How Do Car Dealerships Make Money?: Investing in the Automotive Industry
With tremendous amounts of volatility in current markets, the general public is always seeking more stable avenues of investment. Through research, investors may find that the auto dealership business is an investment opportunity they should further explore. One issue that may arise, however, is that there is a limited number of resources available for finding an answer to the question, How do car dealerships make money? In this series of blog posts, we’ll explore which avenues generate the most profit for car dealerships across the nation.
A common misconception with automotive dealerships is that they profit the most from new car sales. However, to many people’s surprise, new car sales only generate around 26% of a dealership’s annual gross profit. Dealerships generally secure bank financing to acquire cars for their showrooms, but the longer a vehicle sits on the sales floor, the more interest it accumulates. As a result, profits can become meager when cars aren’t moving off the sales floor at a rapid pace.
When it comes to pre-owned dealerships, the same misconception applies. The sale of used cars doesn’t generate much profit for dealerships since dealers generally spend into their potential profit margin repairing these vehicles for resale. Nevertheless, there must be other departments within car dealerships closing that gap by generating additional profits. So again we ask: how do car dealerships make money, exactly?
Additional Avenues of Income for Car Dealerships
Dealerships have multiple income sources, creating significant opportunities for investors. For example, new cars come with a manufacturer warranty that covers the cost of repairs. The dealership acts as a service provider at the expense of the manufacturer. Even after standard warranty coverage expires, cars will still need regular maintenance. According to the National Automobile Dealers Association (NADA), the services and parts department accounts for around 49.6% of a dealership’s gross profit. This vast majority asserts that if a dealer can attract and retain more customers for their spare parts and services, they have the potential to turn a respectable profit.
Car dealerships also make money by providing aftermarket products. These products and services can range from basic maintenance plans and tire & wheel protection to rust-proofing, window etching, retrofitting alarm systems, and more. However, the two most lucrative add-ons for dealers are extended warranty packages and GAP insurance. Extended warranty packages provide coverage once the vehicle’s manufacturer warranty expires and are generally an easy sell to consumers who don’t want to incur high repair costs later on. The second most popular add-on is GAP insurance, which pays off the difference between what is owed on the vehicle and what it is worth in the case of a total loss.
Additionally, dealers often facilitate the provision of financial services to car buyers by acting as a broker between the consumer and the bank or the manufacturer’s financing department.
Providing in-house financial services, which streamlines the buying process, incentivizes customers to purchase their new vehicle through the dealership. This tactic allows dealerships to boost their profits from a single vehicle sale, especially high-value car sales.
Lastly, the sale of extended warranty policies is also on the rise. According to a study by the software company PEGA, about 54% of 16 to 24-year-olds purchased an extended warranty, nearly 30 points higher than the 55-and-up age group that trails the younger generation in extended warranty coverage. A possible explanation for this may be that extended warranty offers are often financed into car loans today. This allows buyers to stretch out this cost over the course of their loan as opposed to paying the cost as a lump sum separate from the purchase of the car.
Readers note: This is the first blog post in a four-part series where we’ll be dissecting various areas within the automotive industry. Stay tuned for our next post, where we discuss how the automotive industry still benefits from in-person sales rather than online.
Azhar Hirani manages the private equity sales team, which involves relationship management, advising and educating retail clients on new private investments, analyzing private equity portfolios, and oversight of clients’ invested capital in internal private projects. Passionate about business, marketing, and sales, Mr. Hirani maintains deep expertise in high ticket sales and has a record of success in sourcing capital and acquiring new customers.