While gross profits get a lot of attention in the business world, the profit margin is a more accurate indicator of a company’s performance. The profit margin refers to the amount of revenue a company keeps after accounting for its costs and is often expressed as a percentage¹. This formula seems simple enough, but the reality is that the numbers are vulnerable to outside influences. Margin compression occurs when the cost of producing or delivering a product or service rises more rapidly than the revenue it generates, leading to a decrease in profit margins. No one can control economic externalities, but dealerships can take steps to protect their bottom line.

The Impact of Margin Compression in the Automotive Industry

In the auto industry, margin compression can affect a company in many ways. Understanding the risks can help you protect against them². These are the areas most likely to be affected by margin compression: 

• Cash flow: Margin compression challenges your ability to manage operating costs, potentially leading to reduced workforce and hindered expansion.
• Purchasing power: When facing margin compression, reinvestment in key areas like inventory becomes challenging. This is compounded by inflation which can diminish cash reserves.
• Growth: Margin compression restricts financial resources, limiting the ability to pursue advancements in technology, sustainability, and other key growth areas.
• Borrowing opportunities: Decreased profit margins can lead to stricter lending and investment conditions due to perceived higher risks.
• Supply chain relationships: When dealing with margin compression, extending supplier payment terms can create cash flow issues downstream, thus weakening overall supply chain stability.

How to Combat Margin Compression

Maximize F&I Sales

Focus on increasing your finance and insurance sales, leveraging these as revenue sources to enhance your profit margins. Not only does an active F&I department provide a growth opportunity by offering customers more services in one place, but it also helps build a relationship for as long as a customer has their car³, whether they’re a buyer looking for insurance and maintenance plans or a lessee with an eye on their next vehicle.

Focus on Fixed Operations Marketing

Employ more strategic marketing for fixed operations, such as service and parts departments, to boost profitability in these often-overlooked areas. Rather than focusing on single big-ticket purchases, consider the value that comes from multiple purchases over the lifespan of a car.

Invest in Employee Training

Invest in training your employees to improve efficiency and customer service, thereby increasing sales and customer loyalty. Ongoing education can occur in all areas of the dealership, whether it’s sales training that helps customers understand today’s more advanced electric vehicles and provide better service in a tech-heavy environment or ensuring your sales team has the skills they need to work on EVs and advance within your company. Not only will these training investments benefit your customer base, but they can also improve employee retention.   

Adopt New Technologies

Integrate cutting-edge technologies to streamline your operations, reduce costs, and enhance the overall customer experience. AI is quickly becoming part of the entire vehicle life cycle, from manufacturing to ownership, so it’s worth understanding how your dealership can use it for business operations and the customer experience.

Utilize Equity Mining Strategies

Use equity mining techniques to identify customers in a positive equity position or those with minimal lease payments remaining. This approach helps in targeting potential sales opportunities within your existing customer base. Much like your fixed operations marketing, equity mining helps you identify opportunities for recurring transactions, not just large-dollar sales.

At some point, margin compression will show up on your balance sheets. But it doesn’t have to derail your business goals and development plans. With the right knowledge, you can reduce the risk of compression and improve margins across the board.

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Sources:

1. Segal, T. (16 May 2023). Profit Margin: Definition, Type, Uses in Business and Investing. Investopedia. Retrieved on December 1, 2023, from https://www.investopedia.com/terms/p/profitmargin.asp
2. What Is Margin Compression? How to Improve Margins When Inflation Rises. C2FO. Retrieved on December 1, 2023, from https://c2fo.com/resources/treasury-management/what-is-margin-compression-how-to-improve-margins-when-inflation-rises/
3. Daniel, R. (24 March 2023). What is F&I? Finance Manager Training. Retrieved on December 1, 2023, from https://financemanagertraining.com/what-is-fi/