Let's start with understanding how dealers operate and create profit. Most people do not understand or even care how dealerships function as a business; that lack of understanding can be costly in the long run.
You may be thinking, “What does this have to do with buying a car”? An understanding of how a dealership functions as a business provides insight for possible future motivations the dealer may have for selling a car below cost, potentially saving you thousands.
A dealership's operation is divided into three segments or departments; the Sales Department, Service Department, and Parts Department. Most people think that the Sales Department is the largest profit center for a dealership. In most cases, this is not true. Most dealers consider the Service Department the largest profit center.
When you visit a dealership, look at the building. Look at the amount of square footage that is devoted to each department in the building. In most cases, the Service Department is allocated a larger percentage. The concept is “dollar profit per square foot.” Service Departments function as the profit center to cover the dealerships overhead.
A majority of people think the Sales Department generates the most revenue. They believe there are thousands and thousands of dollars of profit in every vehicle on the lot. The truth is, in today's market that is not quite true. A dealership considers the profit from the Sales department as “gravy.” The Sales and Parts Departments exist to feed the Service department, the back bone of the dealership operation.
So, how is profit created in each one of these departments? Let's start with the Sales department. I'd like you think of the Sales department as a type of investment, like the Stock Market. You make investments in different stocks, different industries, and the goal is to create a profit, buying low and selling high.
Not every stock you pick will accomplish that goal. Some of those stocks may lose money, and in some cases, you may sell them off at a loss. You may reinvest what's left in another stock and realize a profit, Right?
The Sales department at a dealership is very similar. Instead of stocks, a dealer will invest in vehicles or what are called “units.” They will buy all different types of units, usually based off of past sales performance or what is referred to as “sales model.”
New units are allocated to the dealer by the manufacturer, using that sales model. Used units are obtained from various sources, such as the auctions or units taken in on trade, again, utilizing the sales model.