Buying or selling a car at a dealership is more convenient than through the private party. The dealership makes it easier to look at multiple vehicles, provides additional assistance with DMV paperwork and financing, and they can take your car on trade-in so you don’t have to sell your car yourself.
This convenience comes at a cost, one pays a premium (aka the retail price) for a car you buy at a dealership, than you would pay in the private party market.
“Money isn’t made on the sale, it’s made on the trade-in.”
- Every dealer of all time
According to NADA, 61% of a dealer's used car inventory comes from trade-in. However, the vast majority of consumer don’t really know how to negotiate on their trade-in offer. Dealership sales managers and appraisers are taught to low ball trade-in offers. Let’s explore the why's.
Trade-in Value: A Dealer's Perspective
The Sell or Don’t Sell Decision
Estimated cost to a trade-in customer: ~$400
Whenever a dealership takes a car on a trade-in, they have to decide if this is a car they’re going to keep and try to sell on their lot, or if its a car they’re going to wholesale/send to auction. This decision is important because the dealer has to decide if the car fits their demographics (e.g. a Ford store probably wouldn’t want to try and sell a Land Rover).
If the dealership decides that the car isn’t suitable for retail, they have to estimate how much would a wholesaler pay or how much would it go for at an auction. In addition, they will add some buffer to make a bit of money.
However if the dealer decides to keep the car to sell, they now have to estimate how much money it’s going to cost them to recondition it. Which brings me to my next point.
Estimated cost to a trade-in customer: ~$1000
Dealers have to recondition the vehicles before they can re-sell. Reconditioning means getting the car to be “front line ready”—in a condition good enough for retail.
When a dealer initially evaluates a car, they don’t necessarily have time to do a full evaluation. An experienced vehicle appraiser evaluates based on visual cues to estimate the condition of the car, and how much it will cost to get the car retail-ready.
However this is difficult even for the most experienced appraisers, and their estimates aren't always accurate. The trick is to always undervalue the car. This way, even if repairs cost more than expected, the dealership can cover the cost because they bought the car for less than it's actual value.
Estimated cost to a trade-in customer: ~$300
When a dealer takes a car in on trade, they assign a true value for that vehicle, which is internally known as ACV - Actual Cash Value. In some cases, the ACV can be different than the trade-in value that they present to a consumer.
As the dealer is taking into a vehicle into their inventory, the ACV is treated as cash being paid out from the dealer, and therefore perceived as the baseline value of what they need to recoup their money on.
To purchase the vehicle, the dealer can either they pay for it out of pocket because they have a positive cash flow and reserves, or they could “floorplan” the vehicle—where the dealer essentially finances the car to keep it on their lot. Either way, it costs them money to keep that car. Floorplanning costs interest, and paying cash costs them on their actual cash reserves.
In order to make their money back and protect their investment, these costs are baked into the trade-ins offers they present to a customer.
Market Factors that Impact Trade-in Value
There are market factors that affect trade-in values that are not within the dealership's control, but must still be accounted for. The two most prevalent market factors are:
Estimated cost to a trade-in customer: ~$400
The value of a car changes over time, usually going down. In most cases, the decrease is predictable and dealers will take it into account. In some cases, the value of a car can change drastically overnight as well. Although this is less common, but when these incidents do take place it can cost a dealership millions of of dollars in lost value. This happened on a large scale in 2015 and 2016, which saw the largest recall ever with the Takata airbag recall, and the Volkswagen Diesel Gate scandal. Affected used cars in dealership inventories each lost thousands of dollars in value, significantly affecting their profitability.
Information availability on new cars adds pressure on used car margins
Estimated cost to a trade-in customer: ~$200
For new cars, it has become easier and easier for consumers to search and find fair pricing through services such as TrueCar.com and others. New cars used to be a large profit center for dealers, but have decreased 50% in the last 20 years.
That means that dealers have to make up the loss of profit on used cars. The best way to make up that profit? Increase the potential margins on each used car sale. Dealers will try to do anything to buy the cars for less, so that the spread between what the dealer bought the car for (the trade-in price) and the retail market value for that used car is as large as possible.
The Human Factor
Estimated cost to a trade-in customer: ~$0-$500
It’s important to remember that dealers play the averages. In most cases, the dealer wants to give themselves as much wiggle room as possible, so they will always go for the maximum sale price when selling a car and the minimum trade-in price when giving you a trade-in offer. It’s the optimum strategy, for them.
Traditional human behavior play a large role into the process. For example, if a dealer knows that they didn’t make a lot of money on a previous deal, because some customers are better prepared and better negotiators than others, they may be trying to “catch-up” on the next deal by providing a lower cash value on a trade-in.
Generally speaking, the smaller the dealer usually has more variability in their trade-in offers. Depending on what type of dealer you're dealing with, the trade-in process can be a very different experience. Places like CarMax have very rigid processes for evaluating a car, versus Joe’s dealer down the street will rely heavily on Joe's experience and how his mouth is going. Keep that in mind as you talk to these dealers and evaluate your options.
The estimates provided in this article are based on experience from my past life—where I worked as a car salesman and managed multiple dealerships. For more tips about used car buying and selling, or if you're interested in my insights on the auto dealership world, check back on the Instamotor blog often and stay up to date.