The most fundamental description of buying a car: Car dealerships try to maximize the profit on each vehicle they sell. Consumers try to save as much money as they can. Everyone wants to get a great deal.
This conflict in interests has undergone a rapid change with advances in technology, bringing significant disruption to most retail sectors. Car dealerships, however, have been dealing with the disruption associated with pricing transparency for decades.
For as long as I can remember, car-buying guides have been readily available, loaded with step-by-step advice and details about the invoice price (what the dealer pays for the car) and the sticker price (what the dealer hopes a buyer will pay for the car). Given this abundance of detailed information, it is no wonder that the National Auto Dealers Association (NADA) says that the average U.S. dealership made about $70 of profit per new vehicle sold in 2014*.
Pricing transparency has forced car dealers to find alternatives to fair, up-front pricing in order to profit from vehicle sales. However, while most consumers arrive in a dealership’s showroom armed with the invoice price and knowledge about how to use available incentives and rebates, not enough people understand how other aspects of the purchase are far more lucrative than the selling price of the car.
These are six common ways that car dealers maximize profit, each still frequently used because they work.
The Bait and Switch
In 2014, dealers spent an annual average of $494,776 on advertising, according to the NADA. Because dealers compete with one another on price, the natural inclination for each dealer is to promote the best possible price, payment, and lease deals. In fact, some automakers help their dealers in this effort, building a small number of stripped-down versions of various models that are seemingly designed for this very purpose.
The result is what is known as a “bait-and-switch” tactic. The dealer advertises the lowest possible price on the least appealing version of a model (the bait), and then when you realize that the advertised special is something you’d really rather not live with on a daily basis, or that the only one available has already been sold, you upgrade to a more expensive and better equipped model (the switch).
To combat this, do your homework in advance, know which trim level and set of options you want, and check dealership inventory online using the automaker’s website to determine if the car that will best fit your needs is affordable, and in stock.
Dealer Addendum Stickers
This is a photo of a dealer addendum sticker on a 2015 Nissan Versa SV Sedan. It inflates the price of this entry-level econocar by nearly $3,000. That’s about 15 percent of the original sticker price, and because the Versa Sedan is almost always available with rebates, the actual price inflation is more than 20 percent over what you should pay for this car.
What makes this particularly troubling is that the Versa is a vehicle designed for people who have very little money to spend on a new car in the first place, making this instance almost predatory on the part of the dealership. Furthermore, every vehicle on this particular dealership’s lot had a similar dealer addendum sticker, an excellent sign that management is going to do whatever it can to extract every last possible dollar out of your pocket.
This is not a dealership with which you want to do business. In fact, any time a dealership claims that all of the cars it sells are equipped with paint and fabric protection packages, or anti-theft devices, or similar dealer-installed features, it is time to find another dealership. These tactics are emblematic of the profit padding that will take place at every possible point of a transaction.
In fact, in this particular case, where a Nissan dealer wants to charge $384 for the first two years of maintenance, you should just go and buy a Toyota, which comes with two years of maintenance for free.
The 4-Square Worksheet
Two decades ago, I briefly sold new cars. The 4-square worksheet was one of the first sales tactics I was taught, and when I helped my father to buy a new car last year, it was still in use.
Divide a piece of paper into quadrants to create a 4-square worksheet. In one square, the selling price of the car is shown. In another square, additional dealer-installed equipment is shown. In a third square, the down payment and trade-in value are shown. In the last square, the monthly payment is shown. These four elements are what determine what you pay for a car.
Car buyers quickly become fixated on the monthly payment. Knowing this, dealers use the 4-square worksheet as a conduit of communication between the car buyers, the salesperson, and dealership management. The result is a drawn-out period of tiring negotiations that produces a confusing and convoluted mess of numbers and notations.
Ultimately, the dealership produces a monthly payment that is acceptable to the car buyer, and the buyer doesn’t really understand the other details of the deal. He or she simply wants to get the heck out of there and on with his or her life. And this is exactly why it is so important for car buyers to conduct extensive research and have as much detail associated with the deal prepared in advance of setting foot on a dealership’s lot.
Undervaluing the Trade-in
If you want to get the most money for your old car, sell it yourself. If you don’t want to deal with the hassle of selling it yourself, the dealership will tackle that task for you—for a price.
Your trade-in is another potential source of profit for the dealership. The difference between what a dealer pays for a trade-in and what the dealer will charge for that same vehicle is substantial, even after the costs associated with handling paperwork and reconditioning the vehicle are taken into consideration. In fact, according to the NADA, the only year in the past decade that used-vehicle departments were not profitable was in 2008, when the Great Recession occurred. Compare that to new-vehicle departments, which failed to turn a profit from 2006 to 2010.
While you should expect to take less money from a dealership for your old car than you would get by selling it yourself, you still need to have a good idea of what your car is worth as a trade-in, and push to get close to that value.
You also need to be realistic about the age, condition, and desirability of your vehicle. Newer vehicles with lower miles that are in good condition are worth more in terms of a trade-in. If you’re driving a beat-up Pontiac Aztek, you might need to pay the dealership to take it off your hands.
Charging High Interest Rates
If you don’t know your credit rating, and you do not pre-arrange your financing before going to the dealership, and you are fixated on your monthly payment, the dealership’s finance and insurance (F&I) department can easily bump your interest rate, earning hundreds, or even thousands, of extra dollars on the deal.
Your best course of action is to pre-arrange your financing, and then see if the dealership can beat your pre-approved interest rate and terms. If the dealer can get you a better deal, take it. If not, then you’ll know you’ve done your best on your own, and you don’t need to worry about getting ripped off.
According to NADA data, nearly 42 percent of new and used car buyers purchase a service contract with their selling dealership. You don’t need one of these. Based on what the typical owner’s manual says, you likely won’t require the amount of service for which you’re paying. Plus, a service contract restricts you to the dealership for service, whereas without one you have choice.
Keep the following statistic in mind: In 2014, service contracts and the F&I department delivered nearly 40 percent of new- and used-vehicle gross profits for dealerships. Add the service and parts department to the mix, and these three lines of business generated approximately 75 percent of dealership profits.
Dealers Deserve to Profit, but Protect Yourself
It is unrealistic to expect a dealership to operate without making a reasonable profit, but when many car buyers set foot into a showroom that is exactly the attitude that they bring to the table. There is far more to a typical car deal than the selling price, though, and dealerships are adept at leveraging a buyer’s relative lack of familiarity with other aspects of a typical transaction.
By understanding the different ways that a dealership attempts to maximize profits across all points of the purchase, and entering negotiations in an educated and prepared fashion, you can minimize the degree to which a dealership can take advantage of naiveté. Just don’t expect the dealership to take a loss on your deal, because no matter what they tell you, that simply is not going to happen.
* Does not include the F&I part of the sales process