Car dealers are businesses, and like any business, they need to make money to stay afloat. To many people, car dealers are like money-making machines. Most people worry that when they go to buy a car, they will be taken advantage of and the dealer will make thousands of dollars off them. The reality is that car dealers are actually a lot like grocery stores – they rely heavily on volume to make money, and they don’t actually make much money from each sale. Car dealers make money in a variety of ways, including selling cars, financing cars, and servicing cars.
Smart car buyers plan ahead before they step foot on a car sales floor how much the car they want will cost, what features and options it has, and most importantly – how the dealer makes money. Again, knowing this can prevent you from being ripped off by shady car dealers, most of whom make their money by selling new and used cars.
Do you want to know how car dealers make money? In this article, we’ll take a closer look at the different ways car dealers make money and how they stay afloat.
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New car sales
New car dealers typically have a large inventory of brand new vehicles waiting for their first owners. Dealers purchase new inventory directly from automakers at wholesale prices, and automakers often provide financing to help dealers maintain millions of dollars in inventory. MSRP is exactly what it sounds like: a suggested selling price set by the manufacturer. Dealers may choose to discount vehicles below MSRP, or, for particularly popular vehicles, they may choose to sell them above MSRP. Vehicles sold at or below MSRP typically have lower profit margins, most of which may go directly to the salesperson’s commission.
Car dealers typically sell a large number of new cars each year, and even though the profit margin on each sale may be small, the total profit can add up to a considerable amount. Of course, not every car a car dealer sells brings in a high profit margin, and many dealers only make a few thousand dollars per car sold. According to the National Automobile Dealers Association, the average profit margin on a new car is about 3%.
Used cars
Dealers are happy to sell you a new car, but used cars are often where they make the most money, especially used cars that dealers have had in stock for a long time. If a dealer finds a car sitting on the lot for a few months, it may be more willing to discount it to close to the original price, just to make room for another model.
Dealers’ used car inventory comes from: trade-ins or wholesale auctions. Every used car can be a gamble. If a dealer buys a vehicle with major faults, they may spend a lot of money to repair it, ultimately wiping out all their profits. But that being said, used cars can still be sold for a big price.
Finance and Insurance
One area that car dealers are increasingly focusing on is the finance and insurance office. If you’ve ever bought a car, you’re well aware of the documents you need to sign before the car is officially yours. There’s a lot of paperwork, and it can be pretty intimidating. The process you went through probably went something like this: test drive the car; haggle with the salesperson; agree on a price; determine how you’ll pay for the car (finance, lease, pay cash); the salesperson hands you over to the finance manager; you spend hours reading (or more accurately skimming) hundreds of pages of documents; purchase an extended warranty because you think you might need it and the finance manager suggested it; you drive home with your new car. Yes, I know, buying a car can be a real hassle… Once you’ve been “handed over” to the finance manager, you’ve started the second sales process. Do you think that now that the salesperson is gone, the sales process is over? No way! Car dealers make money in finance and insurance in a few different ways. When a customer finances a car through a dealership, the dealership will typically arrange the financing with a lender. The dealership will then mark up the interest rate on the loan and charge it.
The finance and insurance office, as it’s affectionately called, has always been a significant revenue source for car dealers, but now more than ever it’s the primary driver of profit. Let’s say you finance a $20,000 car at an interest rate of 5%. If the dealer arranges financing through a bank at an interest rate of 3%, the dealer will earn 2% on the new car loan. For a $20,000 loan, the dealer can make an additional $400 in profit. Of course, not all car buyers finance their new cars through dealers. Many car buyers are pre-approved for car loans through banks or credit unions before they ever step foot in a dealership. And if you do your homework and compare rates, you can often get a better deal on car financing than the dealer will offer.
For new cars, dealers can increase their profit margins by selling accessories such as different wheels, rubber floor mats, or paint protection. That being said, while not every accessory is worth it, some accessories can be a real bargain.
If you finance or lease a car, the dealer’s finance department may receive some benefits from the car manufacturer or lender. In addition, extended warranties are often profitable for the finance department.
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Parts & Service are the real money makers
Selling cars is just a means to sell other products and services, which is how dealers make money. As for the products and services offered by car dealers, look no further than their parts and service departments to find a vast selection.
For all car dealers, their primary source of revenue (and profit center) is their parts and service department, and from tires to shock absorbers, a dealership’s parts department will stock hundreds or even thousands of unique items at any given moment. Any car dealer’s parts department will stock a variety of items related to repairing, maintaining, or upgrading a vehicle. The parts department sells these parts to three customers: consumers; other dealers; and their own service departments.
Other ways dealerships can make money
So far, we have covered the traditional ways that car dealers make money, but there are some non-traditional ways that dealers (or rather, their owners) can make money as well.
Another way that dealers make a ton of money is by making money from their dealerships by owning the real estate that the dealerships are located on. Many dealers own the land that they build their dealerships on, and then the dealerships pay them rent every month to operate there. You can’t underestimate the value of the real estate that the dealerships are located on, that piece of land is a veritable gold mine. So, that’s the myriad ways that car dealers make money.
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Dealer holdback on new cars
In most cases, customers are unaware of the existence of dealer rebates, which are a hidden profit center for car dealers. For example, you purchase a new car for $20,000. The MSRP of the car is $22,000. In this case, the manufacturer gives the dealer a 2% rebate on the sale of the car. With that said, the dealer’s profit on the sale of the car is 4% ($800) instead of 2% ($400). Dealer rebates are a percentage of the MSRP that the manufacturer gives back to the dealer after selling a new car. Rebates allow dealers to make a profit on new car sales without raising the price of the car.
In Conclusion
Car dealers are businesses, and like any business, their main focus is to make money. While you may be able to get a better price on a car or financing by shopping around, the dealer will likely make money from the sale in some way. Car dealers make money in a variety of ways, including selling cars, financing them, and servicing them. And if you take your car to a dealer for service, you’ll likely pay more than you would at an independent shop. Remember, dealers are not your friends in the car-buying process—they’re in it for the money.
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