We went out yesterday to buy Shelley a new car and it got me thinking about the car buying process. The process wasn't that painful to me since I am in sales myself, which makes the cheesy sales tactics a little more tolerable if perhaps more embarrassing, and since a close friend of mine was a car dealer for years and gave me a lesson in car buying that I found very valuable. I thought I would share that lesson with y'all in case any of you find yourselves having to buy a car in the near future.One of the most important things to understand when buying a car is how the salesman, the sales manager, and the dealership owner make money. It explains a lot of their behavior.First and foremost, you need to understand the real cost the dealer pays for the car. We've all seen Manufacturers Suggested Retail Price (MSRP). The MSRP is essentially the list price. Nobody should ever pay anything close to MSRP.If you look on the web for a specific make and model, you can usually find the dealer invoice price. Now, that is a good place to start the negotiation with the dealer, but it is important to remember that even the invoice price is not what the dealership really paid.The dealers true cost is the invoice price minus holdbacks. Holdbacks are the way that auto manufacturers ensure the dealerships stay solvent. Since there is intense pricing pressure on dealers and since the invoice price is public knowledge, manufacturers hold some money back on each car until the end of the month. The total holdback is usually around 6% of the MSRP of the vehicle. That is a lot of money when you think about it.So what do you need to know?I. HOW PEOPLE GET PAID AT DEALERSHIPS Car SalesmenCar salesmen get paid in two ways. First, they get paid a percentage (around 50% usually) of every dollar they get over invoice for a given car. So, if they sell you a car for $500 over invoice, they pocket $250. Their incentive is to get as much money for the car as possible to maximize their pay.Second, and more important, they also get direct commissions from the manufacturer based on their sales volume. If they sell over a certain number of cars in a given month, the manufacturer kicks them back a pretty good commission. My friend told me that when he used to sell cars, once he hit 16 cars in a given month, he got a check for $8000 from the manufacturer and that bonus only increased as he sold more cars.Basically, the salesmen use the commission they get from selling over invoice to live on week to week (especially in slow months) while waiting for the bigger money to come through from the manufacturer.The lesson here is that when the salesguy says "I can't go any lower, we'll lose money" he's full of it. The dealership could sell the car at the invoice price and still make 6% profit.Sales ManagerThe sales manager makes his money on volume. Sure, he gets a bonus for overall the profitability of his deals and if he can sell a car above invoice, he will be happy to do it. However, more important to him is moving a lot of cars. He gets paid for volume.Dealership OwnerThe dealership owner makes almost all his money from the sale of a new vehicle on the holdbacks. In reality, the owner makes the lions share of his total profit from the service department, but when it comes to the sale of a new car, the holdback is the key.They are very touchy about playing with holdback money since it is critical to their overall profit model for new car sales. They usually won't dip into holdback money except to eliminate inventory of last year's model at the beginning of a new model year, or if they are really struggling to sell cars.II. READING AN INVOICE It is always important to ask for the actual dealer invoice when you are purchasing a new car. If they won't give it to you for the car you want, get up and leave, or ask to see the sales manager. Typically, they know that once you leave, you're gone forever, so they will give you what you want to make you stay. There are several important numbers at the bottom of the invoice:Invoice price: The actual cash the dealer laid out up front for the vehicle - usually a place to begin negotiating.Actual Cost (A.K.A. "Invoice minus holdbacks"): This represents the dealership's true cost for the vehicle after all is said and done.A & D Plan Price: This is the price you could buy the car for if you worked for the manufacturer or a dealership.X Plan Price: This is the price you could get if your company had an agreement with the manufacturer.The one you should focus on the the invoice price, but also the Actual Cost. The Invoice Price will give you the real starting point for your negotiation. The Actual Cost you should hold in your pocket to throw in the salesman's face if he cries poor during negotiation.III. NEGOTIATING The fact that different levels of people get paid differently at the car dealerships gives you leverage when negotiating. A deal that the sales guy feels is unattractive may very well be attractive to the sales manager. You can use this to your advantage.First and foremost, never listen to "I'll discount is x dollars off of MSRP". MSRP, like all list prices, is a fiction. You should go into negotiations starting with the invoice price and adding just a bit for the salesmans effort. Typical expectations for a final selling price should be:Standard sedan type car: Invoice + $150 to $300Popular car (SUV, sporty car in demand): Invoice + $300 to $500Luxury car: Invoice + $1000-$1500You pay more for the luxury cars since they have lower turnover and dealerships dedicated to selling, say BMWs, still have the same lighting, heating, administrative, and property costs as other dealerships, but they have to spread them over a smaller number of cars.In many cases, with standard sedan type cars, you can walk out paying just dealer invoice.In any event, there are a couple key points to starting negotiations:1) Remember, there are hundreds of car dealerships. Don't fall in love with a given car on a specific lot. You can find exactly the same car down the road someplace else.2) Do your homework - know the invoice price going in, but still request to see the dealer copy of the specific invoice for the car you want.3) Know the price you want to pay (invoice + whatever)4) Have financing arranged before you go in - nothing talks as loud as cash. 5) Be willing to walk out at any time if you don't like what you hear or the salesperson is not giving you what you want. If you think he isn't doing what you want him to, or if he pulls the "let me run this deal by my manager" routine, ask to see the manager directly. Negotiating with middle men is a waste of time. Besides, the manager is going to consider the potential profit from the holdbacks when he decides if a deal is good to make, so he is likely to be more flexible than the salesman. If you let him know that if he meets your price, you'll buy the car that day, he will generally give you what you want or at least be a lot more receptive.6) Be non-specific on your trade in. Tell them you are probably going to sell it yourself. You need to get a price on the new car before you discuss the trade in or they WILL play games with the numbers.7) Don't fall into the trap of liking the salesperson. I get along great with the guy who I bought my car from, but when it came down to dollars and cents, I concluded that every dollar he was asking for was one less I could spend on my family, and that toughened up my negotiating stance.8) Get a quote from at least 2 dealers. How dealers purchase options from the manufacturer on a given car can make a huge difference in their actual invoice. The last car I bought, I checked out the same car at 2 different dealerships. The bottom line invoice for the exact same car was $2000 more at one place than the other because the first place ordered the car incorrectly. Since the actual dealer invoice was higher, it wasn't a case of the salesguy being intransigent. He truly couldn't go any lower because of the cost structure built into the vehicle. That was $2000 I kept in my pocket just by checking another dealership. Besides, competitive pressure is the best way to get a good deal. Don't forget, the sales manager isn't going to let you walk away and lose the holdback money because his salesguy is bickering over a few hundred dollars.9. Check the maintenance history of the model you want online before you buy. The dealership will try to sell you an extended warranty. These are usually a bad deal. You need to decide whether the cost of the warranty is worth offsetting the potential risk of paying for repairs. The thing to remember is that manufacturers price the warranty to cover the cost of the average repairs to the vehicle type over the coverage period plus a healthy profit. If you "self insure" in this case, you may be able to reduce your overall cost of ownership for the vehicle. IV. SALES TACTICS AND RESPONSES1) Crying poor (e.g. "We can't sell it to you at that price and still stay in business")This is generally BS. Remember, the dealer makes money off of holdbacks and volume. Mention the holdbacks to the salesguy if he says this and if he pretends not to understand what you're talking about, he's being dishonest. Tell him so and ask for another salesperson or for the manager.2) Selling to the spouseSalespeople will generally try to get the husband or wife to emotionally commit to a given car. They will focus on the color, amenities, and so forth, the idea being that the family will not be able to negotiate a hard deal if one or the other wants a specific car. This is pretty backwards thinking on their part, but it still happens. Don't forget, there are 10 dealerships just down the road that probably have exactly the same car on the lot.3) Creating scarcity (e.g. "Another couple was looking at this car earlier today...)This is an attempt to pressure you into committing without shopping around. Don't forget that other dealerships either have cars just like the one you want, or can order them for you pretty quickly. If a salesguy tries that, say "Well, we're going to shop around a bit. If the car we want is gone when we get back, we'll just go somewhere else" That will make him very uncomfortable.4) Trading "Book to Book"This is a tactic whereby the salesperson offers to sell you the new car at book value in exchange for buying your trade at book value. This is a bad deal on both ends for you. Your best bet is to tell him to shove his books. You'll pay invoice for your car and get Galvins for your trade.5) UpsellingThe salesguy will show you a car in the color you want and with the options you want, but the car will be loaded down with other options that increase the cost of the car and offer you nothing you wanted.Insist on getting only the options you want, if need be by ordering the car from the manufacturer. You can also tell the saleperson that you don't want option A and option B and he should strip them out of the car, or at least the price. My father used to drive guys nuts when he would buy a car: "Radio? I don't need a radio, strip it out. Air conditioning? That's why you have windows, strip it out." Clearly the dealership would never strip it out, but sometimes it would make them consider a lower price since they had my father on the lot and didn't want him shopping another dealership to find exactly what he wanted. Even if it didn't work, it definitely made the salespeople think my dad was a nutcase, and that can work to your advantage in a negotiation.V TRADE INS Trade ins seriously complicate the process of buying a new car. If you have the option, it is almost always better to sell the car yourself in the paper than it is to trade it in. The difference can be as much as 25% more money in your pocket if you sell it yourself.However, sometimes selling a car yourself is more of a pain than it is worth. In that case, here are a couple of things to remember:1) The Kelley books are consumer trash for trade ins. If your dealer pulls out a small yellow book (Wholesale value) and touts that as gospel, tell him to stick it. The real value of your trade in is the wholesale auction value. Kelley is too generic, doesn't account for regional trends, and isn't current enough to account for current economic conditions. To compensate, they offer lowball values for trade ins.2) The wholesale auction value is available on a regional basis from a service called "Galvins". Most auto dealerships use the Galvins price to determine what they can get from your trade in. Then they offer you Kelley value and pocket the difference. Ask to see the Galvins price for your trade. If nothing else, it will make your salesman uncomfortable.3) Do NOT bundle the trade in negotiation with the car negotiation. Settle on a price for the new car and then discuss the trade. They will not lose money on the trade in since they don't generally keep the car on the lot. They immediately turn it around and sell it at the auction. Don't let them tell you that they will lose money. Look at the Galvins price. Now, in fairness, the dealership needs to make a little money for taking the time to auction the car and for assuming the risk that the prices will drop before he gets your trade in to auction, so you shouldn't expect full Galvins price. However, a couple hundred bucks is more than enough to compensate them for their trouble.VI. Financing It is probably best to get your own financing from your bank before you go to the dealership. The dealership makes money from selling you financing, and you don't always end up with the best deal. There are a few things to look out for:1) Only get simple interest loans. Often, dealerships offer "rule of 78" loans. Simple interest loans are what people normally think of when they think of borrowing money. If you owe $10,000 at 7%, then the first year's interest if $700 and anything you pay above $700 goes to the principle. "Rule of 78" loans work differently. Basically, most of the early payments go to prepaying interest on the loan, and don't significantly reduce the principle. If you refinance, pay off, or trade in a car with a "rule of 78" loan, you will be disappointed to find that you still owe almost all of what you borrowed. They get the name "rule of 78" because the sum of the numbers 1-12 is 78. In the first month of a 12 months "rule of 78" loan, you pay 1/78th of the principle, and the rest of the payment goes to interest. That continues until in the 12th month you pay off the remaining 12/78ths of the principle. The interest goes in the reverse order with the first month requiring 12/78s of the interest and the lst month paying 1/78th of the total interest. Now, if you decided after 4 months to pay off the loan, you would have paid 10/78ths of the principle for the loan and 42/78ths of the interest. In effect, it wouldn't make sense to pay off the loan since the remaining 8 months are at a much lower effective interest rate. This issue gets magnified if you are talking about a 4 or 5 year loan. The numbers can get really ugly.2) Leasing can sometimes make sense and it certainly lets you drive a more expensive car than you might be able to afford through a purchase. However, it is also confusing enough to offer a huge potential for dealer fraud. Be very careful with leasing. The best bet is to download a program like Lease Wizard ($14) or some variation thereof that has vehicle residual values and manufacturer lease rates built in. All you need to do is type in the sales price and your down payment and you can get an honest answer for what your lease payment and terms will be. 20/20 and Dateline each did a piece on auto leasing a few years back and in almost every case, they found some evidence of dealer fraud, either changing sales price numbers, adding fees, or increasing the lease factor. If you are leasing, NEVER tell the salesman what your target payment is. Insist that he give you a lease figure first. Otherwise, I can guarantee you will get a lease payment that is just close enough to your target to make you feel like you got a good deal, but in reality, you will have gotten screwed.VII. SUMMARY So the main lessons are:1) Dealerships make money even selling cars at the invoice price. They won't make an unprofitable deal, so don't worry about gouging them. When you get to a price that they reject and then don't chase you on your way out the door, you'll know you hit their bottom line price.2) Only negotiate with decision makers. If your salesguy claims he can't authorize a deal, tell him to hit the bricks and deal directly with the manager. If the manager gives you a hards time about that, leave.3) Remember that your trade in is your property. Get as much as you can for it and don't get snowed by the Kelley Yellow Book.4) Be careful about what financing you accept and be very careful about leasing.Hope this helps save y'all some money some day...Steve
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