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Do you ever wonder why car dealers are always trying to buy your car? It has something to do with how much dealers markup used cars. There is a lot of money to be made in used cars.
In my career, I’ve seen many different ideas about what the markup should be for a used car. There are many factors to consider. Let’s breakdown how dealers determine their price for used cars, and how much markup they apply to come up with the selling price.
How dealers set used car prices
Where to start? With a quick history lesson.
In the old days (you have to remember, I spent 42 years in the car business),pricing in the good old days was simple, easy, and best of all, it worked.
When a customer would walk in we knew how much profit was in the list price. We’d negotiate, and end up selling the customer their used car with a profit of $1,000 or $2,000. The best part was, the customer felt like a winner because they negotiated us off of our original price, and we made money.
Today it’s completely different. Today’s car buyers have access to more information before they walk in.
On the other side of the deal, car dealers today have software that helps them determine how much a car is worth. These software programs are complex. They tell dealers what they should price each used car at in relation to similar cars in the market so that they’ll sell. They can even take into account geographic and seasonal differences between dealerships.
Pricing for profit isn’t the primary concern for most car dealers. Even more important than profit nowadays is how quickly a dealership can turn its inventory. Turn is the term used to describe the amount of time a car sits on a dealers lot before it’s purchased by someone.
Aging policies affect used car markup
For many dealers (especially the big ones), the idea is to sell or turn your inventory within 60 days of acquiring it.
Many stores have strict aging policies for their used cars. If a used car doesn’t sell within 60 days (or at the max 90), off to the auction it goes. The dealer will sell a used car at auction and replace it with a different car that they think will sell within the 60 to 90 day timeframe. For most dealers, it’s important to turn your inventory as fast as possible. As a car sits on the lot, its actual value is declining. From the dealer perspective, what was worth $10,000 when you traded it is now worth $9,000 90 days later.
The longer a car sits on the lot, the lower the selling price becomes.
Most dealerships work on a strict 60 to 90 day policy for their used cars. This means they’re adjusting a used cars price downward every 10 days to try and sell the car.
There is even software that tracks how much interest a used car gets and changes the list price in realtime. Dynamic pricing decisions occur on an almost daily basis.
So how much do dealers mark up their used cars?
As much as the market will bear for that model. With that advent of sophisticated software platforms and “big data,” we’re seeing more and more dealers allowing algorithms to set prices, rather than human beings.
Last year, one iSeeCars survey showed that 31% of car buyers are paying over MSRP for new cars. At the used car level, it’s harder to collect similar data, but just imagine the markups running rampant.
That being said, the average used car markup today is probably about $2,500. Hard to find specialty cars (Ferrari, Lamborghini, McClaren and others), or models in short supply could (and should) be much higher. But, for your run of the mill used car, expect the dealer to have a $2,500 markup in the price. Remember, to get the best deal, you’ll want to find one of the older cars on the lot!
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At the end of the day, what’s most important to nearly everyone on this planet (after health, family, etc.), is money. Maslow’s hierarchy of needs tells use that after our psychological needs are met (food, water, shelter, etc.) we move on to our safety needs (personal security, employment, resources). Without a doubt, that means earning an income is a top priority. That begs the question, how much can a car salesman make?
In any given year, I managed salespeople that have well out-earned me (earning multiple hundreds of thousands of dollars). I’ve also managed salespeople that barely made a living at all.
In sales, it’s pay for performance, and for the car salesman, it’s no different.
Here’s how much a car salesman can make.
A car salesman’s income is tied to their effort and skill level
A car salesman’s income is tied directly to their effort and their skill level. For example, someone new to the business who is just starting to learn their craft might find themselves on a salary based pay plan for the first 90 days. This fixed pay plans would guarantee monthly earnings of $3,000 or so for the first three months on the job. After 90 days, pay plans for car salespeople generally go to commission only, although more and more dealerships today are developing hybrid compensation plans that include a salary plus commission, with the hope of encouraging more college educated people to consider a career in the retail automobile business.
How hard the salesperson works on developing their skills (either through available training or through practice talking with customers) will directly correlate to how much they make. Sales professionals are like athletes (bear with me here), in that they have to practice to continually improve. There’s a saying that amateurs practice to get it right, while professionals practice so that they’ll never get it wrong. Top car sales professionals always practice and rehearse so that they can make sure they “never get it wrong.”
Those who don’t practice or work on their skills (or those who sit aimlessly at their desk waiting for a customer to come in — the sad reality is that this represents the work ethic of a lot of car salespeople nowadays) as opposed to proactively seeking out customers, will usually find themselves at the very low end of the pay scale. This means they could be earning between $2,000 to $3,000 a month. I hate to categorize them as “bad” salespeople, rather they’re unmotivated salespeople, but the fact still remains, they’ll only be earning a few thousand dollars each month. Any aspiration of earning six figures or more each year is hard to come by for this group of salespeople, they’re lucky to make more than $40,000 annually.
What does an average car salesman make?
An average salesperson, and by average I mean someone who sells around 8 cars a month, will make between $3,000 to $4,000 a month. Above average sales people, those selling between 10 to 12 cars a month, will earn somewhere between $4,000 to $6,000 a month. Selling 8 to 12 cars a month certainly isn’t going to make you rich, but it can provide a steady income stream. Plus, the jump from “above average” salesperson to “superstar” can represent a huge increase in earnings, one that almost certainly will cross the six figure threshold.
What does a great car salesman make?
Top producers (of which there are very few), who are capable of selling between 25 to 50 cars a month will generally find themselves earning $150,000 to upwards of $500,000 or more annually. As someone once said, “that’s not chicken feed, that is some heavy duty money.”
Oh, and you don’t need a college degree in order to earn it, you just need to work on your craft (take advantage of training, never believe that there is nothing left to learn, utilize social media to create your own brand, and always practice and rehearse your sales techniques), and put forth the correct effort. The “correct” effort is staying in contact with your existing customer base and always remembering that all of your contacts with them are about them and not about you.
The most successful automobile sales people I know understand that nothing happens without first connecting on a human level with your customer and always maintaining that type of connection into the future. Building relationships (ie trust) takes time, and in sales it’s easy to lose sight of this. A lot of new salespeople like to focus their energy on the next sale. The salespeople I worked with that earned over $500,000 per year liked to focus on building lasting relationships (and getting referrals from) their existing customers. If you want to make more than six figures as a car salesman, this is one path to do it.
So there you have it, car salespeople’s earnings can range from not much, all the way to “you’ve got to shitting me, I didn’t know that you could make that type of money.” That is what makes the car business so great!
Types of pay plans for car salespeople
Over my 42+ years in the retail car business, I’ve seen too many different types of salesperson compensation plans. At each stop in my career, each pay plan had one thing in common — they were structured to keep the total salesperson’s compensation within the industry benchmark of 18 to 22% of expenses (more on that here).
Most comp plans (98%) fall within those industry benchmarks. So whether a salesman earned 35% of gross profit or 15% of gross profit on a deal, because of other factors involved, the compensation never really exceeded the 18 to 22% benchmark.
How could that be? Easy, every comp plan has things baked into it that lower what part of a sale’s gross profit is commissionable. For instance, most pay plans have a thing called “pack.”
Pack is a predetermined dollar amount that will be subtracted from the deal’s gross profit before the commission is calculated. Pack is utilized to cover such dealership expenses as advertising, inventory management software, utilities and non-revenue producing employees, such as administrative and accounting staff.
The greater the stores expenses are, the larger the pack will be.
As an example, in a store where the salesperson’s commission is set at 35%, the pack might be $1,500. That means that $1,500 is subtracted from the gross profit every time the salesperson closes a deal before the commission is calculated.
In a store where the commission is set at 20%, the pack might only be $500, but when everything is all said and done, each of those store’s sales comp would end up falling within the industry benchmarks of 18 to 22%.
What is truly interesting is that when everything is calculated into a salesperson’s commission (percentage of gross profit, unit bonuses, bonuses from the manufacturer for selling certain models, or hitting individual goals), the average commission for selling a car usually ends up being between $400 to $500. I don’t know why that is, I just know that over 42 years that’s what it would end up being for most of my salespeople.
Does a car salesman make more selling luxury cars?
The other interesting kicker is that most luxury brands tend to produce slightly higher commissions. This is simply because the gross profits tend to be higher as compared to volume brands like, Chevy or Toyota and say, Honda.
I remember working in a Pontiac store (yes, Pontiac was a brand) in the mid 1990’s, where I had two salesmen who each earned in excess of $150,000 a year (selling Pontiacs), while I, as their Sales Manager, was earning considerably less! I have also worked with sales people who represented high end luxury brands like BMW and Porsche who consistently were earning $400,000 to $500,000 annually. Those salespeople would even hire their own 1099 “staff” to help them with all the customer follow up, and relationship building.
If your goal is to make more than six figures selling cars, then getting into a luxury store may be beneficial for you. However, the barrier to entry at a luxury store may also be higher (ie they won’t hire just anybody).
Regardless, as you can see, there is a lot of money to be made in the retail automobile industry.
What if I told you there was no such thing as an unsold new car? Every new car, no matter how expensive, ugly, or unpopular, gets sold to someone at some point. In my 42 years in the car business, I’ve never met a car that didn’t end up with a buyer.
What happens to cars that end up sitting on a dealership’s lot? When you phrase the question that way, there are a few winding roads that new vehicles can end up journeying. Most cars are sold to a consumer. Good dealerships try and “turn” their inventory every 90 days. That is to say, if they can sell a car within 90 days of it arriving at their dealership, they do.
When I was a new car sales manager I would incentivize my sales staff to sell the oldest cars on our lot. Why? Because our dealership has a carrying cost for the vehicle. It’s important you understand what a carrying cost is, because it’s the primary driver for why there is no such thing as an unsold new car.
Carrying costs incentivize dealerships to sell their inventory
You may not know it, but car dealerships are just like you and me, they don’t buy each of the cars on their lot outright. Odds are, you wouldn’t go to a dealership and buy a $40,000 car in cash (some people can, but most people don’t), and dealerships are the same, they don’t go to the manufacturer and purchase millions of dollars in vehicles in cash. Instead, they, just like you, finance the cars.
You’re most likely well aware that new cars are depreciating assets, they’re constantly losing value. Just because a dealership is buying a car from a manufacturer doesn’t change this equation. From the dealership perspective, each day that they don’t sell a car is a day they are cutting into their potential profit (they have to keep paying interest on their loan).
Dealers pay both the interest on their loan for the vehicle, and the opportunity cost of keeping that car longer. There’s finite space on their lot, so each one that sits and takes up space costs them money.
In an ideal world (for the dealership) each car they have on the lot would sell within days of its arrival, but you and I both know this doesn’t happen.
Why do cars go unsold?
Some dealerships I’ve worked for have had cars that celebrate birthdays (sit on the lot for more than 365 days without being sold). Why? I think it has something to do with ego, because most of the time it certainly doesn’t make business sense.
Most dealers are concerned with carrying cost (what we discussed above), and the largest dealers (the publicly traded ones) are measured by how quickly they can “turn” a car (move it from being on the lot to being in a customers hands).
Some dealers (in particular the old school ones) are steadfast that their staff should not discount a car to turn it more quickly. One dealer I worked for operated in this way, and we had many cars that would sit on the lot for well over a year.
Generally speaking, a car that sits on a dealer’s lot for 365+ days isn’t going to make the dealership any profit. However, in some cases the dealer can still find a way to make money.
Usually the cars that sit on a dealer’s lot for that long are relatively rare. What I mean by that, is that there aren’t many other cars with the exact trim level, or equipment, or color available. In my career, there were “new” cars I sold that were over a year old, and our dealership made a healthy profit on them simply because they were the only car in the country that included certain features.
In most dealerships cars really can’t go “unsold,” because that would upset shareholders (remember, the big public dealerships need to “turn” cars to keep their investors happy). However, in smaller, more “mom and pop” dealerships, “unsold” cars are more of a frequent occurrence.
What happens to unsold new cars?
Sold to the consumer
Selling a relatively rare car to a consumer is the first “path” an unsold new car can go down. If you’re looking to buy a car, consider letting me help. There are of course many other paths unsold new cars can travel down as well.
Service loaner or staff demo
At some dealerships older new cars are added to the service loaner fleet (the vehicles the dealership loans out to their service customers to drive while the car they own is being worked on) or as staff demos (cars the dealership staff can drive as a perk for working there). These cars are then converted to pre-owned inventory and marked down for sale.
If you’re looking to get a good deal on a new car, your best bet is to not buy a brand-new car at all. The truth is that a service loaner or demo are well-maintained cars and are lightly driven. This makes them great options for budget conscious car buyers who still want something “new.”
What happens if the car still doesn’t sell after being moved to “pre-owned?” This is where we enter the world of auctions. Automobile auctions are a foreign world to most, and with good reason, they’re restricted to registered dealers only, however they represent a multi-billion dollar industry with thousands of transactions occurring each day.
Auctions
Dealers will frequently send cars to auction that they haven’t been able to sell them at their dealership. This is about as close to “unsold” as a car can get. Sending a car to auction typically means taking a loss, but it’s more valuable for the dealer to take a small loss at the auction than it is to keep the carrying cost of the car on their lot. It’s a trade off, and one that a lot of dealers make.
Generally speaking, manufacturers (frequently referred to as the original equipment manufacturer, OEM) work diligently to stock their dealerships with the right mix of vehicles. By stocking the dealership with the right mix of cars, OEMs are able to support their dealer partners in turning vehicles quickly. But, when that mix goes awry, and dealers truly can’t get a car off their lot, they’ll send it to the auction.
Open auctions and closed auctions
There are two types of auctions, open auctions and closed auctions. An open auction is open to any authorized dealer personnel, regardless of brand represented or whether being a new or used car dealership. A closed auction is restricted to dealerships that are franchised to represent that particular brand.
As an example, Honda may hold several auctions each month that are closed to Honda dealers only. This is done for the express purpose of selling off Honda lease returns and factory executive demos while maintaining a higher per car value because Honda dealers are willing to pay a higher price for nice pre-owned Hondas for their lot.
What happens to your car when you trade it in?
Cars traded into a dealership that the dealer doesn’t want for their lot are sold at open auctions. At open auctions, any dealer is invited to buy as many cars as they may like. These types of auctions are where many used car dealerships buy the inventory for their lots, and where many “unsold” cars eventually end up.
There are a few primary marketplaces for cars, the largest being Manheim, owned by Cox Automotive. If a car is “unsold”, odds are high it ends up at a regional Manheim auction. Most likely, some dealership will buy it.
If you’re interested in learning more about why there is no such thing as an unsold car, let us know in the comment section below. I’d be more than happy to explain how dealerships make money by buying cars at the auction.
No car ever goes unsold
So there you have it, no car actually ever goes unsold. Whether it be a dealer who holds onto a car until the right buyer comes along (even if that takes over a year), or a new car that gets converted into a used car, or if a car goes to the auction, every car eventually finds a home.
In my 42 years in the car business I never once saw a car, no matter how ugly, poor performing, or otherwise, not end up with a buyer. Something tells me that trend will continue for the next 42 years too!
CarEdge Insights
