Why Car Dealers Want to Take You for a Ride

Well-equipped models like this Ford Fusion are very profitable for the automakers, but most mainstream new-car dealers operate on much thinner margins than customers realize. Source: Ford Motor Co.

Did you feel like you got ripped off when you bought your last new car?

Maybe "ripped off" is a little strong. But a lot of people feel like they're giving up too much money when they buy a new car.

But it turns out that most buyers aren't giving up anywhere near as much money as they think. A new survey shows that, on average, people think that new-car dealers make a 20% profit on the sale of a new vehicle. But the reality is that it's far, far lower.

In fact, in recent years, new-car dealers selling mass-market brands like Toyota  (NYSE: TM  ) or Ford  (NYSE: F  ) have seen their profit margins shrink quite a bit -- to less than 4%, on average.

That might explain why car dealers use every trick in the book to try to get you to pay a little more on your new vehicle. But as Motley Fool senior auto specialist John Rosevear explains in this video, those tricks might not be in anybody's best interest.

A transcript of the video is below.

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John Rosevear: Hey Fools, it's John Rosevear, senior auto specialist for Fool.com. Interesting study came out this week from the folks at TrueCar. They found that consumers believe that car dealers make about five times more profit on the sale of a new car than they actually do, and they say this highlights what they call a "trust gap" between consumers and car dealers.

"Duh", right? If you're nodding and laughing right now, as I was when I first heard this, then stay with me because this is interesting.

So back in February, TrueCar surveyed over 3,000 consumers across the country, and they were looking to, as they put it, "identify consumers' perspectives regarding perceived profits made by car dealers with questions aimed at determining what consumers believe a fair profit would be."

And they found that a lot of people buying cars fear that they're overpaying, which isn't a surprise, and that people think that dealers make about 20% profit on the sale of a $30,000 new car. The reality, according to the National Automobile Dealers Association, is that the average dealer's profit margin on a new car is a little less than 4%. So there's a big gap here. Customers feel like they're getting taken for a ride, and the dealers feel like they're totally getting squeezed.

TrueCar's CEO Scott Painter says this shows that "fear and mistrust have a cost in the car buying process", and he's totally right. We as buyers have all  experienced, or at least heard about, these games that dealers play with hard-sell techniques that might be a little deceptive, where they focus on the monthly payment to kind of distract you from the overall cost of the car, or they add all these charges and fees at the last minute or whatever.

But the truth is, nowadays most new-car dealers who are selling the mass-market brands are operating on pretty thin margins, that's why a lot of the little local dealers have gone out of business over the last decade, the ones that have survived are either making most of their money on used cars or they're doing very high volume business, a lot of pickups or commercial fleet business that keeps the numbers up and gives them enough to turn a decent profit at the end of the month. But because there are so many games that have been played over the years, and the games still get played with sticker prices and invoice prices and the incentives and loan terms and all the rest, people buying cars don't trust dealers.

Look at Tesla Motors and how their customers love that sales process, with a Tesla the price is the price and there's no pressure at their stores, just help. Of course, this is TrueCar's thing, the idea that their service gets a price that's good for both parties up front so there's no need to worry about hassles, but there's a reason that TrueCar exists and is thriving.

So something for consumers to think about here when you go to buy your next new car, and something for dealers to think about, maybe no-hassle pricing and low-pressure sales really is the way to go to preserve your margins. Thanks for watching.


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  • Report this Comment On June 29, 2014, at 2:23 PM, weaponz wrote:

    20% is actually about right. And let me explain why.

    First of all, the car dealers make about 16% gross profit margins (Net profit is irrelevant, what matters here is gross profit). That profit margins come from somewhere.

    The dealers do not make their money on sales, most of their money is made on parts and services.

    So how does this raise the price of the car? simple. When a manufacturer sets invoice price (The price the dealer gets the car). The manufacturer factors in recalls, warranty work and etc.

    Since the dealership makes ~16% gross profit, that is about how much dealerships raise the price of cars by.

  • Report this Comment On June 29, 2014, at 2:44 PM, weaponz wrote:

    The amount of stores Tesla is allowed to have is irrelevant. Tesla only needs 1 store minimum per state really regardless of how many they plan to sell. The reality here is Tesla does not need the store in itself, but the ability to do the paperwork and financing/leasing assistance for the customer. That is what really matters here.

    Tesla can have 1 store and 100 galleries, the end result would be the same. The only thing they would need with growing sales is service centers. And from my understanding, none of the laws limit the amount of service centers which are separate from the store/gallery.

    So while it might seem like a compromise, in reality this is everything they really want. The compromise is only "symbolic" but has no relevance.

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