When the Market Heats Up, Get Ready for Change

Temperatures are not the only thing heating up as we head into the dog days of summer. The market for new and used cars is hot, hot, hot. 

Pent up desires for new vehicles after the pandemic shutdown has driven up demand as inventory falls to record lows. 

Besides producing heightened demand, the pandemic generated a semiconductor chip shortage that is pressing vehicle inventory levels as more people seek to buy. Top auto manufacturers warn that without needed chips a potential 1.3-million shortfall in U.S. car and light-duty truck inventory.

Dealers are already reeling from inventory shortages. Cox Automotive subsidiary vAuto put current vehicle inventories at a 44-day supply in May and warned that supply may bottom out in the low 30s. Historically, supply averages 60 days. 

Jimmy Ellis, CEO of Jim Ellis Automotive Group, views the inventory shortage as an opportunity for savvy dealerships. He says, resilient dealers able to navigate things like the financial market collapse of the Great Recession, interest as high as 21% in the early 1980s, and the oil embargo of 1973, will meet these new challenges with success.

“The current inventory shortage at a time of higher demand is driving up market transaction prices on new and pre-owned vehicles,” he says. “Auto dealers are operating out of inventories they have never seen so low. We now must sell into the pipeline.”  

Dealers are now taking orders on incoming vehicles instead of selling out of floor plan inventory. “That is a paradigm shift for many dealerships, particularly for brands like Ford or Chevrolet that historically have a 60- to 90-day supply. But we are learning through this process that it’s more profitable to not have inventory sitting, waiting for someone to buy it,” he says.

Booming market aside, industry veteran Brian Benstock, general manager and vice president of Paragon Honda and Paragon Acura, cautions dealers to proceed with caution. “The seeds of failure are often planted in the soil of success,” he says. 

Yes, consumers want cars, reports the leader of the Queens, New York, dealership rated as the No. 1 Certified Honda and Acura dealership in the world. But, he warns, dealers have been here before. 

He explains dealers created waiting lists in other times of high demand. Customers placed deposits for vehicles and waited for manufacturers to build their rides. But they did this with multiple dealerships fueling unrealistic demand forecasts.

“Whoever received the vehicle first got the business, and the customer cancelled their order at the other dealerships and got their deposits back,” he says. “Sometimes waiting lists show a false sense of urgency or demand as customers go from dealership to dealership and place deposits.”   

In the end, dealerships wind up with sitting inventory. “And when vehicles sit, margin compression results,” he says.

Irrational Exuberance Will End

In a speech during the dot-com bubble of the 1990s, Federal Reserve Board Chairman Alan Greenspan coined the phrase “irrational exuberance” as a warning that the stock market may be overvalued.

One might apply the same phrase to today’s auto market, warns Benstock. 

Consider that Auto Trader cited May 2021 as the strongest May on record for new and used car performance. Its report put May 2021 new car sales at 14% higher than May 2019 volumes. This strong performance continued in the first weeks of June, with sales soaring 15% over the same period in 2019.

Demand is driving up prices. J.D. Power reported the average new car price shattered records in May, coming in at over $38,000, which is 12% higher than the same period a year ago.

Used car sales share a similar story. Preowned vehicles are selling for more than they did new. For example, a 2019 Hyundai Tucson Limited that sold for $31,935 new might now net $35,150.

This phenomenon is irrational and “any time there is irrational exuberance, rational thinking will come back,” Benstock says. He stresses dealers must prepare now for that eventual reality. 

“We need to repair the roof while the sun is still shining, and the sun is shining right now,” he says. “It is a good time for us to reinvest in our people, our facilities, and in the fundamentals. At some point, we are going to have normalization of factors that are currently abnormal, such as interest rates, consumer demand, and inventory demand.” 

Benstock sees too many dealers acting like they created the booming market rather than economic forces. “These dealers might be in for a surprise,” he says. “This is not normal, and I don’t think it’s sustainable.” 

He warns this is “not the time to pat yourself on the back.” Rather it’s time to examine what to add to profit structure that will remain after markets normalize. What improvements can be made in the sales process? What initiatives might provide an advantage in a flatter market? Streamline personnel so that fewer people handle each transaction. Look for ways to remove expense from every sale.

“You need to be disciplined,” he says. “Work your tail off because the harvest is here. Reap the money but save it and reinvest in your business. This is a good time to get ahead and to clean up your balance sheets.” 

Dive into the Data

Knowing that margin compression may take hold and take hold quickly, Benstock reminds dealers to stay agile and stick with the fundamentals.

“Old cars are old cars,” he says. “We don’t keep old cars. Try to get a reasonable profit on your investment but keep your inventory fresh.”

He advises training a close eye on daily changes because when the market shifts, it will do so quickly. Review multiple data points, information from the OEM, and Automotive 20 groups. Monitor basic economic conditions and interest rates because “when inflation gets out of control, we will see shifts in demand,” he says. 

“You need to look at the data daily. You don’t need to react daily, but you need to watch what’s happening daily,” he says, noting dealers who do this will spot slipping sales and margins early. 

Maximize Marketing

“What’s the best way to get margin on a car?” Benstock asks. “Having 10 customers who want the same car. But how do you get 10 people to want the same car?”.

In a word, “Marketing,” he says.

Dealers may back away from marketing in abundant times but Benstock calls this idea “counterintuitive” in times of scarce supply. 

Today’s consumer searches for the vehicles they want online before they set foot on dealership lots. A dealer a block away from their house may have the car they want but miss out on the sale without marketing. The consumer may buy that vehicle from a dealership 50 miles away because the local dealer did not advertise.

“That’s a missed opportunity,” Benstock says.

Dealers sometimes think marketing isn’t needed in a hot market. After all, odds are good that someone wants the car. But marketing drives higher margins and keeps inventory fresh. 

“Don’t hold out for too much money on your used cars, keep your inventory fresh,” he says. “When the market shifts, it shifts pretty quickly. If you have aging cars in your inventory, you could be holding 100 used cars when the price drops $2,000 a car.” 

What Lies Ahead

Isaac Newton said, “What goes up must come down.” Just as a ball thrown into the air eventually falls to the earth, soaring sales will eventually return to normal levels.

Benstock predicts sales will normalize over the next 12-18 months, however, in the ensuing 5 years the industry will appear radically different. 

“Electrification, online retail and things like that will continue to gain momentum,” he says. “And in each area, someone will get it right. Some major player, some technology advancement, from outside the industry, could change everything.”