This article originally appeared on Forbes.com
Two things in life are guaranteed: death and taxes. If we could add a third thing, it would be that a car dealer is going to pay someone less for a car than they could sell it for on their own.
To understand the dynamics of this pricing relationship, we have to uncover how dealers value cars, learn what it takes to re-sell a trade-in, and share a few business lessons around transparency and keeping a business in good financial health.
How Cars Used To Be Valued
The first step in selling a car is figuring out how much the car is worth. There’s a good chance that customers are going to navigate to a site with “book” somewhere in the company name, but let’s take a quick step back.
Car dealers used to keep physical books that gave them an approximation of vehicle values, largely representing depreciation with slight regional variations. They also used local knowledge and expertise on what other comparable vehicles were being sold for by competitors. They would do the math and optimize profit potential.
From the consumer perspective, they often brought in their vehicle to sell or trade in with a fraction of this information, i.e., only the book value. This frequently resulted in a sense of mistrust when their “offer” didn’t match what the dealer was willing to pay.
Contrast that to a modern approach like Zillow.com, where millions of data points are analyzed and ultimately used to support an improved estimate, backed by local and easily viewable comparables.
How Vehicles (Are Mostly) Valued Today
While this older methodology still exists, minus the physical books, a vast majority of dealerships modernized their approach to valuing cars by using tools powered by vast amounts of retail market data. They take into account supply and demand localized to their market so that the consumer’s offer represents a realistic range or number.
The used car manager who used to scan competitor inventory in the classifieds now takes the form of complex algorithms. This data-driven approach informs dealers of recommended ways to optimize profit, inventory mix and pricing.
These dealerships may also regularly present to their customers the data they’re using to value their cars. That data, specifically, is the other cars for sale in the market, just as a realtor or appraiser uses local homes to value your residence.
This leads us to my first takeaway: Just because you’ve done something one way for 1 year, 10 years or 100 years doesn’t make it the right way to do it today. Modernize your approach to stay ahead of consumer expectations.
Why Do Dealers Pay Less?
The reason dealers pay less is easy to get: It costs them more to sell the car than it does for the owner to sell it on their own. The dealership needs to pay the dent guy or gal to pull out all the dents. They need to pay the body shop to fix the scratches and scuffs. They may have to put on new brakes and new tires. They’ll change the oil and perform a detailed inspection of the vehicle. If a person is selling a car themself, they might wash it and vacuum it. That’s a drastic difference in labor and expense.
Each vehicle incurs its own set of costs to get it “front line ready,” and every dealer factors that into their offer to the consumer. Dealers also look at specific market data and work to turn a profit relative to the actual market value of the vehicle. Private sellers don’t have that same data and price their cars based upon basic internet research, whim or emotion.
However, there’s a dilemma. Most consumers generally aren’t aware of the costs, don’t think about them or most likely don’t even care. The first reaction is “they’re just trying to rip me off.” As a business owner, how can you get people who may not trust your pricing to actually trust your pricing?
My next key thought: share the rationale behind your pricing and be transparent with your customers. It’s not just about having access to data, it’s about having access to relevant data and sharing it.
For dealerships, consumers can find any information they want online about vehicle values, much of it not accurate or up-to-date, so dealers must tell a more complete story about their pricing to build trust. What information are consumers looking for about your business and pricing, and does that information tell the story you want it to?
Know Where Your Bread Is Buttered
The smart dealers know where their bread is buttered. Typically, dealers make very little money on new cars and make some money on used cars. This past year they’ve been making great money on used cars, but this market anomaly will disappear once new car inventory levels return closer to normal. They can make money on upselling financial packages, but the real margin in automotive comes from the service department.
The smart dealerships use new and used car sales as customer acquisition for their service department. They understand the lifetime value of a customer and price their trade-in offers aggressively. It’s easier and more profitable to sell an existing customer than to acquire a new one. This lesson is true for any business.
Bridging The Communication Divide
The rub between dealers and their customers always comes down to a communication divide. Yes, dealers pay customers less for a vehicle than what they could sell it for on their own, but it’s because dealers incur more cost and need to turn a profit while balancing the lifetime value of their customers.
The more that businesses can create open communication and share information between themselves and their customers, the more trust they’ll build with each other, and the more fruitful their long-term relationships will become.