Rethinking Used-Car Business

For the next three months, forget everything you've learned about the used-car business. And as radical as it may sound, that means forgetting about making gross profit on your used inventory.

Instead, your sole focus needs to be creating as much liquidity as possible — now.

You have a strict 60, 45 or 30-day turn policy? It doesn't matter. Prices are dropping so fast, your turn policies aren't going to be able to keep up.

Dealers that are underwater in their used inventory come March likely will not survive, says Dale Pollack, a former dealer and founder of VAuto, a used-vehicle inventory management firm.

He may sound like an alarmist, but it's probably better to be safe than sorry. Pollack believes used-vehicle prices will take a huge hit in the first quarter of 2009 once public companies announce their earnings for the fourth quarter 2008.

He gives two reasons (other than the credit crisis and overall dismal economy). One, vehicles are stacking up at the auctions because of an increasing number of “no-sales.” These occur when a company sets a minimum bid level for its vehicles and no bids meet it. This is driving up inventories at the auctions, which in turn, will continue to drive down wholesale and retail prices.

Another reason is due to an accounting method commonly known as mark-to-market or lower cost-to-market that requires companies to adjust their inventory levels to meet actual market conditions.

Used-vehicle values in October and November plunged at a record pace and likely continued the downward spiral in December (as of press time, this was the case). Although public companies — public dealer groups, rental companies, finance firms and auto makers — have been adjusting their inventory values to meet real market prices, the fall drop has yet to be reflected in their earnings statements.

When those earnings are reported in 2009, and as auction inventories sell, Pollack believes the used-vehicle market will suffer its worse deflationary moment in history.

“Dealers will wake up one day and realize they own 60 days worth of inventory that is $4,000 to $6,000 overpriced,” Pollack says. That's a hit dealers will not be able to overcome.

Pollack predicts that alone could put thousands of dealers out of business overnight. “It's a dismantling of the automotive retail system,” he says.

Other analysts and used-car experts downplay Pollack's dire predictions. Ward's columnist and NCM consultant Tony Albertson says he doesn't believe the problem is as drastic as Pollack makes it out to be.

“We're already seeing auction prices come down, he says. “Of course dealers should not be hanging onto their inventory, but I think most dealers are smarter than that.”

Still, Albertson agrees there are dealers whose inventory is in bad shape and that need to get a “huge sense of urgency now.”

What should dealers do? First, be ruthless about increasing your liquidity and reduce the amount of working capital that's tied up in your used vehicle inventory. That means selling your used vehicles now. Pollack suggests shunning the wholesale channel and instead, selling it at retail.

The trick is to price vehicles at a level that insures they will sell. Pollack calls it “wholetailing.”

Realize you're going to sacrifice gross profit, and that negatively will affect some of your employees' pay. Get them on board, explain the situation, and if you have to, change their pay structure for the time being.

Pollack says if you jump on this strategy now it will put you in a great position the next few months. As other dealers scramble to find ways to liquidate inventory they'll never be able to sell, you'll be selling and making money.

You have to be willing to take the bullet now in order to survive 2009, Pollack believes.