Car Portfolio Optimization

As Evenlevel’s website suggests, we are “shifting gears” after some excitement this week end. I’ve had more time to think this week end than I’ve had in years, and I’ve been thinking a little more about lanelogic’s liquidity issues, vehicle risk, inventory risk, cash flow issues.

lanelogic needs more market makers like itself to provide the liquidity, but the necessity of dealing with actual, physical inventory limits the number of companies interested in entering the market. The car market needs more derivatives, financial instruments that can be used by dealers to hedge risk, that could be bought and sold without taking ownership of the car.

Some type of risks do dealers face:

  • Interest rate risk – interest rates taking an unfavorable move against dealers, hurting profitability
  • Vehicle reconditioning risk – the risk that a purchased vehicle has significantly more repair work than originally anticipated, or has undisclosed frame, flood, or other title damages
  • Vehicle sales risk – the risk that a specific vehicle wont sell, or the profit margin will under perform a dealer’s average margin per copy

Any dealer can currently use financial markets to hedge interest rate risk, and OVE and lanelogic have come up with ways to hedge repair and sales risk. However, neither of these options invite liquidity into the marketplace.  Car dealers have another way to hedge these risks.

Portfolio diversification. Modern portfolio theory could be adapted to the car market to help dealers make efficient used car purchase decisions. Each type of car has an expected return (average gross per that type of unit) and volatility (look at past sales and returns of the models and calculate the standard deviation). Then, there is correlation. Are there certain types of units that tend to sell together? For example, in high gas price environments, truck sales likely decline and econ models increase.

Each dealer likely has a set of efficient portfolios depending upon their risk profile (aaXchange – I know). Other market participants would benefit by knowing these portfolios. For example, wholesale consignors could mitigate the risk of remarketed cars not selling quickly, or not selling for the right amount, by buying puts on specific cars from dealers. The dealers would profit from the premium and the consignor would hedge risk.

Alternatively, and even more out there, the expected cash flow from a dealership portfolio could be stripped and then resold. Dealerships would maintain stable cash flows and pass off the vehicle sales risk to other participants better able to take the risk.

Finally, to hedge vehicle reconditioning risk could be hedged with a vehicle reconditioning risk insurance policy. Dealers pay in to hedge the risk of thousands of dollars of unexpected repairs, and the insurance company collects premiums and then pays out to cover those repairs…

That’s it for the day, back to the Evenlevel relaunch (new business plan)!

2 responses to “Car Portfolio Optimization

  1. Michael Brairton

    Now we’re talking about a game plan! Who is taking the other end of the hedge, and where is the market though? Obtaining the necessary data would involve polling from the DMS system. Maybe we could pull some test data from our ADP system or CRM.

  2. Another risks are the warranty and some are on the maintenance and the after sales services. The best thing to do is to study first before doing any move.

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