Prices are sky high - is it a seller's market for used cars?

It is a commonly held adage that what goes up, most come down. But the UK’s used car prices show no signs of falling. The price of a second-hand car in the UK has soared unabated for 21 consecutive months. In December 2019 the average price for a used car was £13,590. If you went into a car showroom last December to buy this same ‘average’ car you would have had to fork out an additional £4,374, a painful increase of 31%.

What has been driving this phenomenal price increase? Well, it is partly a problem of supply; the semi-conductor chip crisis, factory shutdowns, and both COVID and non-COVID related logistical hurdles (I’m looking at you, freak boat blockage of March 2021) have caused global new car shortages. A shortage of new cars has a run-on effect in the used market. When neither fleet companies nor private owners can replace their cars with shiny new ones, they hang onto them, reducing the stock released into the second-hand market.

Our current conditions of dwindling used car supply are combined with very strong used car demand. All those people ‘Escaping to the Country’, have realized the tube network does not extend to the quaint market town in Suffolk where Rightmove found them their ‘forever home’.

Such market forces provoke interesting results: the increase in used vehicle prices has meant that some used cars are selling at more than the original sticker price. Previously, a buyer faced their vehicle depreciating by as much as 60% within the first 3 years life. Now, they may be able to shift that old Dacia for a profit.

A hot market with high growth in pricing and customer demand typically attracts private equity and venture capital interest. The UK used car industry has seen a spate of new entrants: primarily online players, often with financial backers. These dealerships have access to the type of funding that can fuel large marketing campaigns (think plastering one’s name on the sides of taxis, buses, and cricket arenas). They can invest in nation-wide infrastructure to fulfil online orders and expand their customer reach beyond the 1-1.5hr drive-time of a traditional dealership. They are also competing for stock…

Used car dealers in the UK usually procure stock through auctions, leasing companies and company fleets. These traditional channels are being bled dry. With stock scarce, we have heard instances of dealers buying cars from other dealers, selling the cars on at higher prices only days later. Fierce competition over stock drives up wholesale prices. The car dealer will try to pass the wholesale price onto the consumer and add some profit. However, car dealerships struggle to make a margin on the chassis they are selling under normal circumstances. Chassis profit - profit from the resale of only the vehicle - is often below 5%. Sell-on products: finance, warranty, smart repair is where dealers make their money.

Analysis of a sample of the UK’s top car dealers shows gross margin for 2020 between 8-15%. In 2021 there were small increases in gross margin of the largest players. However, smaller competitors suffered margin declines. Dealerships may be facing margin pressure for the following reasons:

• The stock shortage is increasing dealerships’ cost of acquisition. Not only are vehicles more expensive, but they are harder to find and must be sourced from further away.
• Dealers are forced to look beyond the grades of vehicles they would normally buy (grades 1 and 2). Desperate to replenish their forecourts, dealers are taking on vehicles classed as grades 3 and 4. These cars need extensive reconditioning and cosmetic repairs; repairs which are time consuming, labour intensive, and involve specialist skills that are currently in short supply (hello Brexit).
• Increased volumes of poor-quality stock may push the limits of dealers’ reconditioning capacity. Shifts in repair volumes within a functional area can cause logjams and disrupt the overall flow of work. For example, high numbers of cosmetic repairs can overload Body- and Paint-shop capacity, reduce overall efficiency and further increase cost.

Today’s used car dealers may be worried about heightened competition for customers and stock, growing costs of acquisition, the threat of new business models and an increasingly strained reconditioning capacity. Under these circumstances how can dealerships respond?

• Push value-added products. Dealership can use these to supplement margin and make a profit on cars even with a negligible chassis margin.
• Investigate alternative business models for sourcing vehicles - with models emerging around sourcing vehicles directly up the supply chain (e.g. at a fixed volume contract from lessors) dealerships can reduce the level of competition for stock at auction and de-risk their sources of supply.
• Consider the potential trigger point to shift online and compete with new online players such as Cazoo and Cinch. This would require car dealers to review their current branch networks and establish sales sites which could provide infrastructure to deliver online capability to the wider UK.
• Refit or redraw the reconditioning plant process. Invest in technology and automation to improve the reconditioning efficiency and train apprentices in the skills which are in short supply.

Besides making themselves fit for purpose operationally, car dealerships should also pay attention to commercial and strategic changes.  Looking to the future, as customers increasingly put themselves at the center of the purchase experience - a phenomenon coined by my colleague Joel Bines as the “me-centric consumer”, used car dealers would be advised to stop and think. How can we satisfy our customers in a digital age? How do we meet the demands for more of the pre-buying process to move online? What sort of delivery capability do we need to build? Does our CRM system integrate seamlessly across off-line and online channels? And how will we fund the investment required to build these capabilities? These and many more questions may keep our traditional auto dealer awake at night.