Downside of Recon Retail

Pre-owned sales should be driven by a high rate of inventory turn rather than based on gross profit per retail transaction says Dale Pollak, CEO of vAuto and the author of the hot-selling book “Velocity, From the Front Line to the Bottom Line.”

His “velocity” concept is based on the fact that the Internet has changed the way people shop for pre-owned vehicles. When doing an online search, consumers get to a point when they are looking at too many vehicles for them to conveniently take in.

They will then select a sorting parameter. In the vast majority of situations they select “Sort Lowest Price First.”

Pollak maintains, as do his advocates, that it is essential to make sure one's inventory is priced in such a way as to show up in the first pages of the search.

If a unit is priced non-competitively, consumers will probably never see it.

Practitioners of the “velocity” model experience astounding inventory turn rates. They more than make up for the lower average gross profit per vehicle with overall departmental gross and net profit.

But this column is not about Dale Pollak or his proponents. Their theories are proven every day in the marketplace. Dealers who aren't on board are getting their butts kicked by those who are. The pre-owned business is no longer based on a cost-plus model. It is based on pricing that will maximize Internet hits.

Instead, this column is about a new reality in how dealers charge themselves for internal reconditioning.

In the late 1970s, state and federal law mandated that auto manufacturers use retail-customer pay rates to compensate dealers for warranty work.

Dealers and dealership managers, including myself, rushed to increase their “door rate” to capitalize.

It was thought that discounted “menu pricing” would prevent consumers from fleeing to lower priced independents. We can look back with the clear vision of retrospect to see what happened.

The increase in warranty reimbursement more than offset any loss of customer-pay revenue in the beginning. Fixed operations became the cash cow of the dealerships.

But over time, new vehicles were built to increasingly higher standards and the warranty reimbursement vehicle dropped, along with the recent drop in new-vehicle sales.

Pricing cover was created for the proliferation of independent competitors in both the parts and service.

At about the same time, it also became popular for some dealerships to charge themselves internal rates for pre-owned inventory based on their new higher retail door rate.

Instead of using the warranty-compensation time schedule, they used full retail for both parts and labor.

Previously, most dealers used an internal formula based on what they might provide any other large-volume customer, such as company or city with a fleet of vehicles.

Typical was labor based in the range of 67% of retail rate and cost plus 25% on parts. Not only were many dealers charging themselves additional mark ups with the hopes of retaining at least that amount when the vehicle was sold, but many vehicle departments were forced to do everything “in house.”

I'll leave it to readers to decide whether the retail-recon concept has worked. It certainly doesn't make sense to do internal work at “cost.” It makes no sense to send work outside the dealership if the job can be done competitively “in house.”

It is obviously a question of balance. The debate is about where the balance point lies.

The “retail recon” theory was predicated on the premise that sales people and their managers sell from cost. This assumed that a “little extra cost” didn't make much difference and that consumers would pay based on what the sales staff had the guts to charge, and lenders would finance accordingly.

The policy put many used-car managers in the position of having to recondition based on uncompetitive pricing.

As an example, I've seen dealers force their pre-owned departments to buy tires at retail from their own parts departments when the same tires were available at half the price from Costco.

Some dealers went as far as to ban using touch-up specialists and “dent doctors,” instead requiring the work to be done in the body shop. Even sublet tickets have been marked up.

Many used vehicle managers used counter-productive methods to deal with some of the impact of “retail-recon” policy on the wholesale side.

Some would attempt to steal trades to package those fresh retailable units to hide losses exacerbated by the extra money that had been penciled onto their inventory.

Wholesale buyers didn't give a hoot what the store had in a unit. It was worth what the market dictated. The Internet has had that same impact on the retail side of the business.

So how do you measure the lost business from standing down from trades and including potentially high-gross profit units in packages to hide losses?

In my own experience, I watched a dealer tell his used-car manager he could no longer sublet paint jobs on older “affordable”-price vehicles with a local MAACO shop.

He was forced to do the paint jobs “in house” at a cost $2,000 higher than the department had been paying outside.

The dealer lived by the adage, “You can't manage what you can't measure.” But how do you measure what you should have had, could have had, but didn't get?

There were no paint jobs for the dealership's body shop to do because those vehicles now had to be wholesaled. The dealership monthly lost 12 to 15 vehicle sales it had previously achieved.

Retail recon forced other vehicles to be wholesaled instead of reconditioned and retailed. It forced appraisers to become more conservative. Fresh sales were lost as well as the trade in and F&I opportunities that would have gone with them.

But the internal account on the financial statement looked nice and fat! The service manager got a nice commission check. The lost opportunities were like they never happened.

Given the current and future pre-owned inventory shortage, many retailable vehicles in the affordable price category will need to be reconditioned rather than purchased at wholesale or traded for vehicles in lot-ready condition.

Will dealers leave those opportunities to competitors whose internal structure allows them to “make” these units?

Will the future bring a more balanced approach to dealer recon? Dealers using the velocity model don't want you to change a thing you're doing!

Former dealership veteran David Ruggles is a consultant with nearly 40 years experience in the auto industry. He has conducted annual seminars on dealer issues in Japan since 1993. He can be reached at [email protected].

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