You are a prospering super-car dealer, specializing in million dollar exotic, limited production run cars. There are currently two supercar dealers in town, but the other one has run into financial difficulty. This is your chance to undercut the competition and become the dominant high end car dealer in town!
Scenario 1 – Purchasing Stock
To make money, you need to have a flashy set of supercars in your store to show off to rich customers. Problem is, you’ll need to borrow money to purchase the cars, and then hopefully sell some to recoup the money from your customers.
Let’s say you can purchase 10 cars, at five hundred thousand dollars a car. The loan you can get is a 5% interest one, compounding daily.
If you don’t make any repayments in the first year of the loan, how much extra debt in interest will you have accrued?
And how many cars, if you mark them up by 20%, will you need to sell in that first year to “service” (pay off) that interest?
We can use the compound interest formula:
A = P (1 + r/n)^(nt)
A is the amount of the loan at the end of the loan period, P is the initial loan amount or “principal”, r is the interest rate, n is the number of times that interest is compounded per year, and t is the number of years of the loan period
Using the numbers for our loan situation:
A = 10 * 500000 (1 + 0.05/365)^(365 * 1)
A = $5256337
Subtracting the initial principal leaves the interest owed:
Interest owed after one year = $5256337 – $5000000
Interest owed after one year = $256337
The profit per car can also be calculated to find out how many you’ll need to sell to service the interest:
#cars to be sold = interest amount / profit per car
#cars to be sold = 256337 / (0.2 * 500000)
#cars to be sold = 2.56
So you’ll need to sell 3 cars to cover the interest debt at the end of the first year.
Scenario 2 – Moving into Antique Cars
You spy an opportunity to also corner the antique car market in the city. But antique cars require restoration, which costs money.
Let’s say you can buy the average run down antique car for $100,000. Restoration will cost an average of $200,000.
To be worthwhile doing, the antique car will need to earn you more money than the supercars, which you buy for $500,000 and mark up 20%.
What markup would the antiques need (on the original purchase price) to be equally as profitable per car?
Super car profit = 0.2 * $500,000
Super car profit = $100,000
Required antique car sale price = antique car purchase price + restoration cost + current super car profit
Required antique car sale price = 100000 + 200000 + 100000
Required antique car sale price = $400000
Scenario 3 – VIP Customer Program
You remember from visiting the supercar dealership in Europe on your most recent holiday that they have a VIP program that treats potential customers like superstars in order to try and encourage them to be long term, loyal customers.
You can purchase a local VIP service for a cost of $2000 per customer. You also have sales data that suggests that a loyal customer will buy a new supercar (which you purchased for $500000 and then markup by 20%) once every 3 years.
You calculate you can afford for up to 25% of the car profits to go towards the VIP service.
What conversion rate does the VIP service have to produce (converting potential customers into loyal long term customers) for it to be worthwhile?
First we can work out the average profit per year from a loyal customer:
Annual profit per loyal customer = purchase frequency * profit per purchase
Annual profit per loyal customer = 1/3 * 0.2 * 500000
Annual profit per loyal customer = $33333.33
You can only afford for 25% of these profits to go towards the $2000 / year VIP program cost:
Conversion rate required = VIP annual program cost / (annual profit per loyal customer * allowable fraction for VIP program)
Conversion rate required = 2000 / (33333.3 * 0.25)
Conversion rate required = 0.24
Conversion rate required = 1 in 4.17 customers
So the VIP program would need to convert just under 1 in every 4 potential customers to long term, loyal customers for it to be worthwhile.
Real-Life Example – Normal Car Dealerships
There are thousands of car dealers in operation around the world. For the cheaper new cars, the markup is typically fairly small – perhaps 5 or 10 percent. This markup represents the difference between what the dealer pays the manufacturer to purchase the car, and what the dealer sells the car to you for.
So for a new car with a $29995 ticketed price, the dealer would make the following raw profit (forgetting about the dealer’s own costs for the moment);
Raw profit at 5% markup = 0.05 * 29995
Raw profit at 5% markup = $1499.75
And at 10%:
Raw profit at 10% markup = 0.1 * 29995
Raw profit at 10% markup = $2999.50
As with all retail operations, when markups are relatively small, the dealer makes money by “moving” a large volume of product – selling a large number of cars every month. Let’s compare how many cars the low cost dealer might have to sell at 5% profit margin to make the same raw profit as someone who sells one high end million dollar car per month with a 20% profit margin.
High end car raw profit = #cars sold / month * car ticket price * profit margin
High end car raw profit = 1 * $1000000 * 0.2
High end car raw profit = $200000
Now the low cost car dealer makes a raw profit of $1499.75 per car sold. That means:
Number of cheap cars to be sold = high end profit / profit per cheap car sold
Number of cheap cars to be sold = 200000 / 1499.75
Number of cheap cars to be sold = 133.4 cars