Carvana, Used-Car Trading and Sustainable Businesses update from February 2023

It is easy to dismiss Carvana’s rapid fall from grace, with its shares down nearly 90% in the past year, as another victim of the recent financial turmoil. Carvana could be seen as a poster child for tech-enabled but still highly physical businesses – perhaps somewhat similar to WeWork.

After all, the Arizona-based online used-car retailer reportedly now moves nearly half a million vehicles a year, becoming one of America’s top sellers. This means that its unit economics, or the cost and profits associated with each car sold, should also be solid to sustain its growth. 

Like the co-working company WeWork did in its early days, Carvana has proven customer demand for its business model: buying and selling used cars without visiting a physical dealership.

While car manufacturers and their dealers were entangled in franchise wars, (see Ford’s recent announcement it would enforce tougher rules on its dealers with the onset of electric vehicles), Carvana’s customers were rushing to its website – and revenues rose almost 15-fold between 2018 and 2022.

But while customer demand for online car buying is solid, the economics of delivering on that promise are tricky. In simple terms, Carvana makes its money on the spread between its purchasing costs of a used car and its sold price, while in the middle it also pays for the transport, reconditioning and insurance of its sold vehicles. Its revenues get a significant boost from financing (up to 50% of the gross profit per unit). 

Buying a used car has always been a risky business. First, one needs to establish market price, which moves rapidly and is influenced by geographical supply and demand dynamics. Next, sophisticated buyers need to calculate the cost of repairs and preparation for sale. Carvana has seemingly skipped these steps and decided it was going to offer customers a binding offer on their vehicles without seeing them.

Indeed, the convenience of selling a car to Carvana is second to none: Simply type in a few details, disclose any issues and a guaranteed cash offer will be rendered. With a couple further steps the transaction is approved and a pick-up is arranged. This is all great from a customer perspective, but it results in higher risk to Carvana. An expensive one. 

Like WeWork, which had to cancel its 2019 IPO after its valuation tumbled, Carvana’s economics were not adding up. A closer look at Carvana’s financials suggests it was likely overpaying for used vehicles. A Bloomberg report shows Carvana was losing $3,255 per vehicle sold. Meanwhile, industry leader Carmax was turning a profit of more than $400 per vehicle. This is in part due to a mismatch between its purchase prices and sale prices as the market moved downward quickly, leaving Carvana with expensive inventory. However, the operating costs of handling their purchased vehicles also played a role. 

Specifically, when Carvana buys a vehicle unseen, the potential to miss damages means it is not taking into account the repairs required to bring it back to retail-worthy condition. Body damage, worn tires, even a scratch on a leather seat, can make a seemingly good vehicle quite a bad deal.  

For experienced dealers, this is a basic concept of used-car trading. The book value of a vehicle is only a starting point, but to establish a potential retail price, one needs to assess the actual physical condition. This is done by “walking the car” in front of the customer as part of negotiating the final price – not a great experience for the customer.

It’s also the reason why most industry instant-cash offers, such as Kelley Blue Book, have tried to mitigate the risk by providing relatively conservative offers. But in most of those cases, the dealer still calls the seller and asks them to come in with their vehicle for an inspection. 

So how can we have the best of both worlds, offering an instant, competitive cash offer like Carvana but still making money like a dealer would? 

Eliron Ekstein Ravin AI_0

For sellers with cars in good condition, it helps demonstrate their vehicles’ quality and encourages buyers to compete for them rather than going to the used-car dealership and enduring tedious negotiations.  

As Carvana’s rise and fall shows, the inspection step cannot be skipped, or the economics will not work out. But with virtual inspections, this previously time-consuming step can be integrated into a seamless customer experience. The industry is moving forward with online buying and selling, but it needs to make sure it leverages the right tools to make it all profitable.

Eliron Ekstein (pictured, above left) is co-founder and CEO at Ravin.ai, which uses AI to track the condition of vehicles.