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 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.

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 that business, you’ll find those products elsewhere—and that 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, sometimes more.

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.

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.

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 floor plan 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.

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 you won’t get 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.

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.