Inventory How-To: One Solution to Aged Used Car Inventory

I’m going to take a few moments now and just talk about aged inventory in your used car department, and one potential solution about how you might be able to fix it. 

If you’ve been in the car business for a while, and you’re a decision maker or a manager in the car business, then you have to battle aged inventory every single day, particularly in your used car department. It is the absolute bane of every dealership’s existence, and probably aged inventory would be the number one reason why so many new car dealers kind of, either, shy away from it completely, or keep a small presence in the used car market, maybe even just sticking to their own brand, a few nice trades, that’s it. But ultimately, if you’re running a used car business inside your new car business, or as a standalone, you need to manage your aged inventory or you’re not going to be in business very long, that’s for sure. 

You need to manage your aged inventory or you won’t be in business very long.

Here’s the thing, every used car operation battles aged inventory. Used cars depreciate, on average, 2% per month. It’s not like a new car. If you have a new car dealership, and you have new car inventory, then if you buy a new car or get it from the manufacturer, say September 1st this year, then in August of next year, that car hasn’t really depreciated. It’s still worth the same amount of money because probably the manufacturer is incentivizing it a little more, making it a little easier to sell. It’s not like used cars, used cars depreciate somewhere, you know the old saying is 30% a year, but it’s certainly somewhere between two and two and a half percent a month. For this exercise, we’ll just use 2% a month. That’s the reality; the moment you buy a used car, it starts to depreciate, and it depreciates at a rate of 2% a month, and that’s if you buy the car at the perfect price. 

Here’s the other issue, being competitive requires fresh inventory. The drive in the marketplace now is on to online marketing. It’s all about driving to the lowest price. All those online advertising spaces, AutoTrader and the like, they’re all about price competitive advertising. Having inventory that’s competitively priced is a big part of your ability to compete in the marketplace, and a big part of your success. On the one hand you need to have competitive inventory and good prices, but on the other hand, you have vehicles that are depreciating at 2% per month, which means the longer a vehicle sits, the less competitively priced it is, and the less money you’re going to make on it. 

The other issue with aged inventory is that the more you have of it, the longer you have it, the less sellable it becomes, partly because it’s depreciated so much that it’s no longer competitively priced. Or even if you’ve lowered the price, it’s still a car that the staff are starting to walk around, maybe they don’t like the car, maybe there’s not enough profit in the vehicle for them to incentivize them to sell it, perhaps the car’s sitting so it doesn’t start, other mechanical issues start to happen. Suffice to say that as inventory ages it starts to become less and less sellable. Here’s the other problem: as your aged inventory grows and grows-it’s insidious because you don’t really see it unless you’re paying really close attention-more and more of your inventory becomes less sellable and less competitive. All of a sudden, sales decrease, gross decreases and the risk of future losses, large future losses, grows. 

As inventory ages it starts to become less and less sellable.

Let’s just kind of run through one example: one vehicle purchased at the correct value, say $20,000, a value that the unit could be sold at the auction for. You get that unit-either you’re taking it in on trade or you’ve bought it at the auction-but at that moment in time when you first acquire it, that vehicle is worth exactly the actual cash value, what you could dispose of it for. But now you have to recondition the unit, and if you’re a typical new car store that does things properly, and your mechanics make a fortune, then it would not be unusual for you to be averaging $2,000 a unit reconditioning, maybe even more. For this exercise, let’s just say you spent $2,000 reconditioning that $20,000 unit. 

There you have it. On day one, assuming you safety the car on the day it lands, you are already $2,000 underwater in the unit. For those of you that may not know, water is the amount of money invested that is not recoverable should you have to dispose of the asset. Even though you’ve spent money reconditioning the unit, it’s not like you can go to the auction and say, “Hey, listen, I just spent 2 grand in my shop, can I get that extra?” No, it doesn’t work that way, they don’t care. They’re just paying market value, they’re not going to believe a word you say so it doesn’t really matter. All that money you spend reconditioning is for the purpose of retailing the unit, it’s for the customer, it doesn’t help you with the actual value of the car. 

Let’s take that unit that you’ve just bought for $20,000 and spent $2,000 reconditioning. Used vehicles depreciate on average 2% a month, so if that unit sits in stock for 90 days, that $20,000 vehicle has depreciated approximately $1,200. You were already $2,000 underwater, so on day 90, you are now $3,200 underwater. If it happens to still be sitting there in 180 days, which we all know is very possible, we all have aged inventory, then it’s a $2,400 pill at 2% added to the $2,000 of reconditioning and never mind the money that you might have spent starting it when it won’t start, or other things that might happen on the lot. On day 180, you are now $4,400 underwater, 22% of the value by the way, on that $20,000 unit.

Let’s face it, we don’t always pay the perfect amount for cars.

If you actually had to dump that car in 180 days at the auction, you would lose $4,400 plus whatever you spent carrying it, and that’s if you paid the perfect amount in the first place. Let’s face it, we don’t always pay the perfect amount for cars. What if you paid too much at the auction or in the trade for it, how much of a loss is it now? 

Here’s the reality: as inventory ages, the less sellable it is because it’s just not competitively priced or valued. There’s probably something wrong with it, or you could have too many cars, that’s also possible, but staff begin to walk around it, just because they look at it all the time. If a car sits, let’s face it, there’s usually a reason it’s sitting. The more aged inventory you have, the more unsellable inventory you have, and the less competitive you are. Being competitive is a key element of your success in the used car business. If you are not competitive, you’re just not in business. 

Without constant analysis of your inventory-the constant micromanagement of making sure that cars aren’t getting aged, and you’re focusing on this unit, and focusing on that unit, advertising, dropping prices-you would not necessarily be aware of how much of a problem you have until it’s out of control, like a wildfire. One day 10% of your inventory is aged, a week later or a month later, 20%, 30%, 40%, 50%— the problem is, that it just keeps growing and growing, and it may grow without actually being noticed, particularly if you have a manager and staff that are compensated on gross. They’re not going to want to sell that car and lose money, they’re going to want to sell cars that they can make money on because it affects their pocketbook. Problem units will definitely continue to grow on the lot and those problems are difficult to identify unless you’re really micromanaging the issue.

Cars are going to depreciate—you’ve just got to stay ahead of it.

Here’s some of the problems created by aged inventory. First of all, water is just a fact of life in the used car business, it doesn't matter what you do, you don’t sell every car the first day you get it. Cars are going to depreciate, a certain amount of your inventory is going to be water and that’s just the reality of it, you’ve just got to stay ahead of it. Having a disproportionate amount of water in your aged inventory is the real issue. If you have all your water in cars that are unsellable, it drives up your risk long term and it drives down competitiveness. Again, to repeat, aged inventory often just goes unnoticed or ignored, and if unchecked it gradually increases overtime. 

The worst part is, it actually has a tipping point where the amount of unsellable inventory creates such a drag on the business that becomes unsustainable, and the only way out of it is just to take a massive pill. One of the main reasons that people don’t get into the used car business is because of that risk, the risk of a huge loss at some point in the business. The other thing is that you’ve paid commission and bonuses on the gross profit but typically cannot recover any of those expenses on the losses. 

You have all these cars and staff pick the ones that they can sell and make money on, which of course is understandable— that’s what I would do, that’s what anybody would do, and they’re getting paid commissions on those profits. But when it’s time to take a pill-imagine you take in a trade and you pay too much for a trade and then you pay everybody on that profit, and then six months later, you have to take a $3,000 pill or $5,000 pill to dump that trade- you’re not recovering any of those commission expenses. That’s the other issue with aged inventory is that if you have to dump it, you’re not recovering-or even write it down-you’re just not recovering those expenses out of the commissions on the losses. 

Understandably, staff sell the cars they can make money on.

Here’s the bottom line. The bottom line is that with aged inventory, there becomes this disproportionate amount of water in the oldest unsellable inventory which only increases as time goes on. And you continue to pay commissions on the gross on the fresh inventory while future losses keep mounting on the lot. 

Here’s one solution for you, this is one mechanism that you can create that automates the process and really mitigates and prevents the possibility of giant future losses. You would create a mechanism that would transfer the water from the oldest inventory to the newest inventory, balancing out the water in your inventory, factoring aged inventory expense, which is basically potential future losses or write-downs into the commission structure by making it a cost to the vehicle, thus reducing the risk of excessive water in aged inventory. 

Create a mechanism that transfers the water from the oldest inventory to the newest inventory.

How to do it? Decide based on your inventory size, and sales volume, how much of your inventory is a problem on average. What would you say is aged inventory? A typical number for me might be anything over 90 days. Decide on a value that you will add to each vehicle you acquire, and then subtract from an aged unit on a turn by turn basis. A good number is between one and two percent of your average inventory value. 

Here’s one example: let’s say you carry 200 units in stock, and a quarter of them are over 90 days, that wouldn't be unusual at all. That’s 50 units, you have 5 million dollars in those 200 units so your average inventory value is $25,000. You want to aggressively deal with the problem, so you decide that 2%, or $500, is the right amount to use as a write-up and write-down on inventory as you acquire it. As you add each new unit, it gets increased by $500, and the next unit on that list of 50 aged units is decreased by $500. One by one by one, you work through that list of 50 aged units, as you acquire inventory until you reach the end. Then you make a new list and the process begins again.

You want to aggressively deal with your aged used car inventory problem.

Let’s go back to that $20,000 car, and just take a look at it using our write-up write-down scenario. You have an inventory of 200 units, you sell 100 units a month and buy 100 units a month. You use a list of the 50 oldest units to rotate through. I’m giving you a perfectly run used car department, more or less in a perfect scenario. Each aged unit will get hit twice per month.
You’ve got 50 cars on the list, you sell 100 cars per month, which means you’re acquiring 100 cars, so that means you’re going to rotate through a list of 50 units twice a month. Each unit will get hit twice per month. If you use $500, that’s $1,000 a month per unit on every vehicle that’s over 90 days on your 50 used car list. If we look at that example that we had in the beginning that we paid $20,000 for, and we reconditioned it for $2,000, and it was in stock for 180 days and at that point it was $4,400 underwater, and was also continuing to depreciate, and not only that, it’s just becoming a bigger and bigger problem. The only solution to that problem is going to be, at some point, to dump it and lose money. There is no other solution.

If you utilize the write-up write-down system of $500 per unit that began roughly at 90 days when the unit made it onto the 50 oldest list, that unit would have been hit twice a month for three months, 90 days. That’s $3,000, meaning the unit is no longer underwater $4,400, it’s underwater only $1,400. A better position actually than when you first bought it—and decreasing twice per month until it sells. In fact, the unit will be written down at a more rapid rate than that of depreciation, guaranteeing its eventual sale. What you’ve done there, is you’ve now taken that unit that’s just going to be a problem unit and sit forever, and that unit now becomes more sellable, more competitively priced and more attractive to the staff. 

With the write-up write-down system you can take problem units and make them more sellable.

The key benefits of write-up write-down. Your oldest inventory value automatically decreases making it more competitive, more attractive to staff to sell it and make a commission on it, reducing the risk of an ever increasing problem, making aged inventory a factor of commission expense because you’ve now added it to the cost of the vehicle, preventing a potentially catastrophic event or large future loss, and it automates the process, which saves on micromanagement and stress, I can tell you.

Here’s the bottom line, the $500 added to that new inventory you purchased, or took in on trade, will not likely make a big difference in your ability to sell it, and is much preferred to dropping hundreds of thousands of dollars at the auction, right down to the end of the year, or even worse, when you or someone else decides to shut it down. 

Aged inventory is a massive problem and let’s face it, you have to make sure that you take care of it. If you’re thinking about it, do yourself a favor, take the time to do the math, figure out how much of an aged inventory problem you have, how much your average inventory value is, and what the right amount is you should be adding to units as you buy them and subtracting from your oldest units. At that point what will happen is you have this great automated process which suddenly ensures inventory is just dropping off. Aged inventory will stay until it becomes the natural value of your ability to sell it and then it goes automatically. No more write-downs, no more dumping crap at auction, just a smooth operation—that’s assuming you keep your inventory size the right level, and that will be the subject of another How-To. 

Good luck and good selling.