A dealer weighs in on how dealerships are able to survive on those razor-thin margins.

Dear Car Talk

Dear Car Talk | Jun 01, 1998

Dear Tom and Ray:

As a former dealership sales manager, I may be able to shed some light on
how dealerships survive on those razor-thin "invoice" deals.

First of all, you were absolutely right when you noted in your column that
there are many sources of income which a dealer may use to offset the
invoice cost of any individual vehicle. Holdback, financial assistance,
carryover allowance, manufacturer or local advertising group incentives
cover most of these sources. In spite of these hidden profit components,
most dealerships would not long survive if they weren't generating
additional profit on the "back end." For the dealer, after the sale is
where the fun is had and the largely un-negotiated profit is "earned."

First of all, we have the "document preparation fee," an itemized charge
for what is simply a routine clerical cost of doing business. Fifteen years
ago, this charge averaged less than $20 where I live in Maine. Dealers
(including the one for which I worked) watched consumer acceptance rates
remain stable (in excess of 95 percent) as this "fee" was hiked up to $150.
The State of Maine finally recognized this "doc fee" for what it is, a de
facto increase in the price of the vehicle, and started taxing it.

But the most important source of "back end" profit is the "finance
reserve." Commonly the dealer acts as an agent for several banks or other
financing sources. In return for soliciting business (auto loans) and
providing financing contracts to the lending institution, the dealer is
allowed to "mark up" the cost of the money to the consumer. The finance
reserve is simply the difference between the rate that the bank gets and
the rate the customer agrees to pay. Some institutions limit this rate
mark-up to 3 percent, some don't impose any restrictions at all. How much
money are we talking about here? Finance $20,000 for five years at a rate
of 7 percent (a typical dealer "buy" rate), and one would incur a finance
charge of $3,761.20. The same amount financed at 9.9 percent (a common
consumer rate, with 2.9 percent of that going to the dealer), and the
finance charge jumps to $5,437.60. The finance reserve is the difference
between the two, or $1,676.40.

The next item on the profit agenda is the extended service plan. Typically,
the charge for the service plan is cloaked in the monthly payment (for only
a few bucks more a month, you can also get ... ), the actual cost being far
in excess of what the payment would actually be at any reasonable interest
rate. A typical service plan markup may be 100 percent or more.

What bothered me most about the way dealership profits are derived is that
the methods used are so discriminatory. The nicest, most naive, trusting
people are the ones who generally pay obscene profits to dealers who are
more than willing to take advantage of them. Thanks for letting me vent a
little. That's it. I'm done. -- Linc

TOM: Yes, you are done, Linc. And I think you can kiss the Auto Dealer
Association presidency goodbye, too!

* * *

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