Buying a car is a convoluted process. If you’ve ever gone through it you know that it entails a lot of online research, a handful of in-person test drives with salespeople in tow, and eventually a day long negotiation process to finally (hopefully) consummate a car deal.
Buying a car is … not as much fun as it should be. However, when you pulll back the curtain and examine how car dealerships operate, it begins to become clear why the car buying process is so dysfunctional.
Car dealerships are partners to vehicle manufacturers (automakers), commonly referred to as OEMs, which stands for original equipment manufacturers. Car dealers exist because OEMs are not equipped to sell and distribute their vehicles to the masses. OEMs focus their attention on building the best cars, trucks, and SUVs possible, and then their dealer network has to worry about actually selling their products.
OEMs make stuff. Dealers sell stuff. It’s that simple.
The union between OEMs and dealers is supposed to be a mutually beneficial and happy one. However, in practice, the relationship has soured, and many dealers have disdain towards their manufacturers. Why is this the case, and what impact does it have on you and me when we go to buy a car? We’ll answer these questions (and more) below. Let’s dive in!
How car manufacturers make money
Automakers like BMW, Mercedes-Benz, and others make their money when they wholesale a car to one of their dealers. From a manufacturer perspective, they get paid when their dealer takes delivery of their inventory. In order to sell more inventory to their dealer network, OEMs also want to support their dealer network in ultimately selling vehicles to consumers, however manufacturers don’t actually make any money when you and I buy a new BMW from the dealership for example. Instead, OEMs actually lose money when we buy their products from the dealer.
How can that be?
Manufacturers invest a lot of money into bonuses for their dealers when they hit certain volume incentives (an expense for the OEM), as well incur costs when vehicles that are under warranty end up having issues. The only reason manufacturers care about consumers buying cars is because it means they have a reason to wholesale even more cars to their dealers.
The customer for an automaker is their captive dealer network. The customer for a dealer is the driver of a vehicle (you and me). Once you understand this relationship you can begin to see why fundamentally automotive dealers and manufacturers don’t get along.
How car dealers make money
We’ve talked about this topic many times on the CarEdge blog, so we won’t do a deep dive here, however we will touch on the basics. Car dealers make most of their money in fixed operations (parts and service), as well as finance and insurance product sales. The other primary revenue driver for a car dealership is manufacturer incentives that are paid out monthly, quarterly, and annually based on performance.
Here’s our complete guide on how car dealers make money: How Do Car Dealerships Make Money? (Explained by a Former Car Dealer)
At the end of the day, dealers are incentivized to sell as many cars as possible so that they can then originate as many loans as possible, sell as many extended warranties as possible, and service as many vehicles as possible.
Dealers also want as many cars on the road as possible because it then increases the number of prospective customers they have for their fixed operations (parts and service). The more vehicles in operation, the more vehicle maintenance and service the dealership has to deliver, which in turn means more parts sales and lucrative service hours charged to customers.
Why car dealers and manufacturers don’t get along
So where do things sour? It’s simple. In the relationship between the OEM and dealer it is expected that the two act as equal partners with one another. In practice, the OEM has more control over the dealer than the dealer would like.
For example, dealers do not decide what inventory they receive from their manufacturer. The allocation of inventory is dictated by the manufacturer. For example, if I am a BMW dealer in Richmond, Virginia, I may get 20 new 3 series BMWs this August, or I may get 2. The manufacturer decides, not me, the dealer.
The process for how a manufacturer decides is shrouded in secrecy, and certainly a lot of very smart people are employed to come up with demand generation forecasts and models for how many vehicles need to be in certain geographic areas, but no matter how you “slice it,” OEMs are incentivized to allocate too much inventory to each dealer as a way to “pad their stats.”
What do I mean by this? It’s simple. Think back to how OEMs make money. They make their money when they wholesale a car to a dealer. If they dictate to a dealer that they are going to get 45 units of inventory this month, even though they have only sold 15 the past 2 months, who benefits from this? Certainly not the dealer, they are flooded in inventory that they then need to pay interest costs on. The OEM on the other hand just sold 45 more units, they’re one step closer to hitting their internal objective for the month!
I’ll never forget when the 2008 recession was beginning to take shape. I was working at an Acura dealership in Scottsdale, Arizona at the time. Every month I diligently tracked my inventory, and I could see the recession on the horizon. Our dealership went from selling 50 TLs a month to 15. My factory rep continued to send us 45 new TLs each month, even though we weren’t selling them.
We ended up losing a boatload of money on that inventory, and Acura couldn’t care less. As far as they were concerned, they sold their inventory, and it was my problem to deal with now.
This is the flaw of the OEM to dealer relationship. The two parties are not aligned on what is most important. If they were, buying a car wouldn’t be as terrible an experience as it currently is. We see companies like Tesla try and “disrupt” this space by offering direct to consumer sales, and they are certainly helping the industry move forward, but they’re running into their own hurdles.
Ultimately, at the end of the day, automakers and their franchised dealer networks aren’t going away anytime soon. Innovation in the automotive industry, specifically in the retail automotive industry is few and far between. Will car buying be any different in 10 years? Probably not. Will car buying be different in 50 years? I certainly hope so.