Reaping the Profits of the Internet

I did some quick, back of the envelope calculations and came to the conclusion that the Internet has yet to have a positive impact on the used car industry, I would say new car as well, but given how poorly the domestic manufacturers have been performing, it is tough to pull out the data. Here are some numbers:

The US has experience a roughly 5% GDP growth rate since 2001 (unadjusted for inflation), productivity has continued to increase, inflation has been stable, but net profit per unit sold for used cars has actually decreased since 1996, even since 2001. This means, that dealers are making less per car than they were five and ten years ago, and even less once you take into account inflation.

One might be tempted to argue that better informed consumers have driven down the prices, but, according to NADA, the average retail selling price has actually increased significantly since 1996. What is fascinating to me is that the decrease in net profit has coincided with the rise of the Internet, potentially a tool that should have increased margins and profitability for dealers.

I believe that the current operating structure of dealerships that were created prior to 2001 prevents them from fully capitalizing on the benefits of the Internet. The first benefit that dealers should have reaped from the Internet is decreased finding/marketing costs. By uploading inventory to a few sites, dealers have the ability to reach millions of customers a month, in a way that can be tracked. This should be a boon to dealers that can now get a better handle on marketing ROI.

The other advantage dealers should have accrued is increased productivity: more sales per person because of better customer relationship management tools. Most CRMs are inexpensive and should do an adequate job helping a sales person track and manage potential customers, and hopefully, increasing closing rates of a sales person.

Unfortunately, how dealerships were structured in the past continues to hurt profit margins and prevents dealers from fully realizing the benefits of the Internet. Point number one, in the past, dealers would try to find the best retail location for foot traffic, the locations were expensive, but paid for themselves because of lot ups. Now, over 70% of car buyers turn to the net before buying, meaning that most consumers know exactly what they want before they ever step foot in a dealership, ultimately decreasing the amount of foot traffic a dealer receives. At the same time, real estate prices have risen pushing up rent or property taxes, essentially creating a situation where finding costs have decreased, but distribution costs have actually increased.

Secondly, because most sales people are paid on commission, few dealers are able to enjoy the increased productivity of sales people. If a sales person is paid $200 per car, there is no return to scale for investing in better technology. What I mean, is that if a sales person were paid $5k a month, and before implementing a CRM, was able to sell 25 cars a month ($200 per car), but after the CRM, the person sold 30 cars a month, the cost per car sold would decrease to $166 a car. However, by paying on commission, the sales person still receives $200 a car, excluding any spiffs for selling additional cars.

There are new dealerships that recognize this and have structured their operations differently. eCarlink.com and Auto2Auto.com are just two examples that spring to mind. Instead of having an expensive retail location, they both have warehouses in lower rent locations. This helps bring down distribution costs by saving on tax/rent/leasing costs. And, at least in the case of eCarlink, the two dealer principals were the sales people, so as their productivity increased, they were able to decrease the cost per car sold. Ultimately, these two dealerships are able to sell a lot of cars, at a lower price than competitors, and I think, make more money doing so.

I wouldn’t be surprised if the industry sees a period of consolidation and liquidation of assets, especially expensive retail locations, and the ensuing companies were more profitable.

2 responses to “Reaping the Profits of the Internet

  1. Interesting observations. Another “disruptive” impact of the internet is increased sophistication of retail buyers.

    With the resources of the internet available, consumers are much more informed regarding the overall “market pricing” for a particular vehicle. In an opaque, inefficient market, the less informed the buyer, the more opportunity for profits. Said differently, where there is mystery there is margin.

  2. James,

    Thank you for the comment and the input. I agree that a better informed consumer has more power when it comes to pricing, but I wonder if this would lower than overall margin of dealers, or reduce the dispersion of prices for a given car. In the past, a consumer could have gone to two different dealerships, for the same car, and seen two widely different prices. Now, dealers are forced to price at a market level, reducing pricing variability. Dealers who “overcharged” in the past might wind up with a lower margin, but the average margin should be able to stay the same. Excluding potential risk discounts/premiums based upon perceived reputation of the dealership. Here is an interesting blog to look at about information and fishing prices in India: http://gregmankiw.blogspot.com/2006/10/on-cell-phones-and-indian-fishing.html

    The other consideration is reduced transaction costs. Contracts can be sent electronically to lenders instead of shipped, reducing shipping costs and time. A better informed consumer might take less time on the lot to make a purchase, increasing sales person productivity. And finally, an efficiently priced vehicle might sell faster, reducing interest costs for dealers who purchase through a floor plan.

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