How to Survive the Water

For many, it seemed like a tsunami. The wall of water that hit their used vehicle inventory at the end of November – again. After three straight big book drops the phone calls and emails started coming in. Panic. Well, maybe not total panic, but some deep-seated concern for sure.

The calls were much the same. “Have you seen what happened to the books? Can you believe it? What is going to happen next month? What should we do?”

I truly felt bad for my clients. I have been warning dealers since late August and discussed it at length at the Industry Summit in September. The “fall” was coming and if dealers didn’t have their inventories leaned out and on the money, they were going to get hurt.

To me, the signs were all there, and there was no reason to expect it not to happen again. The lease returns were at near all-time highs, the rental car companies were flipping their fleets at an accelerated pace, and with new vehicle sales volume back to a 16 – 17 million SAAR that meant hordes of trade-ins were coming back to dealers. Then you add in model year change and new car incentives that have grown once again on the bread and butter vehicles (similar models to rental cars). They obviously require a spread in pricing between new and used versions which further compresses wholesale values and voila, you have book falls.

What struck me odd was that so many dealers didn’t see it coming, or didn’t react to my (often conservative-based) concerns. Hadn’t they seen this all before, many times in fact?

Then it dawned on me. They hadn’t. I feel older. Many of my clients are now young enough that the “norm” was all they had experienced. Prior to 2008, this was an annual occurrence, just where the cars were less expensive and the drop in dollars was likely never this big. I think I first got a taste of it in 1988. You tend to remember those scars. The fall book drop was as certain as death and taxes. It is largely why my used car inventory always ran at a 30-day level, and why my gross profit on used cars was always strong.

Over the past six years, dealers have become used to an artificial norm – a norm in which there was a scarcity of vehicles relative to the demand. All that has changed, and we are back to the future, and it’s not changing anytime soon. Oh yeah, and whatever you do, do NOT expect a strengthening of used vehicle prices in the New Year. It isn’t going to happen. The ‘new’ old norm had books continually falling, just not nearly as severely from mid-January through August.

Dealers and managers that bought vehicles in mid-October and held those vehicles six weeks watched them devalue themselves in many cases by well over 10%. That is an absolute reduction of profit. In the past month, dealers have been experiencing some very ugly inventory situations and there is no way to escape the pain. You will either get your clock cleaned by wholesaling the vehicles at the auction or, by the opportunity cost in reduced gross that occurs when you retail out of an overbooked unit.

So what is my advice? How do you get out of the problem?

1. Here you go. You may not like it, but it is all that exists without moving money around from an inventory adjustment account, which was built from hard packs that already added more cost to your distressed inventory.
2. Set an inventory level. (30-day level on the ground. It is possible, as I have one dealer client continually selling 160 – 200 used retail units with only 140 on the ground). Communicate it to one and all. Have the discipline to stick to it.
3. Quit buying. Easy right. Uh-huh. The logic and immense temptation is that there are steals at this time of year. And there are, but if you steal one, then you need to mark it up to market and write another unit down the equal amount or you will sell the new one and still have the old ones. Adding additional inventory, unless it is pre-sold, just exacerbates an already bad situation.
4. If you are using an inventory write-down account or pack, for crying out loud use it. I know dealers that book the pack for other income when they buy the car. What if it doesn’t sell? You have nothing to adjust back to the market. If you have taken false profit, be willing to give it back because you never earned it in the first place and if you have nothing to sell, you sell nothing.
5. Make sure the inventory you own looks and drives great. There may be a reason a vehicle hasn’t sold in 90 days. See if you can find the problem, and fix it.
6. Merchandise your lot well. Certainly up north, snow, ice, and rain in the winter tend to impede moving the cars on the lot. Do it anyway. Assign each parking space a number and record where a used vehicle was sitting when it sold. Over 60 to 90 days you will discover there are spots where vehicles sell better than others. Put your oldest vehicles in these spots.
7. Don’t penalize your sales team! They didn’t likely cause your inventory to bloat, so it doesn’t help to take their heads out of the game by penalizing their pay. If you normally own a car at some dollar amount relative to the book value, if you aren’t on flats, pay your commissions from that same spot relative to the book or your sales team will learn which cars to avoid.
8. Authorize your sales management team to take shorter deals or even losers based on what the market truly is on the vehicle. Especially in subprime, you are limited on what vehicles can be financed for by the book values. Without additional (and unlikely) down payments there is little you can do to overcome that fact.
9. Don’t let your need to take short retail deals to get rid of stale inventory mask your ability to sell fresh/newer units at substantial profits – you are going to need that to offset the losers.
10. Don’t repeat it. Many have paid the price once now, just like I did. Learn the lesson and move on. It isn’t a sin to have a problem or make a mistake – it just is a sin to have that same problem or mistake six months from now.

So there you have it. No one looks forward to tsunamis. When they hit – and they always will hit in the car business – you take your lumps and move forward as quickly and efficiently as you can and you work to minimize your damage. Hopefully, this time didn’t cost you dearly, and it will just serve as the impetus to ensure it doesn’t happen again.