in Capitalism

The Best Way to Buy a New Car

I recently bought a new car.

It was my first car purchase in 8 years, and being the obsessive geek that I am, I researched every last detail of the optimal process for buying a new car. By optimal I basically mean “get exactly the car you want for the lowest possible price.”

Since I put in all the time to do the research, I figured I’d share everything I learned in the hopes that it helps someone out if they’re ready to buy a new car. That, and my Dad asked me for details, too.

Just to cut right to the chase, I wound up saving over $3,500 from the original price I was quoted (which included a trade-in of a 2008 BMW 328i Coupe). I won’t bother mentioning the specific car I bought because it’s not relevant to this post, but its MSRP was around $30,000.

Being a conscious capitalist, I believe empowering buyers with this method is good for dealers, too. A car salesman has to spend a lot of time dancing around the idea that you might buy a car, but all that effort may yield nothing for them. This method will put all relevant information on the table and enable decisions for all parties to be made fast.

It’s also worth mentioning that, as you’ll see, the whole setup of the car buying process creates a somewhat adversarial relationship between the buyer and the seller. I think the method I describe here gets away from that, which I consider a good thing.

Alright, here we go.

How It Works in a Nutshell

  1. Decide on the exact car and options/upgrades that you want.
  2. Get basic pricing info, including MSRP and invoice pricing.
  3. Figure out the condition of your trade-in, if any, and estimate its value.
  4. Email every dealer in town and ask for a bid.
  5. Compare the bids, offer competing dealers to match, and choose your favorite dealer.
  6. Buy the car.

Background Knowledge

Before I get into the specifics of each of those steps, it’s important to be aware of some key concepts about buying a new car.

The dealer knows way more than you do.

First and foremost, the dealer sells many cars to many people, whereas you buy a car maybe once every few years. Naturally, the dealer has a huge information advantage on you. We’ll cover specifics later, but suffice it to say that the only mechanism that reveals the true profit margin of the dealer is the auction process itself.

My advice is to make some effort to know the real numbers (MSRP, whatever you can find on invoice price), but also accept that it’s very difficult for you to close the full information gap.

I believe this dynamic creates the classic “sleazy car salesman” stereotype. In the stereotype, the salesman knows way more than you do and exploits your ignorance to charge you as much as possible. This isn’t conscious capitalism because it’s just exploiting information inefficiencies.

Philosophically, I believe the dealer needs to make a profit on each sale to cover the cost of their salesmen, their building, the opportunity to give me a test drive, etc., but I’d rather negotiate on what that profit is rather than play the sucker.

The true profit margin on a car comes from many places.

The naive take on a dealer’s profit margin is that the dealer buys the car from the car manufacturer at what’s called the “invoice price”, sells the car to you at a higher amount than that, and his profit is the difference.

In fact, a dealer will often show you his invoice price and say “Look, I’m charging you what I paid for the car. I’m not making any money on this deal!”

Hmmm, this nice building I’m in is paid for with multiple zero-profit transactions? I don’t think so.

The reality is that the margin on the invoice price is usually not that great. Maybe $1,000 – $3,000 before anyone’s negotiated anything. The cheaper the car the smaller it is, too. So the dealer has to make up the margin somewhere.

Or, rather, at least seven somewhere’s.

First, the dealer “pre-installs” a bunch of options you didn’t think you needed. This includes paint protection, seat protection, a GPS tracker in case your car gets stolen, etc. There is a huge amount of mark-up in these. Some of them are legitimately valuable (ahem, window tinting in Phoenix, AZ where I live), but compared to what you’d pay aftermarket, it gets a little crazy.

Second, there’s a concept called “dealer holdback” that never gets included in the invoice price. This is money the manufacturer pays the dealer directly after making a sale of a car. It’s pretty hard to know what this is because it’s obviously not public knowledge, but it’s part of what allows a dealer to sell you a car at “invoice price.”

It’s important to note that not every car has dealer holdback, but this is a tool a manufacturer can use to incentivize certain cars to sell high. Maybe the manufacturer wants to clear out last year’s model, maybe they want to report high sales. Maybe they know they’re sitting on a hot car and don’t need to do anything.

Third, dealers earn end-of-month, end-of-quarter, and end-of-year bonuses for hitting certain sales targets. For this reason, a dealer is usually more motivated to sell at the end of a month/quarter/year. Optimizing for end-of-month is probably good enough.

Fourth, dealers sometimes earn a kickback for arranging financing for you. Nothing prevents you from going to the bank directly and financing things yourself. But for whatever reason, this will usually result in a higher interest rate than if you finance through the dealer. Since the dealer originates a loan for the bank, the bank sometimes gives them a kickback, but apparently this isn’t always the case.

Fifth, the dealer makes a profit on your trade-in. You could get an amazing deal on your new car but a lousy trade-in value and you’ve effectively negotiated no discount. I directly experienced this when I got a lowball offer for my trade-in from a dealer.

Sixth, the “documentation fee” is pure profit. By law, a dealer can’t charge a different doc fee to different buyers, but that makes no difference because the dealer can charge a different price on the car itself. The doc fee can be as low as $150 or as high as $499.

Seventh, after you agree on a final car price and go to the “finance guy” you’re offered yet more things to buy like an extended warranty, tire protection plan, etc. These also have significant markup in them. When I bought my car, I asked for 25% off one of the quoted prices and got it. It made me think I should have asked for more.

So, as you can see, the invoice price is a pretty lousy way to compute how much profit the dealer’s making.

The dynamic with the salesperson can sometimes be frustrating either way.

As I’ve reflected on all the car buying experiences I’ve ever had — witnessing my parents buying a car, buying my wife’s car, buying my car, this latest new car — there are four different social dynamics I experienced with sales people, three of them equally frustrating, and one of them satisfying.

By the way, the frustrating dynamics are not a knock on the individuals who work hard selling cars. I respect their effort to get out there and work to make a living. The frustrating dynamics are more a criticism of the system in which they work, and the resultant vibe that comes out of it.

First, I’ve encountered the salesperson that seemed friendly and easygoing, but was in fact manipulative. I hate to use a word like manipulative, but the basic pattern is that you feel an emotional connection with the salesperson but they then exploit that to make you think you’re getting a better deal than you are by hiding material information or making untrue statements.

Second, I’ve encountered the salesperson that was not at all pushy (a positive) but primarily because they lacked the sales skills to effectively get you to a purchase. This is frustrating! When I was ready to buy a car, I *wanted* to be sold. Quote me a reasonable price, and get me to yes so I can get on with my life. Sadly, not all the car sales people are able to do that.

Third, I’ve encountered the salesperson that is stereotypically pushy and untrustworthy. Assertions are made that don’t feel true. You don’t get the warm & fuzzies and don’t feel you can trust what the sales person says. Again, I don’t judge the sales person because he is working hard to earn a living, but the sales method used — overpromising — benefits the sales person at my expense, which isn’t going to work.

Fourth, I’ve encountered the talented salesperson who can honor my needs and honor his to close the deal when it makes sense. When we bought my wife’s Honda Civic, our salesperson pushed us along the process, but always respected our needs and our questions. When we bought the car, we felt great! We were happy to have arrived at a decision.

This salesperson has the technical knowledge to educate you about the car, the sales skills to guide you through the buying process, and the moral compass not to cross the line. He’s still selling, but he’s allowing you to buy.

Nothing will push your out-the-door price down like competition.

The final insight is that negotiating in person is the sucker’s game compared to the competitive power of an auction. With all the information advantages a dealer has, the most likely outcome with 1-on-1 negotiating is you’ll get a significantly worse deal than you could have if you knew what the dealer knows.

With the auction process, I found that (a) almost every dealer that had the car I wanted in stock or available to them was willing to participate, and (b) the prices started to naturally converge on a number.

To be continued…

Wow, this turned out to be a lot longer than I anticipated. If you found this useful and want me to write more, please leave a comment below. If I get some interest, I’ll try to make the time. Thanks for reading!