If dealers always sell cars below dealer invoice, how do they stay in business?

Dear Car Talk

Dear Car Talk | Jul 01, 2000

Dear Tom and Ray:

I assume that car dealers pay rent or mortgages, sales commissions, interest, taxes, utilities, etc. Since most dealers frequently offer sales promotions at or below "dealer invoice," why haven't they all long since gone out of business? Two percent or 3 percent holdbacks won't pay for all that stuff. So what gives? Is "dealer invoice" complete BS, or does it bear some tenuous relation to the actual price the dealer pays for the car? -- George

TOM: Good question, George. Unfortunately, it's like asking the CIA how it really does that spying stuff. Even if they told you, would you believe them?

RAY: The last time we addressed this question, we asked former car dealers -- who are now in the witness-protection program -- to write to us and let us in on how the business really works. We learned some interesting stuff. But most of those guys were never heard from again.

TOM: Here's what we do know: There is a thing called "dealer invoice." When it was first made public back in the early '80s it was a valuable piece of information for car buyers. At the time, it was thought to be a pretty decent approximation of what a dealer paid the manufacturer for a car. And most car dealers were genuinely annoyed when a customer came in knowing the invoice price.

RAY: But that's no longer the case. Now, dealers almost EXPECT you to have the "dealer invoice" price. After all, you can practically get them on the back of milk cartons these days. So dealers have had to rely more on other, less obvious sources of profit.

TOM: Like the "holdback," which the manufacturer "holds" onto until after the car is sold, then gives to the dealer. That's typically another 2 percent or 3 percent of the car's cost. Then there are cash-to-dealer incentives and cash-to-customer incentives to move cars that aren't selling fast enough. And who knows what else?

RAY: That's why several organizations that previously reported "dealer invoice" prices have switched to prices they now consider more useful. For example, Consumer Reports (www.consumerreports.org) is now offering customers the "wholesale price," which it believes is a more realistic estimate of what the dealer actually pays.

TOM: And -- while it varies from model to model and region to region -- the difference between the old "dealer invoice" and the "wholesale" price can be anywhere from a few hundred dollars to $1,500 or $1,600 on a mid-priced car.

RAY: You probably won't be able to BUY the car for the "wholesale price," -- remember, the dealership is entitled to some profit, just like any other retailer -- but at least you'll have a better idea of how much profit is in there.

TOM: A different approach is taken by www.cars.com, where you'll find a "target price" listed for each car. The "target price" tries to factor in the invoice price, the holdback, any dealer incentives, consumer demand for the model and a reasonable profit for the dealer on the sale.

RAY: And the dealership makes money in other ways. One of the biggest sources of dealer profits is financing. When you borrow money to buy or lease a car through a dealer, the dealer is usually making a few percent of the interest rate you're being charged. That's a huge source of income for dealerships.

TOM: Then there's stuff like extended warranties, racing stripes, floor mats, rustproofing and other accessories. And, of course, the used-car and repair businesses.

RAY: So, while we appreciate your concern for the poor dealers that are selling cars at just a few dollars above (or below) invoice price, I don't think it's time to weep for them just yet. Most of them don't like these changes -- where consumers have easier access to all of this information -- but most of them are still managing to do OK.

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