Car Dealer Profitability Eroding

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While rising interest rates impact various industries, certain components may not be immediately apparent. Today, we will examine auto floorplan financing and its effects on car pricing and dealer margins.

Auto floorplan financing is a form of short-term lending that enables car dealerships to stock their inventories by essentially borrowing funds to purchase vehicles from manufacturers. This financing covers the cost of the vehicles until they are sold to customers. As interest rates increase, the cost of floorplan financing rises proportionately.

The automotive industry is currently grappling with the lingering repercussions of negative equity stemming from the COVID-19 era, when supply chain disruptions led to vehicle shortages and inflated prices. This negative equity, coupled with higher interest rates, has meant that new car buyers are unable to trade in their existing vehicles, contributing to a buildup of new inventory levels that are now at three-year highs.

Traditionally, manufacturers offer floorplan credits to dealerships as an incentive for rapidly selling vehicles. However, with rising inventory levels, these credits are transforming into expenses for dealerships, eroding their profitability.

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Exacerbating the situation, some dealerships are paying upwards of 14% interest on their floorplan financing, significantly compressing their profit margins and eroding their pricing power. This loss of pricing power is a significant factor behind Tesla's recent decision to discount its vehicles, which has contributed to the company's declining share price.

The prospect of higher interest rates persisting for an extended period implies that dealers will face higher costs and the need for more substantial incentives for a prolonged duration.

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