Article

The Second Essential Element: The Importance Of Inventory

August 2006, Auto Dealer Monthly - WebXclusive

by Greg Goebel - Also by this author

The second in a series of Eight Articles on the Eight Essential Elements of Special Finance

Last month I discussed the foundation and most important of the Eight Essential Elements of Special Finance – Commitment. This month I move forward to the second of those elements – Inventory.

Before I go any further, I will address the fact that people often bristle when I state that I believe that inventory is more important than personnel. Make no mistake; I always state that to be successful you have to have both. That stated, I have personally witnessed in many dealerships a “green pea,” that is coached well by the desk, land a $4000+ gross profit - not because of his sales skills, but because the dealership had appropriate Special Finance inventory in stock. I have witnessed just the opposite as well. I have seen some of the most skilled sales personnel stymied with a sub prime customer because the dealership is either upside down in its inventory, or the inventory is too expensive (or both) and essentially there is no way to structure a profitable deal.

No, I wouldn’t want a sales staff full of “green peas”. No more than I would want a field full of $15,000 (cost) vehicles that are in inventory at, or above book. Please bear with me and read on and you too will understand why I feel that inventory is so important.

Let’s first understand a couple of points. We know that, 80 percent of all sub prime loans funded by sub prime lenders are under $400 per month. That is funded, not approved. Pretty significant. Sure, there are lenders offering payment calls of $500 and $600 per month and more, but I assure you, at the end of the day, there are many more customers that are contracting at $300 per month, and less.

The next issue at hand with Special Finance is that the loans are collateral or equity based. And they are also discounted. This simply means that the book value of the vehicle becomes a hard-cap which is nearly always going to be the limiting factor as to how much can be financed.

These same loans are almost always written at a higher interest rate, and often for a shorter term – again, driving up the payments.

What this all adds up to is that using a 60 month term, and 21.0 percent APR interest, and 6 percent sales tax, and the typical $1000 down payment, the hard-cap for the sales price on the transaction is $14,900 to keep the payments under $400 per month, which is where the magic is.

Allowing for a $500 discount from the lender, to achieve the 20 Group benchmark gross profit on the deal, the vehicle must book for at least $12,950 and you must own it for roughly $1000 less than that. Of course there is no room for a service contract at that payment, and the benchmark $852 additional profit that it would generate. Hence, the hard-cap for Special Finance inventory winds up somewhere in the vicinity of $11,000.

Does that mean that you cannot sell vehicles to Special Finance customers with a cost factor over $11,000? Of course not. But it does mean that if that becomes the rule as opposed to the exception, you will find yourself having to cut your gross profits in order to be able to put deals together. Generally when I work onsite with dealerships that have either a gross profit or volume problem (where there is plenty of traffic), I find many of the answers by looking at the inventory.

The bottom line is that there are countless dealerships that have an abundance of used vehicles in inventory, and management assumes they are set up well for Special Finance. Even if they have 200 used vehicles available, it is all for naught if the Special Finance department is left with nothing but a glut of vehicles with an inventory value of $15,000+; or, that is at or above the book value used by the Special Finance lenders.

Where does this lead us? Well, if you are a typical department of two people, you are likely selling at least 25 vehicles or so per month – or should be. To have sufficient stock, you should have in inventory at least 80 percent of your forecasted sales level (in this case 20 units) in the $7K to $11K range (at wholesale cost) at a minimum of $500 behind book value (usually much more). This will allow you to sell 80 percent of your vehicles for under $400 per month, and do so while achieving benchmark gross profits. Without it, you will struggle with mediocre gross profits and deals that you just can’t find a way to put together.

Now that we have figured out how much inventory we need, we need to determine which vehicles should make up the mix? We will always look a minimum of two factors – wholesale cost and the “spread” – which is the difference between average book value and cost. Let’s start at the top and go backwards.

At the top, for approximately eight months of the year, some of the best gross profit opportunities lay in current year off-rental units. Why? Because the better sub prime lenders calculate their advances on current-year used vehicles off of “like invoice”. This provides a huge spread. In 2004, one of the most favored vehicles was the 2004 Intrepid. Most Dodge dealers couldn’t give a new one away, and stocked them only as it would help them earn Magnums in the future. Many were sold as “mini” deals. As a result, very early in 2004 you could buy the Intrepids with fewer than 30,000 miles for $11,000 and under.

These same vehicles had an MSRP of over $21,000, and an invoice of $18,500. All you have to do is the arithmetic and you can see why they were so popular to Special Finance departments around the country. Using a multiplier of 115 percent of like invoice, it was easy to have a $10,000 spread. Without a doubt, these vehicles became part of the 20 percent, not the 80 percent, but gross profit opportunities abounded with them. The same can be said for Chevrolet and Ford products.

For 2005 Focuses are already available, as are Stratus and Caravans. As the months roll by, be on the lookout for these vehicles, as they will represent great opportunities.
 
Past the higher priced units come the bread and butter traditional Special Finance vehicles. They are marked by being one to three years old, again with a wholesale cost of $7,000 to $11,000, and a minimum of $500 below “left-hand book” once they are reconditioned and on the lot, ready to go. Ideally these vehicles are under 50,000 miles – primarily so that you are able to get extended terms, which allows you to keep the payments down.
 
Having bought vehicles as a dealer in all parts of the country, and now having worked with thousands of dealers, I must say I see very little difference between what dealers stock from one market to another. Cars will run the gamut of the Taurus, Intrepid, Impala, Sonata, Grand Prix, Grand Am, Stratus, Focus and similar models.
 
Sport utility vehicles will include the Cherokee and Grand Cherokee, Blazer, Jimmy, Explorer, Escape, Tribute, Durango and even RAV4.
 
S-10, Ranger, Sonoma, Dakota, and B-Series Mazdas make up the smaller pickup segment and certainly the full size big brothers make up the bigger pickup segment.
 
Minivans include the (Grand) Caravan and its corporate siblings, the Windstar and Freestar and any of the GM trio of Venture, Montana or Silhouette.
 
The key when buying any of these is to remember to look for the spread, and keep the cost under $11,000. Many dealers will develop a grid or chart to help keep their auction buying staff focused. Others will just use the loan value as a ceiling – knowing that if they can buy the car and have it ready to go at loan value, they will come out ahead. The importance is the ability to “just say no,” when the bids cross the point where the vehicle is no longer appropriate for Special Finance.
As we are now in peak season for Special Finance, I urge you to take a hard look at your inventory. What are you forecasting in sales for the next six weeks? Do you have 80 percent of that number available in Special Finance units? Do they really qualify to be Special Finance units by virtue of cost, book value and mileage?
 
If you don’t have the appropriate inventory, now is the time to invest. Similar to the movie Field of Dreams, if you buy it, they will come. Make sure that your inventory allows you to take advantage of all sales opportunities. If it does, 2005 will be a banner year for your department.
 
Vol 2, Issue 2

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