Car dealerships are a cornerstone of the automotive industry, but how they generate revenue might be more complex than you think. Many car buyers focus on the sticker price and try to negotiate down, often believing that the dealer’s profit comes solely from the difference between the invoice price and the selling price of a new car. However, this is a misconception. To truly understand dealership profitability and answer the question of whether dealers make more money from selling cars or auto repair, we need to explore the various profit centers within a dealership.
New Car Sales: Beyond the Sticker Price
While selling new cars is a primary function of dealerships, the profit margins on new vehicles are often slimmer than many consumers imagine. Several financial mechanisms are at play that influence how dealerships make money from new car sales:
Dealer Holdback: A Hidden Margin
Manufacturers often implement a system called “dealer holdback.” This is essentially a percentage of either the invoice price or the Manufacturer Suggested Retail Price (MSRP) that the manufacturer pays back to the dealer after the car is sold. Typically ranging from 1% to 3% (and in some cases higher for luxury brands), this holdback acts as a cushion, allowing dealers to potentially sell a car at, or even slightly below, invoice price while still maintaining a profit. For example, on a $30,000 vehicle with a 2% holdback, the dealer would receive $600 back from the manufacturer after the sale. This money helps cover operational costs such as advertising, sales staff commissions, and facility maintenance. While holdback is a factor in dealer profitability, it’s generally not negotiable for car buyers.
Dealer Cash Incentives: Moving Inventory
Automakers also use “dealer cash” as a tool to incentivize dealerships to sell specific vehicles, particularly when they need to reduce inventory. Dealer cash is a direct bonus offered to the dealership, not the consumer, to push certain models or clear out older inventory to make room for new models. This incentive is often unadvertised and can fluctuate based on manufacturer needs and market conditions. Dealer cash provides an additional profit opportunity for dealerships and can sometimes lead to more aggressive pricing on targeted vehicles as dealers have more room to maneuver.
Sales Commissions: Incentivizing Volume
Salespeople at dealerships typically work on a commission basis, often receiving a percentage of the “front-end gross profit”—the difference between the dealer invoice and the selling price. Traditionally, this commission percentage might be around 20%. However, compensation structures are evolving. Many dealerships are shifting towards models that reward sales volume, even if per-car profit is reduced. The emphasis is on moving cars quickly. Sales staff are also heavily incentivized through bonuses tied to sales targets and customer satisfaction scores. These bonuses can significantly impact a salesperson’s earnings and dealership profitability overall.
Used Car Sales: Higher Profit Potential
Used cars represent a significant profit center for dealerships, often boasting higher profit margins compared to new cars. The acquisition of used cars, frequently through trade-ins, is crucial to this revenue stream.
Trade-ins: A Source of Inventory and Profit
Trade-ins are a vital source of used car inventory for dealerships and can be highly profitable. Dealers aim to acquire trade-in vehicles at a price below their market value, allowing them to recondition and resell these vehicles at a substantial markup. The difference between the trade-in value offered and the eventual selling price of the used car contributes significantly to dealership profits. Furthermore, the reconditioning process itself often bolsters the dealership’s parts and service departments.
Used Car Market Dynamics: Opportunities for Margin
The used car market is dynamic and influenced by local factors, demand, and vehicle condition. Dealers with expertise in appraising and pricing used vehicles can capitalize on market fluctuations and secure favorable profit margins. Unlike the more transparent pricing of new cars, used car pricing allows for more flexibility and potential for higher returns.
Finance and Insurance (F&I): A Major Profit Hub
The Finance and Insurance (F&I) department is a critical profit center within dealerships, often contributing significantly to overall revenue.
Financing: Interest and Lender Relationships
Dealerships facilitate vehicle financing for customers, and while sometimes they offer competitive interest rates, this service is also a source of income. Dealerships work with a network of lenders and may receive a commission or a percentage of the interest rate markup for arranging financing through these partners. While customers benefit from the convenience of on-site financing, it’s essential to compare rates with external lenders to ensure the best deal.
Aftermarket Products: Warranties and Protection
F&I managers also offer a range of aftermarket products, such as extended warranties, paint protection, fabric protection, and theft protection packages. These products often carry high profit margins. While some products can offer genuine value, it’s crucial for buyers to carefully evaluate the terms, coverage, and cost-effectiveness of these add-ons before making a purchase. The sale of these products represents a substantial revenue stream for dealerships.
Auto Repair and Service Department: Consistent Revenue and Customer Retention
The service department is arguably the most consistent and reliable profit center for many dealerships, often outperforming new car sales in terms of pure profit margin.
Service and Maintenance: Recurring Revenue Stream
Dealership service departments provide routine maintenance, diagnostics, and repair services. This generates a recurring revenue stream, as vehicle owners require regular maintenance and occasional repairs throughout the lifespan of their vehicles. Dealerships benefit from customer loyalty and the convenience factor for owners who prefer to service their vehicles where they purchased them.
Parts Sales: Integral to Service Profitability
The service department’s profitability is closely linked to parts sales. Dealerships sell parts required for repairs and maintenance, often at a markup. The parts department supports the service operation and contributes directly to the dealership’s bottom line.
Higher Margins in Service: The Profit Differentiator
Service and repair work generally carry higher profit margins than new car sales. While new car sales are volume-driven and competitive, service departments can command higher prices for labor and parts, resulting in a more lucrative revenue stream per transaction. In economic downturns, the service department often acts as a financial stabilizer for dealerships.
So, Do Dealers Make More from Sales or Service?
While new and used car sales are essential for attracting customers and initiating the dealership relationship, the auto repair and service department often generates a more consistent and, in many cases, higher overall profit margin for dealerships.
Here’s a simplified comparison:
- Car Sales (New & Used): Higher revenue volume, lower profit margin per unit, influenced by market fluctuations, incentives, and negotiation.
- Auto Repair & Service: Lower revenue volume (compared to sales), higher profit margin per unit, consistent demand, less price sensitivity from consumers in urgent repair situations.
- F&I: High profit margins on products, significant contributor to overall profitability, but dependent on sales volume.
Conclusion:
Dealerships operate multifaceted businesses with diverse revenue streams. While the allure of selling a car is the visible face of the business, the service and parts departments are the unsung heroes of dealership profitability. The F&I department further amplifies revenue. For consumers, understanding these profit centers provides valuable insight into dealership operations and can inform their approach to car buying and vehicle ownership. Recognizing that dealerships rely on service revenue can also explain why building a long-term relationship with a reputable service department can be beneficial for car owners. Visiting Edmunds dealer ratings and reviews can help in finding dealerships with strong reputations in both sales and service.
