The eye-opening truth about dealer invoice prices

Editor’s note: This is Part 1 of a five-part investigative series.

Most new-car shoppers turn to those big new-car pricing websites for the information and advice they need. But those so-called “experts” aren’t telling you what you really need to know: The truth about the sea change in the automaker-dealer financial relationship that began in 1995 and has continued ever since.

Since they won't, or can't, I will. Uncovering and telling car-shopping consumers the truth is what I do. As you might guess, that doesn't please all of the players all of the time. So in return, I ask that you promise to visit me when I enter the witness protection program!

Here’s why the dealer invoice price is not a real number anymore

For decades, the conventional wisdom has been that “the dealer invoice price minus holdback” is a good estimate of a dealer’s true vehicle cost. I’ve doubted that wisdom for years, for these reasons:

1. Auto dealers aren’t stupid. But new-car shoppers are gullible, and on this subject, they’ve sent their common sense on a multi-year vacation to Dumbsville.

You and I buy hundreds of products and services every year, and no one can tell us what the seller paid for any of them. Yet we’re willing to believe that people with a $10 million net worth, half or more of which is sunk into their new-car dealership, are going to let you and me know what they pay for those cars. Isn’t that naiveté on stilts? Does stupidity get anyone to $10 million?

2. Anyone with the savvy to run a profitable lemonade stand should be able to look at the difference between the invoice and retail (sticker) prices on any new car and conclude that no business could survive if those invoice numbers were the real deal.

Today there isn't a single new vehicle with more than a 10% difference between the invoice and retail prices. The average is a paltry 6% to 8%. (It's 7% on every Mercedes.) And that's at the sticker price! Who pays that? (Only the guy who thinks Taco Bell is a Mexican phone company.)

Over and above the vehicle’s cost, every dealership has at least a 10% overhead expense. In addition, it needs to make a profit to provide a decent return on investment. So how can ‘the dealer invoice price,’ which those ‘trusted’ Internet sources use as the foundation for their ‘target price’ advice, be a bona fide dealer cost number?

3. Talking to tens of thousands of new-car buyers for over 20 years, I frequently hear transaction prices that are light years below any “invoice price minus holdback” number.

Regularly $500 to $1,500 below and sometimes $2,000 or more below, excluding the impact of any cash incentives. Were the dealers really losing that much money on those deals? If so, why? And if they weren’t, what was the source of all those extra dollars?

4. I was convinced that the 1995 arrival of the Internet had compelled the auto industry to take action to offset the negative impact of the sudden easy access to invoice prices.

The invoice price probably was a decent vehicle-cost estimate before the Internet's arrival. Consumers could buy invoice prices then from Consumer Reports and publications like ConsumerGuide's New Car Price Guides, but most folks didn't.

In a 1985 luncheon meeting where the industry’s most influential market researcher was the featured speaker, I asked him, “What percentage of car buyers walks into dealerships with invoice prices?” His answer was, “Not more than ten or fifteen percent.” Then 1995 happened, and any doofus with five thumbs and a keyboard could get invoice prices for free all over the Internet.

You and I aren’t stupid. If we owned a retail business selling expensive merchandise, and suddenly our real product costs went viral on the ‘net, surely we’d have called our suppliers and said, “We’re getting killed here! If you don’t find a way to compensate us that consumers can’t discover, you won’t have stores to sell your stuff.”

Like I said, car dealers aren't stupid either. I was convinced they'd seen this storm coming and built a shelter to weather it. My long search for and discovery of that shelter — part "cold case" analysis and part archeological dig — are covered in detail in my book, Letting the Cat out of the Bag: How the Auto Industry 'Redesigned' the Dealer Invoice Price When the Internet Arrived .

Here’s a synopsis:

'In response to this threat, the auto industry launched a secret program to transfer beaucoup bucks from the sticker price to the invoice price, a process that has continued for almost two decades. They've done this by steadily raising the invoice price by more than they raised the MSRP, thereby disguising a big cache of available dealer-incentive dollars as dealer-cost dollars. They chose this approach because car shoppers have been conditioned for decades to believe the invoice price is a real cost number. And they did it slowly and deliberately, year after year, so that we wouldn't notice a sudden substantial change.'

For living proof of what I'm saying, click here to see an exhibit that illustrates for 47 popular models of 23 different brands how the visible gross profit has been cut systematically, step by step, since 1995.

As a result, the invoice price has become a bloated imposter, a big chunk of which is allocated to secret “below-the-line” incentive programs in which multi-month sales objectives are set dealer-by-dealer and typically based on total sales, not sales of individual models. And the visible gross profit at the sticker price has been cut to the point that no dealership could keep its doors open if the invoice price were a real cost number.

I'll tell you a little secret. Auto dealers love having those invoice numbers all over the Internet. Because, on this subject, they know we're willing to believe anything we're told.

The bottom line

Today “the dealer invoice price minus holdback” is only a distant third cousin of the true cost of any new car. And, like the hundreds of other things you buy every year, no one, on or off the Internet, can tell you the seller’s true cost.

In my view, there’s nothing deceptive or deceitful about this. If it angers you, take a long look in the mirror at the simpleton who deep-sixed his common sense and bought into a fantasy — hook, line and sinker.

Q. Do the trusted “experts” at those big new-car pricing websites know the truth?

A: Stay tuned. They go under the microscope next in the second installment of my five-part series.

Read the rest of this five-part series

Part 2: Whose side are the new-car pricing sites really on?

Part 3: Debunking the myth around dealer cash incentives

Part 4: How to beat the pricing from online car-buying sites

Part 5: It's time to jettison the conventional wisdom about how to buy a new car