profit margin percentage, others

have a low margin percentage. For example, Lexus vehicle have very

high 13% margin, while Suzuki vehicles have only 4% margin. A

vehicle with a high potential profit margin provides an opportunity

for a higher dollar discount than a similarly priced vehicle with a

lower profit margin. (The Lease Kit compares profit margins for all

vehicle makes and models.) You are more likely to get a better deal

on a car with a $5000 potential profit margin than on one with a

$1500 potential profit margin. Invoice price alone, however, does

not tell the entire story of what a vehicle costs a dealer. He has

other costs and other sources of profit. Dealer Costs

Dealers usually have to pay national or regional advertising

fees (for TV and newspaper ads) and interest on loans

("floorplanning") he uses to buy vehicles from the manufacturer.

Dealers also have typical costs associated with running a business:

employee salaries, rent, utilities, taxes, etc. Many customers

mistakenly believe that dealers should be able to routinely sell

cars at their base cost. If they did, they would soon be out of

business. Any business must make a profit to survive. Dealers also

pay interest on the loans they use to buy cars from the

manufacturer. The longer a car stays unsold on a dealer's lot, the

more interest he pays. Many consumers believe that a dealer's cars

belong to the manufacturer. Not true. Factory Assistance to


Dealers receive special fees, bonuses, and rebates from car

manufacturers that reduce costs and add to profit potential.

Without manufacturers' assistance, many dealers wouldn't be able to

make it. "Holdback" is an example of a common type of bonus

received by dealers. Holdback is a kind of rebate from the car

maker that is usually a small percentage (typically 1%-2%) of a

vehicle's MSRP or invoice price that a dealer receives only after a

vehicle is sold. Technically, holdback is intended to be

compensation for finance fees the dealer incurs while vehicles sit

unsold. The faster a vehicle sells, the more profit he makes on the

holdback. A vehicle that sits on the lot for a long time can be a

money loser, even with the holdback. There might also be

promotional factory-to-dealer rebates or bonuses based on certain

conditions or sales goals being met. Such rebates can often be

significant in times of slow sales. Dealers can choose to pass some

or all of his factory rebates along to customers, or not. These

rebates are especially common at the end of the model year. In most

cases, heavily advertised discounts have a "factory contribution"

as well as a "dealer contribution." This means both the

manufacturer and the dealer give up some (or most) of their

potential profit to help promote sales and move cars off the sales

lot. Holdbacks, factory rebates, and bonuses are what allows

dealers to sometime sell cars for less than invoice price,

and still make a meager profit. Additional Dealer Profit


Dealers have other profit sources. Documentation fees

("doc fees") of a few hundred dollars are administrative fees but

usually exceed actual costs, thereby providing a profit.

Preparation fees ("prep fees"), allegedly for cleaning and

preparing a car for delivery, are often excessive, providing

profit. Add on items such as rust proofing, security

systems, window etchings, extended warranties, and credit insurance

are all high profit generators for dealers. Even dealer-arranged

financing brings a dealer profit from commissions and

interest rate mark-ups ("reserve"). Lease acquisition fees,

although charged by lease companies, bring some kickback profits.

Trade-in vehicles are a large dealer profit source. Dealers

who take trade-in vehicles and sell them on their used-car lots

make more profit per vehicle, on average, than on brand new cars.

Selling Price - "Cash Price"

This is the price that customers actually pay for a vehicle,

which is usually somewhere between MSRP and dealer invoice price.

Again, there are conditions under which selling prices could be

higher than MSRP or lower than invoice, depending on supply and

demand, and promotional incentives. Selling prices can vary

considerably for a particular vehicle make and model, depending on

the dealer, area of the country, city size, competition, time of

month, time of year, negotiating skills of the buyer, and available

incentives. With all these factors at play, it's easy to understand

the wide range of prices that consumers pay for a particular

vehicle, even from the same dealer on the same day. Price


There are two parties to new-car price discounting - dealer and

manufacturer. Manufacturers provide factory-to-customer cash

rebates and factory-to-dealer rebates. A dealer can provide

additional discount ("contribution" or "participation") by giving

up some of his own normal profit, or some/all of his

factory-to-dealer rebate, if any. Customers sometimes overlook the

possibility of a negotiated dealer discount when they are already

getting a factory-to-customer rebate. Dealers often encourage this

misunderstanding. There is no reason a dealer cannot offer an

additional discount on top of any rebate that a customer is already

getting from the manufacturer. The combination of strong dealer

discounts and aggressive manufacturer incentives can easily result

in below-invoice selling prices. However, without manufacturer

participation, dealers can not and will not routinely sell cars at

or below invoice price. Consumers often have unrealistic

expectations regarding dealer discounting. What Are Others


Ideally, we should be able to determine what other customers are

paying for the same vehicle make and model that interests us.

However, this is virtually impossible since dealers are not

obligated to publicly report selling prices. Although posts a True Market Value (TMV) price for

each vehicle make and model that purports to be a representative

average selling price, these are based on limited information and

not always accurate. Edmunds also has "Town Hall" user discussions

regarding pricing. Many vehicle makes and models have

owner-enthusiast web sites in which users willing share

prices they've paid. Although this can be helpful, it doesn't

provide an accurate picture that represents all dealers, in all

cities, under all conditions. Price patterns can vary greatly

across the country. Prices also vary from customer to customer,

depending on negotiation skills and knowledge about pricing. How

to Get Prices

One of the best ways to get an accurate feel for dealer selling

prices in your town is to request free quotes from online

pricing/buying services that partner with dealers across the

country to provide Internet customers with discounted prices. See a

list of the most popular services below. The more prices you ask

for, the more prices you'll have to compare. Another reason to get

prices from more than a couple of services is that, for various

reasons, some services may not respond to you. Getting Online


You should understand that Internet-based car-buying/pricing

companies are not car dealers. State laws dictate that all new-car

sales must be transacted by a licensed franchised dealer - new-car

dealers in your town. CarsDirect (below) comes closest to actually

selling cars online because they can handle all the details

themselves (for most zip code areas) up to the point at which

customers must go to a local dealer to pick up their vehicle. It's

a great service for those who don't have the time or interest in

haggling with dealers. Participating dealers typically agree with

the online service to offer the services' customers prices that are

a percentage or dollar amount over invoice price (or under invoice

if manufacturer incentives are available). In return, the dealers

pay the services a small fee for the referral. The service is free

to potential customers. If you request quotes from a minimum of

three pricing services, you'll start to get a good idea of the

actual selling price for your vehicle of interest. For example, if

you get five prices, and see that three that are similar, one is

higher, and another lower, you know the range of prices that you

have to work with. A little negotiation may get you a better deal

than the already-discounted quotes you receive but, at least you'll

have a good starting point to begin your negotiations if you are so

inclined. Typically, dealer-discounted quotes will already include

any currently available rebates - but not always. It doesn't hurt

to ask.

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