How Do Car Dealerships Make Money?
Updated on: March 20. 2022
Standing outside a car dealership reveals an armada of shiny new vehicles. The latest and greatest models are kept safely indoors on the showroom floor, but there are plenty more outside. Wade a bit deeper into the ranks and you'll find the used models lined up on the back row, buffed and looking for a new home in your garage.
Walk through the Front Door, glide across the sales floor, pass the Finance & Insurance Department and wander by the parts counter on your way to the shop. If you could look behind the curtains of the dealership, you would discover that each and every operation you are passing by is set up as a profit center—all of them competing for the money in your wallet. So, who typically wins this war of dollars, and how does the dealer actually make any money? The answers might surprise you.
New Car Sales
High price tags, factory fresh (complete with that new car smell)—you would think the brand-new inventory represents the biggest bucks, and in many ways, you would be correct. Because new cars are such a big-ticket item, new car sales account for over half of the total gross sales at most dealers. Gross profits hover around $2,000 per car, but from a net-profit standpoint, new car sales generally lose money.
Yes, the typical new car sold loses a dealership about $200.
Thanks to commissions, transparent pricing, dealership rebates, and what’s known as "floor planning," new cars turn out to be the sizzle, but not the steak for dealerships. A new car dealer secures inventory by borrowing money, sometimes from the automaker itself, to get all those cars into the showroom and onto the lot.
The bottom line is that the longer the cars sit, the more interest the dealer has to pay its lenders. "Hold-back money," small chunks of cash rewarded back to the dealer by the manufacturer when a car actually sells, make up for a portion of this. Overall, though, there is no money to be made on the sale of new cars. Cash flow, yes. Profits, no.
Used Car Sales
Here's another loser for the dealer. The average retail net profit in 2016 from selling a used car was $65. The dealership's ability to make money selling used cars depends on many things, starting with how much money the dealer "has in it." This number depends on the trade allowance the dealer made to acquire the used car. Add on the cost of any repairs necessary to get the car ready for resale and any repairs made under warranty after the sale, and you're left with paper-thin margins. Commissions are also paid on used car sales, and the longer a vehicle sits on the lot, the less it's worth. Studies from the National Automobile Dealers Association (NADA) recommend that used cars sell in 45 days or less. If they sit longer, they are money losers.
Back in the old days, the car business was much less transparent. Car values were determined and published in books that were available only to dealers. The books—which were usually blue—provided a "retail," "low wholesale," and "high wholesale" value for every car model ever built. Or course, all the numbers were subject to the condition of the car.
The best possible trade-in scenario for the dealership would be to offer a car buyer the "low wholesale" number for a trade and then sell a new car to the same customer for the Manufacturer's Suggested Retail Price (MSRP). The dealership could then put the trade-in on the lot and ask the "retail" price. The dealer would make good money on the trade and the sale of the new car. Those days are long gone.
CarGurus can tell you what your trade is worth in a couple of clicks on our [Car Values](https://www.cargurus.com/Cars/instantMarketValue.action) page, and a quick search will allow you to compare prices for the same car at multiple dealerships and from private owners. Thanks to this level of transparency, only buyers who don't do their homework to learn what their car is actually worth, and are put off by haggling, stand to help car dealers make money on trades.
Dealers buy and sell cars at auto auctions. Some auctions are open to the public, but others require a "dealer’s license" to participate. Auctions can be sexy affairs filled with collectible cars and rich people—or they can be held by police departments or the IRS. Auctions are risky propositions even for the professionals.
Dealers may take cars to auctions that have been on the lot too long or are too expensive to fix. Dealers may buy cars at auctions if they have room in their inventory for certain quick-selling models. Pure capitalism, risk and reward: Automotive auctions are not for amateurs, and even savvy car dealers can make costly mistakes. These are yet another risky-at-best potential profit center.
If you're buying a new or used car, you will spend time with the Finance and Insurance salesperson. Along with loaning you the money to buy your car (at a healthy interest rate), they want to sell you an extended warranty, gap insurance, undercoating, fabric protection, and anything else you can think of. Why? Because we've finally found a winner for the dealer. According to NADA, net profits are pegged at 2.8% of the sales price of new car sales. For used vehicles, it's even better, with a profit margin clocking in at 3.7%. Turns out selling money and peace of mind is more profitable than slinging rubber and steel.
Parts and Service
If you buy a new car (or a certified pre-owned car), it comes with some kind of warranty from the carmaker. If you have a problem with the car and it's "under warranty," you won't have to pay to get it fixed. Who does pay? The car manufacturer pays the dealership's service department to fix a new car, but usually not at the same hourly rate that you, as a customer, would have to pay. Therefore the dealer would prefer to do as little warranty work as possible, because it doesn't pay as well. If it's a used car, they really don't want to perform warranty work—they usually pay for that out of their pocket.
By combining warranty work with non-warranty service work, rolling in the profit from parts sales and the work that's coming out of the body shop, you'll find the big profit leader for the dealership. The dirty work in the back of the building generates a 15.6% net profit rate. Most of that comes from mechanical repairs. Dealers also sell wholesale parts to independent garages, and some will sell retail parts over the counter to people just like you, at a markup, of course.
So the next time you visit or drive by a dealership with all that shiny metal parked around it, remember that all of that is just for show. Those new cars are essentially loss leaders for the dealership: It's the stuff going on out back that actually makes the dough.