Thursday, January 5, 2012

Buying a Car (a personal case study)

My wife and I just bought a new car, after a decade of loyal service from our Honda Accord.  Car buying is arguably the classic negotiation, so I'm going to use my own experience as a case study.  This is not meant to illustrate the best way to get the lowest possible price; as we'll see, at one point I deliberately didn't push for the lowest price I might have gotten.  My goal here is to focus on how to approach a negotiation to maximize the chances of coming out with a result you're happy with.

Negotiation is costly

It might seem odd to hear it from me, but negotiation is a costly activity -- in time, in emotional energy and often financially.  One of the first steps, therefore, must be to assess the potential gains from negotiation work and plan your own investment accordingly.

The cars my wife and I were most interested in cost about $30,000.  The difference between what one might pay given absolutely no preparation and the lowest possible price is perhaps $2,000.  Most of that gain will likely come from the first few hours of research, with diminishing returns afterwards.  (For example, it's probably pretty easy to get within $500 of a dealer's normal walkaway price, but if you want to track down the special incentives that may be in play that's going to take more work.)

That forms a base point for thinking about how much time I want to invest in negotiation.  Someone else might well use that same information to make a different choice -- investing less time if they don't enjoy the process and time is scarce or more if they really want to get the best possible price or need to save every dollar possible.

Know thy Enemy

One of the most common mistakes people make in negotiation is failing to look at it from the other side(s).  Putting yourself in your counterpart's shoes is one of the best ways to find value-creation as well as value capture opportunities.  Once you understand their interests, their constraints and where you want to improve your knowledge you're in much better shape.

A car dealership faces some pretty significant challenges.  Their fixed costs aren't small, and they sell a relatively modest number of cars in order to cover them.  Their capital requirements aren't as big as one might think (the cars on their lot are largely financed by the manufacturer), but they still need to make several hundred dollars per car (on average), even allowing for future profits from service & maintenance.

The big problem with charging that kind of margin is that dealers are, essentially, commodity brokers.  The car held at one dealer is identical to the car (of the same model) at another dealership; in fact, dealers typically have swap agreements in place to maximize their effective inventory so if you're talking with multiple dealers about, say, a Subaru Outback 2.5i Limited in deep indigo pearl, they may be negotiating with you on the exact same car that just happens to be sitting in one of their lots.

Let's say you need to average $600 in profit from selling something.  Now imagine that you and two other people have equal right to sell it.  Do you expect to make $600?  Of course not...because if you're offering me a price that earns you $600, one of those other people is going to undercut you.  Then you'll undercut them, and so on until you're barely better than not selling it at all.

This brings us to the approach that websites like recommend.  Get the dealer cost from their website, then invite multiple dealerships in your area to offer you quotes.  Play one against the other until you've gotten the best possible price.

A great chess coach once wrote, "Your opponent also has a right to exist."  Car dealerships aren't just shrugging their shoulders and saying, "Wow, I wish we weren't dependent on making good margins in a commodity business."  What should we expect them to do in response?

First off, they should strive to maintain their biggest advantage -- information.  It's a safe bet that "dealer invoice" isn't going to be nearly as accurate as when sites like first got started.  We have to assume that a host of hidden payments make their true cost less than invoice.  (I was able to confirm this by asking one dealer what he recommended I do for research -- when he said, "The first thing I'd do is check out the websites that have dealer invoice data so you know exactly what my cost is," it was obvious that his cost was usefully less than invoice!)

Next, we should expect them not to cooperate with our efforts to turn the negotiation into an auction.  A hidden price doesn't help them much if they're bidding against each other.  Thus, we should see behavior that balances out their wish to get the sale with a recognition that a full-out auction should be resisted.

Sure enough, my request for bids from the four local Subaru dealers didn't come back with four clean, competitive bids.  One dealer called me and said that one of his Internet specialists would be putting together an offer but what he really wanted to know was whether there was a price I had in mind that would close the deal right there.  Another made an offer that was only a few hundred dollars below MSRP (i.e. way too high) but added that his email constituted a guarantee to match or beat any competitor's offer.  Another came in a bit better (but still too high) with a similar guarantee.

Whether you've anticipated your counterpart's responses or not, it's important not to lose control of the negotiation.  Even if you do have an aspiration price already in hand, don't share it yet!  You can make an outrageous offer if you like, but in my view your best bet is to keep steering the negotiation (or, rather, negotiauction) in the direction that favors you.  In this case you want to make clear that you plan to keep talking with multiple dealers so they know they won't get the sale with anything much higher than their reservation value.

As I was soliciting bids I was also researching other price information.  As I mentioned I didn't have much faith in the dealer invoice number (just under $29K) but Edmunds offers another useful number -- the average price at which this car (including options) has been sold at in your region.  For us, that was $29,775.

Beware of Bias

As I discussed here, one thing I do after every negotiation is a review with a focus on where I went wrong or could have done better.  As we'll soon see, in this case I exhibited two very common "mind bugs": susceptibility to anchoring and small pie bias.

Remember how I knew that the dealer invoice number couldn't be right?  Despite that knowledge, it stuck in my head as a "real" number and subconsciously I considered it the dealer's BATNA.  This combined with small pie bias led me to set a target price of $29,500 for our car when I went in to negotiate with the dealer with whom we'd done our test drive.  At this price I'd be almost $300 better than the average deal.  The dealer's margin would be about $500 (if only the invoice number was really his cost), which was enough to be better than me going somewhere else and high enough that I could close the deal without losing a whole day haggling.  (I love to negotiate but I only love haggling when it's on behalf of someone else; again, know thyself!)

Close the Deal

Negotiating for a car is part theatre.  Prices get written down.  Salespeople go talk to their boss to see whether there's anything they can do with your unreasonable demand.  Ours went about like this:

I started off by explaining that I'd looked up the invoice information and was only willing to pay a small premium to it.  I made it clear that I had solicited bids from other dealers and was still in discussions with them but that my preference was to give him the business since he'd spent real time helping us compare models, test drive, etc.  I was open to closing the deal that day but only if I was happy with the price and otherwise I would have to go back to the other dealers.

He came back with a printout of what he said was the actual invoice for the car we were interested in.  It was pretty low on details but gave the invoice price at $29,700, over $700 higher than what was on Edmunds.  He explained that in order to cover their costs they aimed to make $800 per car, so his offer was $30,500.  At this point I took a different approach than the normal back-and-forth.  I told him that we might have a problem because my walk-away price was lower than his cost.  I was willing to agree today to a price of $29,500 but that anything higher than that would mean that I went back to the other dealers.

He went "behind the curtain" and came back with a price of $29,910.  I reiterated that I had put my cards on the table but was no longer haggling; either he could do $29,500 or not.  He left and returned with $29,596.  When I repeated my position he said, "Come on, it's less than a hundred bucks.  I'm doing all the moving here!"  A few minutes later he did another round trip, muttered, "My boss is not a happy man," and agreed to my price.

Despite his protestations, I suspected I hadn't been ambitious enough.  Three iterations was less than I expected, although I do know that a car dealer hates to see a customer leave to think it over.  Sure enough, that very evening one of the other dealers (the one who had asked me for a price) decided they'd waited long enough for me to go to them and made an offer of $29,000.

Know the Rules

Once you agree on a price, a car dealer typically does everything they can to make that deal feel fixed in stone.  They bring out paperwork, ask for a deposit, etc.  You want to make sure you know what you're actually committed to.  In this case I knew that the paperwork was non-binding and the deposit could only be applied to actual expenses incurred by the dealer if I didn't take the car.  Thus, I had every legal right to take the lower offer (or to try to squeeze it even lower).

Instead, I called the salesperson I'd met with and explained what had happened.  I told him I understood my legal rights but that the sale was still his if he would come down $400.  He conferred with his boss and, as expected, agreed to the lower price.

Why did I leave money on the table?  First, personal preference.  I don't like to waste people's time, and while I don't think test drives and talking with a salesman incur any obligation I also know that I'll feel better (assuming he did a good job) giving him the business.  Second, going with the other dealer would have involved some additional time and potential risk.  I'd already found one "trick" in the offer (on paper it looked like it was even lower, but not all the fees were identical) and there was some cost in time to going to this different dealership and confirming that everything was as it seemed.  With those considerations in mind I preferred to close the deal quickly with a $400 improvement rather than to try for more.

Enjoy the Prize

While I strongly encourage negotiators to review their performance and identify mistakes, don't let that ruin the experience or taint the results.  Trish and I now have a new car that we're very happy with.  I didn't get the lowest possible price but I got one I'm very comfortable with and didn't sink too many hours into either the research or haggling.  Negotiation should be fun and rewarding; if you're not enjoying it, and the outcomes from it, that's your real problem.


  1. Couple things Chad -

    One of the hidden charges any dealer adds is called 'ad pack'. That's the fixed amount each dealer adds to the supposed invoice for advertising costs they supposedly incur. During my years selling Mercedes & Range Rover we had an $800 ad pack on each and every vehicle. So what you see when you see this invoice is often not reflecting that fee. Mostly the ad pack is pure profit above the actual advertising costs. The thing to understand is that the salesperson (if they are on commission) doesn't get a percentage of the ad pack.

    Another thing that the general public doesn't know is what is called 'dealer holdback'. Essentially the manufacturer (who, as you say, often will finance inventory) will hold back a small percentage of the wholesale cost of each vehicle... the true dealer invoice DOES NOT reflect this hold back. Then, usually on a quarterly or semi-annual basis the manufacturer will bonus the hold back to the dealer in increasing increments based on volume.

    Often there are dealer-only incentives for vehicles that aren't selling well. These can be amazingly high. In 1989 (our dealership also sold Volvo) there were some Volvo models with $800 paid directly to the salesman and similar rewards to the dealer... per vehicle sold.

    Dealers also make money on their doc fees... these are also pure profit and vary from zero to $400, depending on the dealership.

    They strike deals with banks and lenders and if the financing goes through a preferred lender the dealer will receive points on the loan. The points vary but typically the better the buyer's credit, the better the return for the dealer.

    I think you nailed one of the critical elements that makes car buying so stressful... people fail to grasp the value of their own time and many start spinning like one foot is nailed to the floor as they ponder, and ponder and ponder... never just pulling the trigger and buying a car they like.

    But the real money for most dealers is used cars. Wow. I have sold $75,000 cars and made maybe $800 commission then turned around and sold the trade and put $2,000 in my pocket, which means the dealer made $8K on the trade and only $3200 on the brand new $75K Mercedes.

  2. Oh.. and the above comments are by me - DW Tripp

    Not sure why this software called me "unknown" because I am registered.

  3. Thanks for the comments! I deliberately left out some details (my blog posts are often too long), lumping hold-backs and ad money in with "other incentives," the key point being that in response to our efforts to turn things into an auction dealers have taken steps to make their true profitability as opaque as possible.

    When I bought my last car I timed it for a change in model and bought the prior-year version when incentives were pretty high. My research suggested that Subaru incentives weren't very high, so I don't think I missed out on too much there...hard to know, though.

    As for why it calls you "unknown"...can any of us truly say we know DWT?

  4. I don't even put much value in Edmunds' averge price: without any significant haggling, I've never gotten a price anywhere near that high: Around here, you can beat that price by just sending an email to a few major dealers.

    Now, what surprises me is how the pricier dealers keep selling new cars: There's this dealer nearby that refuses to sell under invoice, while a nearby competitor, who advertises quite a bit, starts the talks $500 under invoice, on the same car. Only laziness stops people from asking the other guy for a quote. I understand that the money is in the used car lot. But how can someone make sales while being off by over 2k over a major competitor every single time? It's not as if they are in any way a friendlier dealer.

  5. I think you're right that the Edmunds average is clearly higher than you should aim, but I suspect it's accurate. There is a non-trivial number of people who either don't haggle or are very bad at it. They get the first offer, ask for something $500 less, and then meet in the middle. I did just an OK job of haggling and came in about a thousand dollars better than this. It's both aversion to negotiating and small pie bias at work.

  6. I *love* car negotiation stories. I always wished more people would share their car negotiations so that we buyers could learn from each other and have a better chance out there. I definitely re-read your site for inspiration last August when I bought a Kia Sorento (and the BATNA which I had to hide was "our trade-in car would require thousands of dollars in repairs if we want to keep it for another year." Some highlights:

    My edmunds data was off from what the dealer presented as well, for both price and options available. Their initial quotes for the car package I wanted turned out not to exist (3rd row seating used to require convenience package for 2011 models, but didn't for 2012, so quote did NOT include it). On top of that, they went way below the $3500 KBB for my trade-in, offering only $2300. I used all of these "mistakes" as ammunition halfway through the negotiation, with me packing up my stuff, pointing out that their numbers were way above what I had expected, and getting up to leave. That shook out a better deal.

    The sales manager came over and said she was doing the best they could, then contradicted that by offering $3500 for the trade-in if I bought a car with the convenience package. I was able to get her to honor that trade-in offer for a car without the convenience package.

    As they tried to close me, I introduced a new issue to create more negotiating value: my wife really wanted an OEM (not aftermarket) car starter on the car, but I had not mentioned it until now. The finishing move after working through finances was "Add the remote starter, take $50 off it, and we have a deal." He winced, which made me happy: "You always want to see the sales guy wince."

    In the paperwork stage of the negotiation, they were happy to find a Bank of America finance package that was cheaper than the Kia dealers', which I'm sure was better for the dealership and for me. We also got the $2500 extended warranty down to $1500--this was a big deal for us because our only other worry was that we'd heard some questionable things about Kias from mechanic friends: they work great unless they don't, basically, so the warranty was secretly on our shopping list.

    All in all, it was a healthy reminder that car buying requires preparation, a negotiation strategy, and often a lot of work disguising your BATNA and wish list if you're to come out feeling satisfied.

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