Ever Wonder How Car Dealers Make Money?

Read this before heading to a car dealership to buy a new car.

Ross Hamilton, General Manager at Apple Ford and Apple Chevrolet in Marlin, Texas says car dealerships make money in every capacity.

“We sell a product and we mark up the costs,” he begins, adding that cars are generally marked up from three to five percent over the invoice price the dealer paid for the car, which is not the same as the MSRP on the window sticker.

“We make money on everything though, and that includes parts, service and the car sale.” Industry estimates put dealership per-car profits at just over $2,000 per vehicle sold, even though dealers tend to lose about $200 per car over their cost to purchase it. How can that be? Keep reading.

Learn these terms: Dealer Holdback, Dealer Cash and Stair-Step Incentives; These are What’s Driving the Dealer 

Yes, dealers make money on each car they sell. But often, that profit comes from the manufacturer, not the customer.

When a car shopper finds herself in a car dealership she should remember the sticker price on the car is just a starting point and the price she should pay for a new car should negotiate down from there.

That’s because there are incentives at work that the consumer never sees. “Dealer holdback” is money that is given to the dealership by the manufacturer when the car is sold. This is usually no more than three percent, but it puts money in the dealership’s pocket.

Then there’s a thing called “dealer cash” that is used by the manufacturer to give the dealer a reason to make sure that each car rolls off the lot. Dealer cash incentives are often tied to particular models, something you might see when you go to look at one model but hear a lot about another model instead.

And, there’s the practice of “stair-step incentives” in which the manufacturer pays the dealership for the total number of cars sold in a given period and typically this builds throughout the year. So while the dealership may earn a single sum for the number of cars sold in a given month, that sum may jump up for a larger number sold that quarter and an even larger number sold for the year.

Now you can see why end of the month and end of the year deals can be so enticing.

Further Reading: Yes You Can Buy a Car Through Costco and No, You Don’t Have to Haggle

Yes, Dealers Make Money On Financing

“Financing makes the dealership money,” Hamilton explains. “It is here we can increase our revenue through extended service plans and marked-up finance rates,” which is a big area of profit for dealers. Dealerships ‘buy’ financing at one rate and ‘sell’ it to customers at another and keep the difference. This can add up to thousands of dollars over the life of a loan. However, this means that loan rates are a negotiable item for dealerships, too: if they are feeling pressured to hit a sales goal, they may be able to lower a customer’s loan rate to meet or beat that of a bank.

Dealers also can profit from “what is called gap insurance,” Hamilton told us. “If a car gets totaled this insurance will pay off” the the difference between what the insurance company pays for the car and the amount you’ve borrowed to buy the car. Gap insurance is usually only recommended to buyers who make a very small downpayment on a car and finance most of the purchase.

Further Reading: The Best Day to Buy a New Car and Get The Best Deal

Your Trade-In Equals More Money For The Dealer

Of course, most people are aware the car salesperson is working for a commission and that means the salesperson wants to sell you a car for more than you want to pay.

Normally, when a car buyer is in the market for a new car there is also going to be a trade-in to use for negotiating purposes.

This is where car dealerships can make money, too, if the buyer does not know what the trade-in is worth. A tip from www.autocheatsheet.com suggests “You will not make as much money if you trade your vehicle in at a dealership. You should always attempt to sell your vehicle privately or on your own.”

It is also a good idea to remember that when you buy a car you are the buyer and when you trade-in your car you are the seller. Make these two different negotiations and you’ll get a better deal on both counts.

Further Reading: Lexus Doesn’t Want You to Haggle, Either

How Much Money Do Car Dealerships Really Make On Car Sales?

In regard to the sale of the car, the National Automobile Dealers Association points out that only about 30% of a dealership’s revenue comes in through car sales. Hamilton says that over 35% of the dealership’s profit then comes from finance and insurance as well as service contracts.

Then, there’s service, which is a big profit area, too. Customers returning to have their cars serviced or repaired, new tires installed, and recall repairs, which are paid for by the manufacturer, can add a lot to a dealership’s income.

And then, there are other profit centers: Carrying a brand’s signage and decor can yield payments from the manufacturer, selling used cars bought at auction and selling merchandise and accessories all add to the bottom line.

Be Smart in the New Car Purchase Game

So, while we all have to make a living, just remember: dealerships selling new and used cars have a set way of earning their paycheck. By doing your due diligence and knowing how they profit before you buy a new car, you’ll come away knowing that both you and the dealership got a fair deal.