Why Carvana Will Fail (and How They Might Succeed)

 

(This is an updated and edited version of my two-part series originally posted on the 3 Birds Marketing blog.)

Before we dive into why Carvana will fail (and how it might succeed), I want to make sure we’re all up to speed on the used car market, in general. Unless you just don’t pay attention to such things, you likely already know about February’s $150 million flameout formerly known as Beepi. 

Beepi, for the uninitiated, was an ambitious (aren’t they all) startup that was going to revolutionize the used car market for the benefit of consumers. As Beepi saw it (and apparently the press, as this TechCrunch article inferred), they would be “bypassing the costly overhead and commission structure of car dealerships” on their way to liberating the poor consumer from the clutches of dastardly retail automobile dealers.

Beepi, when it was founded a few years ago, described its benevolent mission thusly: “Beepi is a … company offering an online peer-to-peer marketplace for buying and selling used cars … The Internet has changed everything. Well, not quite. Buying and selling used cars, unfortunately, hasn’t changed for decades. Now that painful world is waking up…”

The painful world woke up all right. The painful world of overvalued startups trying to solve a problem that simply does not exist woke up and spanked Beepi and its investors to the tune of one-hundred fifty million dollars. Apparently, they were all unaware of this little website called eBay that had already been relatively successful at providing “an online peer-to-peer marketplace for buying and selling used cars” for well over a decade. Though certainly not for everyone, millions of vehicles had been sold through eBay Motors before Beepi ever raised its first dollar.

So, there was already a Beepi (of sorts); though more than that – and this is the biggest reason Carvana will also fail – the used car market in America is already highly efficient. This means there isn’t a profit windfall waiting for those who can do little more than tweak the mousetrap. (And, as we know from a recent Fortune article issued after this post was originally published with 3 Birds, Carvana isn’t likely to turn a profit in this efficient market any time soon.)

How efficient is the used car market in America?

For starters, about 9 million used units are sold at dealer auctions each year (a little Economics 101 for the geniuses in Silicon Valley: there is no more efficient market than an auction where there are ample buyers and sellers). Add that to the more than 30 million total used units that are sold by franchised and independent dealers to consumers every year and you’ve got a heck of a lot of transactions… and a heck of a lot of data.

Data (more precisely, the availability of data from millions of transactions) and pricing transparency (brought on by the internet) has ensured that dealers make no more than a fair profit on their used units. (According to NADA data, the “fair” profit, aka the retail net profit per used vehicle sold at franchised dealers in 2015 was a whopping $132 per unit. Some sellers might argue that’s far from fair.)

Just how much more than $132 per unit did Beepi expect to make after they stripped out “the costly overhead and commission structure” of traditional dealers? (Oh, and added in their own costly overheard, bloated Silicon Valley salaries and ridiculous executive perks?) I doubt the Beepi founders were touting just $132 per unit profit to their potential investors. It seems unlikely one could enjoy multi-billion dollar valuations at that level.

To every potential startup who wants to “revolutionize” used car sales, it’s important to understand that there is no more efficient resale market in America than automobiles. There are too many transactions, too many units for sale, too many sellers and too many B2B, B2C and C2C online and offline marketplaces for the average dealer (or startup) to consistently sell for more than the market will bear.

But what if we cut out the Middleman?

Ah… yes, the dreaded Middleman; that mythical beast that makes all the money and provides none of the value. Yes, by all means, let’s cut out the Middleman.

Oh, wait, not dealing with Middlemen has always been an option. Today it’s called Craigslist; and before that it was called the newspaper classifieds; and before that it was called the town square. For any human wishing to buy a used vehicle directly from the vehicle’s owner with no Middleman, the option has been there since the day after the wheel was invented.

Clearly, with all the online options available, there is basically nothing stopping anyone from cutting out the Middleman today. Oh, except for that whole not-wanting-to-get-scammed-or-killed philosophy some of us have. More than that, even buying a vehicle from an honest, non-murderous Craigslist seller means any vehicle inspection, repair or reconditioning costs fall on the new owner, along with the process of licensing, titling, setting up any financing and paying any sales or other taxes (and all this without a warranty).

Of course, whether or not you want to remove the Middleman from the transaction is immaterial to why Beepi failed (and why Carvana will too). You see, they are also Middlemen; they just represent themselves as something else to the consumer. They get in between buyers and sellers and they add costs; and in the case of Beepi, apparently not enough value.

Interestingly, because Beepi tried to be “Craigslist Plus” by adding in an inspection, marketing the vehicle on sites like CarGurus, handling the paperwork, helping arrange financing, transporting the vehicle and providing a 10-day money-back guarantee, in many instances they incurred higher costs than the average dealer (not including repair and reconditioning, which were the burden of the buyer should anything go wrong after ten days).

Adding Unnecessary Costs

Can you imagine the cost of sending a team of inspectors out to inspect vehicles for sale by owner (many of which fail inspection and are ultimately not even offered for sale)? Of picking up and delivering the same vehicle more than once? How about storing and reselling a car that gets returned within the guaranteed 10 days? For Carvana, their gimmicky vehicle “vending machines” make for great marketing and PR, while adding unnecessary costs to the vehicle transaction.

Of course, studies show most people will truly pay more for a great experience, but does this include a car vending machine? Seriously, let’s contain ourselves for a moment; after all, this is a used car we’re talking about, not a Caribbean cruise. How much more is the question? (Remember, the used car marketplace is pretty stinking efficient already.)

Plus, adding the experience of buying 100% online is available right now for any dealer who wants to provide this functionality to their website visitors. There are robust and easy-to-implement tools from great providers like AutoFi that give today’s new and used car dealers all of the advantage Carvana claims to have… oh, except for that vending machine. (Yes, dealers are really selling new and used cars 100% online with to-the-penny calculations thanks to partners like AutoFi. You can learn more about how this creates a great buying experience for consumers by viewing our How To Create The Best Car Buying Experience Ever video.)

Beepi also wholly misunderstood what consumers actually wanted fixed; that’s why they were solving for the wrong problem. Consumers overwhelmingly dislike the dealership experience, not necessarily the dealership visit. A car is a very personal item to most consumers; so they want to explore it and touch it and compare it… even when they already have their minds made up. Bringing them a single car on a flatbed to test drive might avoid the dealership experience, but it also avoids the dealership visit.

In the words of Jurassic Park’s Dr. Alan Grant, “T-Rex doesn’t want to be fed. He wants to hunt.”

But, why will Carvana fail?

Carvana is basically Beepi with a vending machine; though without the peer-to-peer, anti-establishment allure of the latter. Carvana will fail because they too are solving for the wrong issue. Carvana is helping consumers avoid the dealership experience by completely bypassing the dealership visit. They bring consumers one car at a time to “test own” – pretty much like Beepi did.

While customers who live near a vending machine can pick up their vehicles themselves (saving Carvana the cost of delivery), in those instances where a customer lives too far from a vending machine, but still wants to enjoy this novel delivery experience, Carvana will pay up to $200 of their travel costs and “arrange white glove transportation” to pick them up at the airport and bring them to the vending machine. (Hmm, sounds like there are some unnecessary costs eating into that $132 profit.)

Moreover, Carvana will fail because they source their vehicles just like the rest of the dealer world. Then they have to inspect them, repair them and recondition them just like the rest of the industry. While the current batch of startups may employ better processes than the average dealer that allow them to complete many of these tasks faster and cheaper, they still need to market, sell, transact business and pay for cool vending machines.

Oh, and for the Carvanas of the world who don’t understand what actually drives dealer profitability, they forgo offering parts, maintenance and repair. Thus relinquishing those potential profit centers and the customer loyalty these can drive. (The Carvana founders, of course, have dealership roots; which makes it that much more odd that they chose to omit fixed operations from their plans so far.)

But Carvana saves consumers $1,889 per vehicle versus a dealer, right?

Um, yeah, no.

Despite Carvana’s website touting a savings of $1,889 per vehicle over a traditional dealer, they apparently aren’t passing these “savings” on to their customers. (As one would expect from a benevolent tech startup hell bent on revolutionizing the car buying experience, right?)

I randomly grabbed a dozen vehicles from the Carvana website and easily beat the price of each one of them within a few minutes just browsing dealer listings on sites like Autotrader, Cars and CarGurus. Carvana’s price was always beat by at least half of the comparable vehicles, including those with fewer miles (even after adding in the dealer fees).

(To be fair, I’ve been contacted by dealerships who sell against a local Carvana location who’ve told me Carvana’s prices are “too low to touch.” This is likely an unsustainable pricing strategy used to generate interest/sales in new markets. Ultimately, the used car market is too efficient for any seller to maintain a cost advantage over any other seller – unless the seller acquires all of its vehicles directly from consumers via trades, which does not describe Carvana, of course.)

Of course, they’re selling some cars, so this begs the question: Will Carvana be able to continue to charge more for the same vehicles once the novelty of the car vending machine wears off? (I say no.)

How Carvana might succeed

With a multi-billion dollar IPO officially in the works, the founders of Carvana will likely “succeed” regardless of whether or not their creation proves sustainable for even the medium term.

Post IPO, if Carvana is able to take just half of their reported “savings” to their bottom line, they have a shot at surviving. (Does mere survival justify multi-billion dollar valuations? Probably not.)  Of course, their current process of requiring consumers to buy before they touch (even with a 7-day return policy) appeals to just a small percentage of the population.

As eBay has discovered, a majority of consumers say they want to buy completely online, but only a small minority are willing (today) to do so. Add in the loss of impulse buyers and it’s definitely an uphill battle for them to expect anything more than to be acquired by a Berkshire or AutoNation in their current form. (When I was browsing their listings, Carvana promised to deliver the vehicles I was interested in to me in either five or seven days depending on the vehicle. Seven days; how many consumers are willing to wait for a week to get a car they’ve already selected and purchased?)

Instead of trying to out-eBay eBay, Carvana stands a better chance of long-term success by trying to become a national Texas Direct Auto that includes some fixed operations.

That is, give customers a place to browse inventory live. Add a service lane or two. You know, become CARite with a cool car vending machine. Of course, in order to do that, Carvana needs to keep from trying to grow faster than their systems and people can adjust. They are selling an experience and they cannot deliver on that experience if they grow too fast or try to do too much at once.

The bad news for Carvana is it looks like that’s exactly what’s happening today. Based on their online reviews, Carvana is currently providing no better customer experience than a below-average dealer. (CARite, by comparison, seems focused on improving the dealership experience by improving the dealership visit – among other things – and their growth appears to be less about the founders cashing out for billions and more about actually changing the way consumers buy, sell and service used vehicles.)

Any dealer can and will sell cars online!

Venture capitalists can be an odd bunch, and they may continue to put hundreds of millions into Carvana thinking there is some multi-billion dollar pot at the end of the rainbow. However, as already stated, any traditional dealer can already complete the entire deal online today simply by adding a robust partner like AutoFi to their website.

Moreover, when dealers actually add an AutoFi to their websites and include it in their marketing messages, where does this leave Carvana? Can those vending machines be converted into small parking garages for downtown condo complexes?

Beepi never learned this lesson, but there is a flaw in the logic of everyone who tries to out-dealer the car dealer on a grand scale: You can’t. Dealers ultimately adjust and crush you (or buy you). They have the name, the facilities, the loyal customers and the brand. If all you have is a cool car vending machine, my money is on the dealer.

Good selling!

…

About TheManager:

Steve Stauning, creator of The Appointment Culture and a sought-after consultant for companies large and small interested in improving The Customer Experience and/or their Automotive Retail Sales. He is also an extremely popular keynote speaker and writer. Learn more about Steve at SteveStauning.com.