Combat Margin Compression by Controlling Holding Costs

Prepare for a potential margin compression of 25% or more this year, a significant threat to your profitability. One key to mitigating this risk lies in your ability to manage inventory holding costs effectively.

This per-vehicle cost is an accumulation of interest, insurance, advertising and other sale expenses charged against the margin made on the sale of the unit, multiplied by the number of days until it sells from when you bought it. Today's cost is between $50 and $80 per day, depending on the brand.

The Challenge

According to Gina Cocking, managing director and CEO at Colonnade Advisors, today's turn time averages 50.2 days, a 23% increase from 2023, up from a 32-day average in June and July 2021.

"This prolonged time on the lot drives up costs, with dealerships spending an estimated $40 per day for new vehicles and $85 for used ones. Consequently, there's a pressing need for dealerships to expedite vehicle sales to reduce inventory holding costs," Cocking shares in a recent LinkedIn post.

NextGear Capital reminds us that "holding cost per unit per day is a useful metric that can help a dealer keep their inventory balanced and determine how quickly a dealer might turn a unit."

Ed French, a dealer himself and principal consultant with the dealership performance firm AutoProfit, points out that the theory of holding costs is about figuring out how quickly you can put vehicles through your reconditioning and sales systems and sell them.

Understanding and managing holding costs is crucial today, especially for large groups focused on improving earnings per share.

This pressure against retail margins arises from higher interest rates, more vehicles in the market than in the previous three years and consumer affordability issues – compounded by the considerable pool of consumers significantly underwater in vehicles bought at inflated pandemic prices.

Some industry watchers predict margin compression of 20% to 30% this year. The Presidio Group's fourth-quarter 2023 "Quarterly Outlook on Auto Retail and M&A trends" notes the average franchise dealership posted a 20.4% drop in net profits for all of 2023. "Two-thirds of 3,100 dealerships surveyed for the report expect profitability to continue to fall this year," it says.

There is a way out of this margin pressure. One useful tool for helping you do this is the holding cost report from your reconditioning software provider. This report provides visual evidence of how reconditioning efficiency influences holding cost. Dennis McGinn, founder and CEO of dealership reconditioning software company Rapid Recon, has said one of a general manager’s most profitable routine tasks is working the dealership’s holding-cost reports.

"Understanding holding cost and minimizing this expense propels the manager's ability to manage dealership cash liquidity. Liquidity management is critical because cash is the fuel that runs the dealership engine – and when times are hard, liquidity is the safety net that keeps the doors open,” McGinn says.

Turn increases for every 2.5 days you can remove from your recon operation. The holding cost report shows you where to look:

Managing Outcomes

Today's average holding cost is $50 per day per car, up to $80 per car for luxury imports and domestic high-contented pickup trucks. Consider a dealership taking 15 days to get used cars from acquisition to frontline-ready and reconditioning 100 vehicles monthly. Here is the math:

These changes have reduced this cost by $25,000 a month or $300,000 a year. For a 20-store group, better holding-cost management is $6 million of opportunity cost for inventory, capital investment or earnings per share.

Routine scrutiny of holding cost reports equips you to find profit leaks in your reconditioning process to show you how to push back margin compression.