Car Buying Articles

Where Does the Car Dealer Make Money?

Mostly From Service, Not From Car Sales


  • New Cars Aren't Tops for Profit Picture

    New Cars Aren't Tops for Profit Picture

    The new vehicle department of a car dealership accounts for about 30 percent of a dealership's gross profits. | November 26, 2013

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It goes without saying that car dealerships can't exist unless they are profitable. That's true for every business, from a neighborhood dry cleaner to a mega-retailer like Wal-Mart. At auto dealerships, the rows of shiny new cars might prompt shoppers to believe that they're where the business makes most of its money.

But that's not the case. According to the most recent data from the National Automobile Dealers Association (NADA), the new vehicle department of a car dealership accounts for about 30 percent of a dealership's gross profits. In addition to car sales, that figure also reflects profits from finance and insurance (F&I) products sold on new cars. That means such things as Gap insurance, alarm systems and, notably, extended warranties.

The used vehicle department represents nearly 26 percent of a dealership's gross profit, according to NADA. In addition to car sales, the figure also reflects profits from F&I products sold on used cars.

So where does the majority of a dealership's profit come from? It's not from car sales: at least not directly. It's from the service and parts department, which accounts for 44 percent of the dealership's gross profits, according to NADA.

Knowledge Is Powerful
What makes some shoppers wary as they enter car dealerships is the fact that they don't actually know what they're going to pay for the product. Shoppers don't expect to negotiate the cost of a quart of milk at the supermarket or the price to dry-clean a dress at the shop around the corner. We do expect to negotiate car prices, however.

An alternative to car price guesswork can be found via Edmunds Price Promise®, which gives shoppers an upfront, guaranteed price on a specific car. But until every dealership offers Price Promise, you can better navigate some of the more complex purchase negotiations by understanding some of the financial aspects of the car selling business. Here are some examples.

New Cars: Dealer Holdbacks and Dealer Cash
Car pricing is a complicated process. To simplify things, consumers learn to look at the invoice price of a car and assume that's what the dealer paid for it. They may then wonder how a dealer is making a profit if it's selling the car for the invoice price. This is where two other sources of manufacturer money come into play.

Dealer holdback: This is money the manufacturer pays to the dealer only after a car is sold. It's typically 2 or 3 percent of either the invoice or the sticker price of the car. On a $20,000 car, a holdback represents $400 to $600. The holdback allows dealers to sell a car at invoice price (or even below invoice) and still make money. Most manufacturers offer holdbacks to their brands' dealers, but not all. You can check the holdback percentage before going shopping but don't try to build it into your negotiations. Dealers consider this money off limits for the purposes of price negotiation.

Dealer cash: Dealer cash, on the other hand, is something you can make work for you. When a car isn't selling well, the manufacturer will sometimes offer an incentive — often as much as $2,000 — to move it off lots.

Dealer cash can also come into play at the end of a model year, when both the dealership and manufacturer want to clear out even popular cars to make way for the incoming new vehicles. Dealer cash is listed on our Incentives and Rebates page.

The Role of Commissions
Traditionally, a car salesperson works on commission, and maybe even "straight commission," without a base salary. The salesperson typically tries to hit sales goals in order to earn a more substantial paycheck. This can set up strains between the buyer, who wants a lower price on a car, and a salesperson, who may be paid better if the selling price is higher.

"Confessions of a Car Salesman" has an explanation of how this worked at a high-volume, high-pressure dealership in 2000. It boiled down to this: The higher the per-car profit for the dealership, the higher the commission a salesman would earn.

Today, dealerships vary in how they structure compensation for the sales staff. Some still hold to traditional commission-based plans. But in a growing number of dealerships, the push is to sell as many vehicles as possible, even if it means little or no profit per car. The bonuses are instead based on the number of cars sold, with higher percentages paid to salespeople for more cars sold above a certain goal. Bonuses based on sales volume, rather than more profit per car, have long been the model for dealership Internet departments. That's a good reason for car shoppers to work with them.

Used Cars: Trade-Ins and Purchases
Although used cars account for the smallest percent of a dealership's gross profits, the trade-ins themselves can be a "huge profit center for the dealer," says Oren Weintraub, a former general sales manager at a top Ford dealership and now president of the concierge car buying service Authority Auto in Los Angeles. And dealers really need those used cars. According to NADA, 61 percent of a dealer's used car inventory comes from trade-ins.

Used cars are far more profitable for a dealer than are new cars. For example, there's a $4,000 difference between the trade-in value of a 2010 Toyota Camry XLE (what the dealer would pay you for it) and its dealer retail price (what the dealer would sell it for). That $4,000 is essentially the dealer's expected profit. Dealers will point out that they have to recondition used cars, and that costs money. But even so, the profit margin on a used car is typically more than what a new car sale can bring. NADA reports that at the average car dealership in 2012, net profit per new vehicle retailed was $111.

On the buying side, used cars can be tricky for shoppers because they can be a "blind negotiation," Weintraub says. The car shopper doesn't know what the dealer paid for the used car and might not know its current market value. An Edmunds' True Market Value (TMV®) appraisal of a used car can help. While TMV adjusts for regions, local markets can have quirks that are difficult for the car shopper to spot. Only by researching the current market and comparing prices can you know the right price for a used car.

Finance and Insurance: More Important Than Ever
F&I is an important source of dealership income. According to NADA, nearly 37 percent of a dealership's gross profit comes from the sale of F&I products and service contracts on new and used cars. And while the gross margin on the sale of new cars and trucks fell to 4.2 percent in 2012 from 4.6 percent in 2011, aftermarket income rose, "because of increasing F&I and service contract dollars," according to NADA.

The average profit on a new car from F&I products was $804 in 2011, according to a 2012 survey of 800 subscribers to F&I and Showroom magazine. With increased training for the F&I staff, that figure can go up to $1,200 per car, according to Zurich, a company that does F&I sales training. In short, F&I sales are critical for a dealership's success.

The dealership's F&I manager is primarily there to present the dealership's pitch for financing. It's worth listening: Sometimes the interest rates are lower. But you also should arrange independent financing first.Then you'll be able to know for sure how good the deal is.

In addition to offering dealer financing, the F&I manager typically offers extended warranties (also known as extended service contracts). The pitch for extended service contracts appears to be a winning one with car buyers. In 2012, customers bought extended service contracts on 42 percent of new vehicles. That's the highest rate in the past two decades, according to Automotive News, citing NADA data.

If you do want to buy a product such as an extended warranty, it's important to remember that the price is negotiable. To get some tips on arriving at a better deal, read "How To Get the Best Price on an Extended Car Warranty."

The Service Department
In economic hard times, service bays have kept many dealerships afloat. Dealers know that there's a good chance that a car buyer will bring the vehicle in for regular service, and even if the dealership only ekes out a thin margin on a new car sale, there's the possibility of continued cash flow from a service relationship.

Commissions play a part in the service operation as well. Service advisors typically receive a commission on all the parts and services they sell. Again, the amount of sales pressure you'll experience varies widely.

For some tips on how to handle scheduled maintenance visits and auto repairs, please read "Maintenance Basics" and "Stop Changing Your Oil."

Reputation, Reputation, Reputation
Now that you know more about where a dealership makes its money, you can move on to picking one that has a good track record in how it deals with customers, both as buyers and as clients of the service department. Visit Edmunds dealer ratings and reviews, where you can read about real consumer experiences.

Most Recommended Comments

By azgm
on 02/14/12
2:52 PM PST

There are too many blanket statements in this article. Everyone wants a good deal, but there's too much attention on where the dealer makes money. Dealers have huge overhead in their facilities and are not non profit orginazations. If you like the service and feel good about it then you should move forward... that sounds like a much less stressful experience that trying to figure out where the dealer makes money. It's laughable that the previous Ford GSM is making it sound like it's bad to work on commission. Maybe he worked for a dealer that liked to take advantage of people (takes one to know one kind of a thing) but my experience is that people still buy from people they like. I'm paid on commission too, and sometimes my store goes into the red for a month or two, but using the logic in this article I should raise my prices if this happens? Edmunds has make lots of money by spreading false propaganda about dealers and asking shoppers to find out how dealers make money? So stupipd!

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By erzuahsiam
on 09/12/12
6:55 AM PST

Even though you guys have some insight into the car business, the picture you have portrayed in this write-up is a gross representation of the car business. Anybody reading this post will automatically cultivate a carricatured image of these hard-working sales persons. Here are people toiling daily not only to feed their families but also helping the economy to move along being depicted as cut-throat vermins bent on wrecking the pocket books of Americans. To help beef up your outdated knowledge, I will like to point out to you that NOT EVERY CAR SALES PERSON IS ON COMMISSION. For example, sales persons working for the Sheehy Auto group are paid salaries, plus FLAT AMOUNTS on every car sold. The arrangment allowed the Sheehy company to usher in the concept of Sheehy Markdown where every single car is marked down below average market price. For your information, Sheehy arrives at markdown prices uses sources like Edmunds.com, Cars.com, KBB.com, etc. Thus, for Edmunds to turn around and castigate dealers (which, of course, include Sheehy Auto company) is tantamount to saying that car buyers should not trust Edmunds.com. Talk about shooting oneself on the foot! Also, what is so heinous about dealerships making profit ? Is Edmunds surviving on hand-outs and donations from philantropic organizations ? This drum-beat of car dealerships making profit is getting old, stale, annoying, and stupifying. Why won't Edmunds contributers write about Walmart making profit, or Exxon Mobil making profit ? PLease, if you have nothing to write about, start finding something else to do and stop painting this gargoyle-like picture of harworking and sincere sales people. Siam Erzuah Sheehy Honda Alexandria, Virginia

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By pryorpat
on 08/30/12
4:33 AM PST

The author talks about profit as if it is evil. If you own a business with millions of dollars in inventory and millions in payroll, you need to make a profit, and compare to many other businesses that require such large dollars, selling cars does not have a great rate of return all the time. If your financial adviser told you that you may make somewhere between $500 to $1500 on your $20,000 investment, and it may take a week or 10 months, and you would have to pay overhead the longer you have it, would you invest? No. The largest profit center for a dealership is the service dept. Service is where the long term relationship is built. You only buy the car 1 time and even if you only return for warranty repairs, it is still profitable. Salespersons commissions are not always based on a tier system by profit, or at all. Financing is offered to buys via the dealership and they have a buy rate which is lower than what you can get and they mark it up, just like the guy/gal at the bank, they get a piece of the action. There is much much more but Edmunds needs to keep that quiet to preserve their relationship with the manufacturers.

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