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How Do Car Dealerships Make Money?

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Are you wondering how car dealers make money? In this article, we’ll take a closer look at the different ways car dealerships make money and how they keep their doors open.

Smart car buyer does their homework before they step foot on a car lot. This includes knowing how much the car they want costs, what features and options are available, and most importantly – how dealerships make money. Similarly, knowing this will prevent you from getting tricked by shady car dealers.

With that being said, we’ll dive into the car dealer business model and show you how they make money off of each car sale.

Car dealerships are businesses, and like any business, they need to make money to stay afloat. Car dealerships make money through a variety of methods, including selling cars, financing cars, and servicing cars.

Most car dealers make money from selling new and used cars. When a car buyer makes a purchase, the car dealer makes a new car sale. On the other hand, the dealer’s gross profits can be about 10% on used cars.

However, for a new car, most dealers could gain a dealership’s gross profits of only 3% to 5%. So, they count on selling extended car warranty, paint and fabric protection, and other services and products to increase their profits.

So, are you ready for a smart car buying experience? Let’s dive in!

Selling Cars

The most obvious way car dealers make money is through car sales. Dealerships typically buy cars from manufacturers at a wholesale price and then sell them to customers at the manufacturer’s suggested retail price. The new car sales are the difference between the wholesale price and the retail price is the dealer’s profit.

Let’s say a car dealership buys a car from a manufacturer with an invoice price of $20,000. The dealership then sells the car to a customer for $30,000. In this case, the dealer has made a $10,000 profit on the sale of the car.

Of course, not every vehicle that a car dealership sells is going to result in such a high-profit margin. Many dealerships only make a few thousand dollars on the sale of a car. According to the National Automobile Dealers Association, the average profit margin for a new car is about 3%.

However, car dealerships typically sell a large number of new cars each year. So, even though the profit margin on each sale may be small, the total profits can add up to a significant amount.

Car Financing

Are you looking for the best car loans available? In the car business, many car buyers finance their vehicles through the dealership. And, while this may be convenient, this is one of the ways dealerships make money.

When a customer finances a car through the dealership, the dealership typically arranges to finance with a lending institution. The dealership then marks up the interest rate on the loan and charges

Let’s say you’re financing a $20,000 car at an interest rate of 5%. If the dealership arranges financing through a bank at 3%, the dealership is making 2% on the new vehicle loan. On a $20,000 loan, that’s an extra $400 in profit for the dealership.

Of course, not all car buyers finance their new vehicle through the dealership. Many car buyers get pre-approved for auto loans through their bank or credit union before they ever step foot in a dealership. And, if you do your homework and compare interest rates, you can often get better car deals on financing than what the dealership offers.

Servicing Cars

Car dealers make money through service sales. Most dealerships have their service department where you can take your car for maintenance and repairs. The service department typically charges more for its services than independent shops do.

For example, an oil change at a dealership service department may cost $80 while the same oil change at an independent shop may only cost $40. That’s an extra $40 in profit for the dealership.

And, of course, the more expensive the repair, the more money the dealership makes. So, if you need major repairs on your car, the dealership is likely to make a hefty profit.

On the other hand, the dealership’s service department is one of the most convenient places to take your car for repairs. The dealership’s mechanics are typically well-trained and experienced. And, if you have a warranty on your car, the repairs may be covered.

Service and parts department

The car dealership’s parts and service department is another major profit center. Dealerships make money by selling service contracts, charging for routine maintenance, and selling parts and accessories.

Service contracts are one of the most profitable things a dealership can sell. A service contract is an extended warranty that covers repairs after the manufacturer’s warranty expires. Service contracts can be very lucrative for dealerships because they often have high markups and low claims rates.

For example, the dealership’s service contract that costs the dealership $1,000 to buy may be sold to the customer for $2,500. And, of course, the customer is likely to never use the service contract because most repairs are covered by the warranty provider. So, the dealership keeps the entire $2,500.

Charging for routine maintenance is another way dealerships make money. Many dealerships include free oil changes and other routine maintenance for the first year or two of ownership. But after that, they start charging for these services. And, of course, they charge more than independent shops do.

On the other hand, the parts department is typically a losing proposition for dealerships. The markup on parts is usually low, and the competition from online retailers is fierce. So, most dealerships only make a small profit (if any) on the sale of parts, especially with the new vehicle.

Commissions

Car dealers make money through commissions on the sale of new and used cars. In most cases, the car salesperson who sold you the car will receive a commission of around 3% to 5% of the sale price.

For example, if you buy a $20,000 car, the car salespeople will make a commission that is likely to be between $600 and $1,000. And, if you buy a $40,000 car, the commission is likely to be between $1,200 and $2,000.

As you can see, the commissions on car sales can add up to a lot of money for the dealership. With that said, the more cars sold, the more money the dealership makes. So, it’s in the dealership’s best interest to have a high volume of sales.

According to the car sales account, the average dealership makes about 60% of its profits from new car sales and 40% from used car sales.

Promotions and Incentives

Car dealerships often offer promotions and incentives to customers to increase their new car sales. For example, a dealership may offer a cash rebate, low-interest financing, or a free extended warranty when you buy a car.

Similarly, this could be done to increase used car sales. For example, a dealership may offer a free oil change or tire rotation when you buy a used car.

These promotions and incentives can be very effective in increasing used car sales. But they also have an important effect on the dealership’s bottom line.

That’s because these promotions and incentives must be paid for somehow. And, in most cases, the dealership will raise the price of the car to make up for the cost of the promotion or incentive.

So, while promotions and incentives may help you get a better deal on a car, they also increase the dealership’s profits for all cars sold.

Trade-In for used cars

Car dealers make money when they buy used cars from other customers who are selling their cars outright or from trade-ins. In most cases, the dealership will offer you less than what your car is worth. That way, the dealership can turn around and sell the car for a profit while the customer is losing money.

For example, you have an old car that you want to sell. You take it to a dealership and the dealership offers you $5,000 for the car. The dealership then turns around and sells the car for $7,500. In this case, the dealership has made a $2,500 profit from the car purchase.

Of course, not all car deals are profitable for the dealership. In some cases, the dealership may lose money on the car deal. But, over time, most dealerships make a profit on the majority of the cars they buy and sell.

Insurance

The insurance department at a car dealership is another profit center. In most cases, the insurance department will try to sell you an overpriced and unnecessary insurance policy.

For example, you’re buying a new car and the salesperson asks if you want to purchase an extended warranty or gap insurance. The salesperson may tell you that the extended warranty will cover repairs for five years or 100,000 miles.

What the salesperson doesn’t tell you is that the extended warranty will cost you $1,500. And, in most cases, the extended warranty is a waste of money because the car is likely to be covered by the manufacturer’s warranty for at least three years or 36,000 miles.

Most dealers offer unnecessary add-ons like gap insurance, tire and wheel protection, paint and fabric protection, extended warranties, and a variety of other insurance products. In most cases, these insurance products are overpriced and not worth the money. It’s only the dealer’s cash cow that benefits from these insurance products.

In perspective, car salespeople typically make between $50,000 and $100,000 per year. And a large portion of that income comes from the sale of overpriced insurance products. On the other hand, the new car department at a dealership typically only makes about 2% profit on the sale of a new car.

Dealer holdback on new cars

Dealer holdbacks are a hidden profit center for car dealerships. A dealer holdback is a percentage of the MSRP that the manufacturer gives back to the dealership after the sale of a new car.

Here’s an example. You buy a new car for $20,000. The MSRP of the car is $22,000. In this case, the manufacturer is giving the dealership a 2% holdback on the sale of the car. With that said, the dealership’s profit on the sale of the car is 4% ($800), not 2% ($400).

The holdback allows dealerships to make a profit on the sale of new cars without raising the car prices. And, in most cases, customers are unaware of dealer holdbacks.

In Conclusion

Car dealerships are businesses and, like any business, their main concern is to make money. There are a variety of ways that car dealers make money including selling cars, financing cars, and servicing cars.

While you may be able to get a better deal on your car purchase or financing by shopping around, the dealership is likely to make money on the sale one way or another.

And, if you take your car to the dealership for service, you can expect to pay more than you would at an independent shop. Just remember that, when it comes to the car buying process, the dealer is not your friend – they’re in it to make money.

The dealership’s gross profits could reach as much as 50% on new cars and 30% on used cars according to the National Automobile Dealers Association. The average net profit after all expenses is around 5% on new cars and 3% on used cars.

Thank you for reading! We hope this article was helpful. Please feel free to share it with your friends or family who may be in the market for a new car.
Are you ready to drive your dream car home? Give us a call today and let us help you get started on the process! We can’t wait to serve you.

About Me

I've been in car sales and finance for over 20 years, working at the highest volume dealerships in the nation including Fletcher Jones, DCH and more. Want to pick my brain on finding cars, negotiating cars, and structuring car deals?

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