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Car Dealer Secrets: What Invoice Pricing Really Means

Negotiating the sale of a new car is a dance: As a buyer, you want to pay as little as possible. As a dealer, I want to run a profitable business. Sometimes, this dance becomes a fight – an unpleasant, drawn-out battle of the wills.

Believe it or not, sales managers don’t like these kind of grinding, painful negotiations any more than buyers.

So why does it happen?

A lot of times, it’s because customers walk into the showroom and say the Internet told them that “invoice” is what they should pay for the car. Today, I’m going to try to explain why invoice pricing doesn’t work for you or the dealer.

You’re buying more than a car

In addition to profit, customer satisfaction plays a big role in which dealers succeed and which ones fail.

When you purchase goods from a company you are also buying a relationship with that business. It’s true in almost every aspect of our daily lives. Do you have a favorite restaurant? What brings you back? Good food is only half of it. If the service were horrible, wouldn’t you eventually go elsewhere? It’s the same deal with grocery stores, coffee shops, banks, credit cards, etc. You have to want a business’s products. But if you have terrible experiences with the business, you’ll find those products elsewhere — and the business will fail.

A local coffee shop knows that the barista who remembers your order keeps you coming back. A well-run car dealership is no different.

Now for the $1 million dollar question…

Other than the car dealership, do you negotiate the cost of products at other businesses? Can you imagine the look on the barista’s face if you asked what their cost was to brew a cup of coffee, and then offered them a 1 percent margin over cost? Most of us know that the actual cost of a cup of coffee is probably only about 50 cents, yet we happily pay $1 or $2 for it … or more.

Overhead costs are proportionate to the size of the business

I’m not going to claim that I know what a financial statement looks like at a restaurant. But I am confident saying that overhead operating costs are proportionate to the size of a business.

Let’s look at some costs of operating a car dealership’s sales department. (Let’s forget parts and service; they’re treated as distinct businesses even though they’re under the same roof):

  • Rent or mortgage payment: Split three ways, the sales department’s share might be $10,000 a month.
  • Employee compensation: $20,000 to $60,000.
  • Credit card charges: $3,000 to $5,000.
  • Phone and Internet/data processing/software: Most of this is industry software that lets us manage inventory and set pricing. $10,000 to $20,000
  • Fuel: $10,000 to $15,000
  • Interest (floorplan): Paid to the bank to stock a couple million dollars’ worth of new and used cars ($10,000 to $20,000).

Add these to smaller expenses not mentioned and a sales department can easily cost $150,000 a month to operate. And that’s just average. A larger Toyota dealership with 20 salespeople selling 250 cars a month might have expenses twice what I’ve outlined here. So a dealer’s costs are significant: $150,000 divided by 30 days in a month is $5,000 a day and we haven’t even sold a car yet.

Profit margins need to be proportionate as well

Nike sneakers cost $5 and retail for $80 — a 1,500 percent markup!

A Starbucks Grande Latte retails for $3.26 but costs only $0.57, a 471 percent markup.

The average price of a new car in 2011 was $30,303. $500 over invoice represents a 1.65 percent margin.

Let’s say a dealer sells 75 cars a month at an average of $500 over cost. That’s $37,500 in gross profit. Not bad, but the dealer hasn’t even covered its costs yet. They would need to average $2,000 per sale just to break even. I’m not saying a dealership needs to make a 500 percent profit, but we need to keep the lights on.

Who’s telling the truth? The dealer or the Internet?

If you’ve researched new cars online, you’re probably screaming, “But you’re not telling the whole story! Dealers have holdbacks! That’s where you hide all your profits!”

Yes, there is such a thing as a holdback. But dealers don’t earn as much from holdbacks as you think.

Dealers have a bank statement that matches the invoice price showing that is what we paid for it.

Holdback is designed to defray operating expenses like floorplan interest. Manufacturers pay dealers holdback each month based on the volume of cars the dealer orders. Although holdback used to be included on a dealer’s invoice, manufacturers later removed it in an effort to simplify the information consumers received on invoice pricing. Now holdback is quietly tucked away on a financial statement.

Here’s the thing about holdback: It’s used to reduce a dealer’s monthly overhead, so it’s not “profit” in the way a car buyer and a car salesperson think of it. In fact, salespeople and sales managers aren’t paid anything for holdback. They never see it. They work from invoice up.

Yes, some cars sell for invoice

There are cars out there that transact for invoice and less. It’s the same way a grocery store sells milk and other popular items at ridiculous discounts; they are loss leaders to get you in the door.

A Toyota Camry is a perfect example. Any Toyota dealer would jump at an invoice deal on a Camry. The dealer has volume on its side. But go into that same Toyota dealer and ask for an invoice deal on a Land Cruiser, and it won’t go very far. It’s a premium car, and there aren’t a lot of them made.

Unfortunately, sites like Kelly Blue Book or Edmunds.com do not break it down like this. They record the lowest transaction prices they can report and use that to set the bar. (After all, they want to attract readers, and low prices will do that!) But this gives customers misinformation, which is usually why negotiations go sour at the dealership. Pricing structure is going to vary by manufacturer, model, and even by day.

The lowest price isn’t always the best deal

You can see why invoice pricing isn’t great for the dealer, but what do you care? You just want the best deal.

It all comes back to the relationship I wrote about earlier.

In my opinion, the more expensive the item you buy, the more important the relationship. I bought a watch from a local jeweler. Before I bought it I went online and found the same watch for sale on eBay for $500 less. I still bought the watch from the jeweler and I’m glad I did. It’s been repaired twice. Once under warranty and the second time out-of-warranty but still at no cost to me.

I’ve bought other jewelry there including my wife’s engagement and wedding rings, and I feel they have given me great customer service. I even got a free watch winder from them last Christmas. I enjoy working with them, and they enjoy working with me.

It’s similar in the car business, only the relationship is even more important.

You think dealers don’t remember who the good paying customers were? I’ve seen out-of-warranty repairs covered by the dealer for upwards of $10,000 for “good” customers. That’s the treatment I want when I drop $30,000 on a new or used car.

I also want that dealer to be in business the next time I’m in the market. I want their employees to be well trained, professional and compensated. There’s a saying in the car business: “The happiest customers are the ones who paid the most.” And it’s true. I’ve seen it time and time again. They get treated better and have a better buying experience. They tell their friends what a great dealership it was and how fun it was to buy a car there. They go online and leave positive reviews.

We get negative reviews once in a while, too. Nine times out of 10 those customers are also the ones who paid the least and turned negotiations into World War III.

Research a car dealer before you walk into the showroom. Pay attention, and you’ll be able to tell whether it, like any business, has a few negative reviews from grumpy people or if it has a large volume of negative reviews that indicate poor management or sketchy sales tactics (because a good dealer won’t have either.)

Do your pricing research but keep an open mind. The dealership needs to make a fair profit. Don’t believe everything you read on the Internet. When it comes time to negotiate price, ask for a discount, but take the boxing gloves off and hear them out. There are still some good car dealers out there, and they are probably making a lot less on selling you a car than you think.

Get Free New Car Price Quotes at Edmunds.com now

About Tom Niejadlik

Tom Niejadlik has over 15 years of experience in the auto sales industry and is eager to help us understand his industry and save money on one of our biggest expenses: our cars. He lives in Portland, Maine with his wife, sons, and golden retriever, Barkley.

Comments

  1. I 100% agree with this post that relationships are key to getting good service (on both sides of the deal).

    Although, since this is a financial blog, and if you want to make the best financial decision, I’m a believer of Dave Ramsey’s approach to buying cars. Don’t have more than 50% of your annual income tied up in vehicles, because they are a depreciating asset. In other words if you make $40,000 a year, you shouldn’t have more than $20,000 worth of vehicles, and you should pay cash for them. Why? The rate of depreciation on a new car is faster then the loan pay off in the first year or two. So, consider buying a 2-3 year old car for cash, to avoid the big depreciation hit and the loan payment.

    Good informative post though, I’ve always wondered how dealerships worked with invoice pricing and profits.

    • Thomas Niejadlik says:

      Good advice. Leasing is another option that allows you to keep more cash in the bank rather than shell it out on a depreciating asset. I might have a tough time convincing the “financial types” of this so I’ll save that one for a post all on its own. -Tom

  2. It’s far better to shop around and get a feel for the local market. Knowing the invoice price is a good starting point and OH costs are always a big factor in price. However, a dealership could be operating inefficiently and that cost will roll up in the price. There is no good reson for you to pay more than the market, just because the dealership isn’t managing costs.

    • Thomas Niejadlik says:

      In my experience the dealers who are running their store inefficiently are the ones that won’t pay attention to their profit levels (or lack there of). I agree with paying fair market price. Any way you slice it operating costs are significant and shopping around to get the closest to invoice deal you can can be looked at as counterproductive.

  3. I couldn’t agree more about the relationship aspect. At the end of the day, people do business with people, not companies. It’s the personal touches and service that make customers come back to the same place again and again, and refer their friends and family. The problem here, of course, is that it’s easier to convince yourself to fork over a dollar for a coffee – forking over a whole lot more money for a car, when the invoice price shows otherwise, requires a bit more convincing.

    • Thomas Niejadlik says:

      Daniel,
      Your comment is a positive one and I’m not trying to start anything here. I just wanted to make a more general comment that the last few words of your post made me think about. The only person who has the right to pay invoice for a car is the person who put up millions of their own dollars for a franchise, real estate, inventory and operating captial. You are paying a lot more for a car than a cup of coffee but only a small fraction of what you’re paying is profit for the dealer. That’s what the consumers tend to ignore.

    • Thomas Niejadlik says:

      Daniel,
      Your comment is a positive one and I’m not trying to start anything here. I just wanted to make a more general comment that the last few words of your post made me think about. The only person who has the right to pay invoice for a car is the person who put up millions of their own dollars for a franchise, real estate, inventory and operating captial. You are paying a lot more for a car than a cup of coffee but only a small fraction of what you’re paying is profit for the dealer. That’s what the consumers tend to ignore. -Tom

      • I appreciate your perspective, but ultimately, I was not persuaded by this piece. What I took away from it is that: (1) yes, the dealer has costs to account for that are over and above the invoice cost of the car, but (2) it is their responsibility to keep those costs in mind during negotiations, while it is my responsibility to ensure that I pay the lowest price possible for my car. (After all, I have other “operating costs” in my daily life, too, and it’s my responsibility to be true to those costs just like the dealer has to consider theirs.)

        I found your comment about “the only person who has the right to pay invoice for a car” odd. We’re talking about a private marketplace here, so it has nothing to do with who has the “right” to charge or pay a particular price: if you are offering a product, you have the “right” to receive what we as consumers are willing to pay for it, and not a penny more. Meanwhile, we have the “right” to request whatever price we want, but not the right to force a business to let their inventory go at that price.

        Finally, your post offers a number of reasons that a dealer might want to receive more than the invoice amount (obviously!), but only offers one reason that a consumer might want to consider paying more: the purported relationship with the dealer, which ostensibly is going to lead to greater savings down the road. In my experience, this is speculative at best. My family is a Toyota family, and we bought our cars (three of them, all common models) new at a particular dealership in state X. We did not turn negotiations into World War III or receive the very lowest price possible, and my parents had a good relationship and were personally friendly with the salesman. This did not translate into any special treatment during the years we had our cars maintained at that particular Toyota location, which may have been – as you point out – due to the fact that the maintenance business is effectively separate from the sales business (another reason not to prioritize the “relationship” with the salespeople in your purchase negotiations). In a couple of years, my parents moved to a new town about 30 miles away, where we certainly were not known to the Toyota dealer and did not receive special treatment. (The salesperson in question was aware of our move, but did nothing to ensure that we were personally embraced by the new dealership. After all, our transaction had long-since concluded, and he had already received his profit.) In turn, after I finished college and grad school, I moved to the opposite coast, where I feel I’ve been treated dishonestly by the local Toyota dealership (e.g. claiming on multiple occasions that tires with a single nail in them could not be repaired and needed to be replaced, and identifying an astonishing number of “necessary” repairs that no other car maintenance shop can see). In fact, I am so underwhelmed that I hope to avoid dealers altogether in future car purchases, and I plan to purchase all future cars used if possible.

        To be honest, this post felt out of keeping for this website, which is usually dedicated to helping 20somethings who are financially somewhat vulnerable engage in business transactions to *our* advantage – not explain why we should pay more because of businesses’ need to profit. (E.g., we don’t have guest posts from Visa and Mastercard explaining why their interest rates are necessary for the relevant banks to profit sufficiently – we’re advised on what credit cards will work to *our* advantage.)

  4. Couldn’t agree more. As a manager at a dealership that is part of a large corporation, I can’t believe the lengths consumers and websites go to ensure that no car dealerships make no money. I understand in today’s economy that “profit” is a dirty word with the buying public, but I can’t think of any other business that routinely sells $30,000-$40,000 products for profits of less than $500. In many cases the dealer is losing money on the vehicle purchase in hopes of making some money back in finaancing or future service business.

    Working for a reputable corporation, and great manufacturer, I hope that more consumers would take into account the other aspects of the vehicle purchase like the article suggests.

  5. I think the big disconnect is in scale of economy. Why do we haggle on cars? For the same reason we haggle when buying a house, it is a major expense and haggling can have large rewards.

    One thing to consider is the cost/benefit aspect of haggling. It is not worth my time to haggle over $1 at the coffee shop. However, it is worth it to spend a few hours haggling at a dealership if I can save $1-2k, just like it makes sense to spend a few days negotiating buying a new house if you can end up saving $5-10k.

    There is also a supply/demand edge for the buyer. Unlike a cup of coffee, at any given time there are a small number of car buyers compared to a large supply from multiple competitor dealerships. All that adds up to buyers having the edge.

    It’s basic economic principles at work. I don’t absolutely need the car today or even this month. However, as you pointed out, you have overhead and need to sell the car this month. Big supply and low demand, means lower prices. Same reason why that Land Crusier has a better margin, small supply, high demand.

    • Drew – I think your economic breakdown is perfect. I think it’s unfortunate for Thomas that the car business is more difficult than it was before the internet, but I don’t think it’s a reason to pay more for a car.

      Similar to Bethany, I have trouble following Thomas’ logic about the added value found in a better relationship with your car dealership. I value the relationship I have with the owner of my neighborhood coffee shop because I see him at least a couple times a month. However, I haven’t needed a relationship with my dealership because I purchased a reliable and affordable Honda Civic in 2005. Before making this purchase, I used the internet to research the car and make sure it was what I wanted and that other consumers, rather than a car salesman who, rightfully so, would have the profitability of his dealership in mind, also had similar experiences with this car. Thanks to making a careful purchase decision, I haven’t needed a relationship with anyone at the dealer.

      Also as I referenced above, I just see the internet as changing the market for cars. Craigslist and other similar sites changed the price point as an individual’s willingness to pay is higher than the a dealer’s trade in value because the car’s price at the dealership would exceed an individual seller’s price point. We sold my boyfriend’s car very effectively in this manner, and he is very happy with the truck he purchased directly from someone on Craigslist as well.

  6. Thomas Niejadlik says:

    Well, at least people are reading my posts. Let me first say that the reason I’m a “guest poster” here is that the owner of the blog felt that I could shed some light on my business and how it relates to personal finance. I’ve had many discussions with David and both of us were interested in each other’s the point of view. He knows that I am honest and the dealership I work for is well respected in my market. Secondly, I’m not arguing that you can pay less for a car on Craigslist. That’s not going to change the need for dealerships anytime soon.
    There are some good dealers out there and some dishonest dealers. What the consumer might view as dishonest sometimes can be a situation in which they are not knowledgeable about. I hope to share what I know with you so the entire process is a little clearer for you. There will be some people that can benefit from this and some people like Bethany who has completely written off all car dealers because of her experience. There are two sides to every story. As well respected as the dealership that I work for is I hear customers all the time in the service department claiming we made unnecessary repairs. When I have to look into one of these situations 99 times out of 100 we are generally correct with our diagnosis and the customer just didn’t completely understand the matter at hand.
    If anything was received from reading my post it was that a dealer needs to make a profit to stay in business and continue to service you the customer. Go into the process knowing that and ready to pay a fair profit (not invoice) and you will be better off in the long run. Some of you will say you don’t care about the relationship with the dealer and you still want to pay invoice or less. That’s your prerogative. You can base that on the 3 or 4 cars you’ve bought in your lifetime thus far. I was involved in roughly 1,000 transactions last year alone. So when I say the relationship is important I’ve seen it first hand and can say that with confidence. I also think that as you grow older, more financially stable and make larger transactions this entire concept might make more sense to you.

  7. I came across this post and was utterly disappointed in the slant that it has for dealers. There are far more consumers taken advantage of daily than dealers who see their profit margin reduced. I helped my grandparents buy a car years back and they would have paid $2,000 more for it had I not done the research and found a better price at dealership B. Now, they are on a fixed income, but that dealer would have gladly accepted that extra $2,000 and been as sweet as pie to them throughout the process. For every jerk buyer who negotiates the heck out of a new car purchase there’s an uninformed buyer who’s really getting the screws turned. So what’s really fair? It’s just how car sales work in this country and have for decades.

    • Thomas Niejadlik says:

      Bob,
      There are two sides to every story. The “slant” towards dealers is the other side of this story. Last time I checked dealerships were for-profit organizations and making a profit is good business. Is paying a dealership a profit what you consider being taken advantage of? Car sales are changing in this country. Dealers have less margin and the process is far more transparent. That’s what informed buyers are figuring out. I think it’s good for the readers to hear both sides of the story.

      -Tom