Training » 5 Critical Success Factors » Appropriate Inventory

5 Critical Success Factors:

3. Apropriate Inventory

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Investigating the fundamentals

The third of fundamental is having the appropriate inventory. What defines “appropriate” inventory? It will be driven by a number of factors.

Consider the credit in your market area. Profile the percentage of B, C and D paper your dealership typically sees and mirror your inventory to what you want to sell.

If you have been actively involved in subprime, an easy way to profile your market is to pull a report or gather data on your funded deals across the last six months by Lender by Tier. You will see where your paper falls and here’s why that’s important. The inventory needed for each segment varies. A near prime customer has more finance options available to them and is typically going to be more selective in their purchase decision. Discount fees and rates for these customers will be lower and to sell them you will need to have vehicles that meet their wants. For that customer remember, “What sells good new, sells good used”.

The deeper subprime or captive credit customer is not in a position to be as particular. For these customers, consider not so much what is “hot” but what carries the largest margin between wholesale purchase price and your lender’s retail book advance or “% of like invoice” (for current year models). This is necessary not only for the sake of profit but also to insure you can cover the higher fees associated with those customers. For the captive credit customer or a customer carrying negative equity, look for those vehicles that were “cold” when selling new. As a used vehicle, they can usually be bought well back of book. Purchase your inventory to mirror your credit mix and you will deliver more vehicles.

Selection will be driven by the average income in your market. Vehicles should be inventoried to match not only your customer’s income and budgetary constraints, but also your lender’s underwriting guidelines.

Average income is critical when considering which inventory is appropriate. Most lenders allow 20% of gross income for a payment. An $1800/month income translates to a maximum payment of $360/month. The payment and therefore the unit that should be stocked for a metropolitan area with higher income will differ from that of a rural area with lower income. Your inventory should be priced to meet the income of your customers and deal structure of your “worse-case” lender. If your customer is approved under a more favorable call, it will only mean your gross profit improves.

After looking at average income, consider your lender guidelines. Start by looking at restrictions for year, make and mileage. One dealer I know looks only for late model vehicles with under 30,000 miles to minimize these issues. Above 50,000 miles you may have problems with deal structure. Make note of criteria for vehicles to qualify for extended terms of 72 months. Be aware of flexibility on DTI and PTI as it regards to credit quality. Also watch for restrictions on advance. Finally, be conscious of which book (NADA vs. Kelly Blue Book) your lenders allow you to use to book out a vehicle. An allowed difference in book value can make a difference in a unit being appropriate or not.

I’d suggest creating a matrix that looks at income for your market along with terms and discount rate for your “worse-case” lender. That matrix will provide your target ACV for the gross profit you are looking to earn. Do you know the average income in your market area? If not, e-mail me with the name, address and number of your dealership and I’ll be glad to provide you a free report with that and other valuable information.

The majority of marginal credit customers need to purchase used vehicles due to budget limitations. Vehicles need to be purchased far enough “behind book” to afford discount fees and yet still enjoy significant profit.

Some new vehicles will be sold to subprime customers. I know franchised dealers with lower price point vehicles that drive new car sales through captive credit customers. Subprime business however is largely based on pre-owned sales. The lower price points and gross profit associated with pre-owned vehicles better match the payment restrictions and deal structure subprime requires. A good target or rule of thumb is to look for vehicles you can buy $1,000 to $1,500 back of wholesale book. Finding these vehicles allows you to cover the fee structure of your lenders and still make a good gross profit. Some of the better profit opportunities are with current year vehicles, not yet in a retail book, where lenders advance a “% of like invoice”. Finding the greatest spread from wholesale purchase to advance on retail book or “% of like invoice” will create your best opportunity for profit.

Remember that margin or “spread” is dynamic not static, book values change. Target a 60 day turn on your inventory. Going beyond that will erode your book values and opportunity for profit. As a rule, your wholesale values should fall between $8,000 and $12,000 to meet typical payment calls. Keep a history of what you sell to track “average gross by make and model”. Keep in mind the “seasonality” of some inventory. A little business intelligence will go a long way in helping your buyer target the right inventory.

Typical vehicles are program or auction vehicles, not retail trade-ins. Some new vehicles with factory rebates also structure well. If you are attempting only to sell from retail trade-ins, you are fighting a losing battle. So where do you find inventory? Program vehicles, rental fleet sales and auction vehicles will provide the bulk of inventory. Some lower price point new vehicles structure with available cash back rebates allowed by some lenders. Don’t forget the “virtual inventory” available from your manufacturer’s online auction. Here you can find complete descriptions on lease returns, early terminations or repossessions. With your customer, you may be able to select a vehicle, take a deposit and in so doing take your customer out of the market.

Your sales to inventory ratio should be approximately 2 to 1. If you plan to sell 50 subprime units, you should have at least 100 on the ground. Remember “approvals” will mean nothing unless you have vehicles your prospects will buy!

As a rule, you will find domestic vehicles structure better than foreign ones. It will be difficult to buy a Honda Accord at a price that will book out. Look for vehicles that are “option” rich. They carry higher book values and greater advance. You will find better success with automatic transmissions and 4-doors for cars. Conditioning and re-conditioning are important. Another successful dealer I know puts new tires and brakes on everything to build consumer confidence and curb appeal.

Managing inventory is a dynamic process. What is appropriate today will change tomorrow.

Once you’ve purchased your vehicles, don’t forget to price them properly. Initial pricing should accommodate your worse case scenario with bank fees and higher down payments. If it doesn’t, you may be leaving profit on the table. If not required by state law, consider not posting a price. If required by law, utilize addendum pricing to accommodate the bank fees and down payments.

Having appropriate inventory is essential to any special finance program. While your vehicle selection will be dynamic, the principles by which you should manage your inventory are not. Pay attention and discipline yourself to follow fundamentals and you will enjoy increasing subprime sales success! Between now and next month, happy selling.

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