Old cars for new

But as price-conscious buyers turn their backs on new cars, which are quick to lose value after purchase, mainstream dealers are increasing their exposure to this highly lucrative trade. And innovations by well-funded car retailers are helping the used-car industry shake off its spivvy reputation and lure buyers in.

According to figures from the Society of Motor Manufacturers and Traders (SMMT), the UK used-car market is eight times the size of the retail market for new cars, with 6.8m vehicles sold over the last 12 months. And while the new-car market shrank 6 per cent in 2011, the used-car market held fairly steady. "Strategically, the greatest opportunity to grow the business is in the used-car sector", says Trevor Finn, chief executive of Pendragon - a company that provides some useful indications of the future direction of the industry.

Over the last two years, Pendragon has increased its underlying used-car volumes by 13 per cent, significantly ahead of the national used-car market. That growth meant that in 2011, 29 per cent gross profit came from second-hand vehicles, overtaking the proportion received from new cars for the first time.

Learning from the retail masters

Like mainstream rivals, Pendragon has benefited from the withdrawal of independent dealers from the market. It was recently estimated that the number of dealerships has fallen 12 per cent over the last five years, with independent car dealers bearing the brunt of the closures. But by working out how to leverage the internet to drive volumes, Pendragon has also been the architect of its own success in the used-car market.

The group has grown its web traffic by 41 per cent over the last two years, and put in place sophisticated logistics and stock-management systems to make sure it can convert buyer interest into sales. "20 years ago selling cars was based on intuition", says Mr Finn. "Today it's all data driven". Although these techniques are now common elsewhere in the retail industry, in motor retail they are revolutionary.

Pendragon is also taking an unusual approach to pricing, adopting an 'Every Day Low Price Approach' more common in supermarkets like Asda rather than the traditional price-high-and-haggle-down tatics employed by the motor trade. That means more centralised buying and pricing, and the ability to provide price transparency to buyers when they're searching online, which Mr Finn believes has been a key component of its recent online success. "We're the only large player adopting EDLP" says Mr Finn.

The approach should also, in theory, help Pendragon continue to trim its operating costs, which it reduced by £9.2m in 2011. "By putting these processes in place they're taking out the risk of management error at a dealership level", says analyst Sanjay Vidyarthi at broker Espirito Santo. "CarMax in the US has proved the model can work, but it's all about the execution."

Used boost for aftersales

While Pendragon's EDLP model means it has grown its market share, it does come at the expense of gross margin. Selling used cars remains more profitable than selling new cars, but Pendragon’s used-car margin slipped from 10.5 per cent in 2010 to 9.7 per cent last year.

However, the increase in volumes is so far offsetting this, with underlying used gross profits holding steady at £125m, against a near 10 per cent fall in gross profits in new to £120m - a 7.9 per cent profit margin. And growth in used-car sales has provided a useful buffer for Pendragon's highly profitable aftersales business. "A quarter of the 15,000 used-car buyers last year also bought a service package", said Mr Finn. "Without that business, our aftersales revenues would have been down £5.9m."

Of course, challenges still remain. A stagnant new car market means getting hold of a steady supply of pre-owned stock remains a huge challenge. As Analyst Mike Allen at broker Panmure Gordon points out (see Broker's View, below), the SMMT's sales predictions for coming years could prove overly optimistic if the economy suffers a further step downward.

IC VIEW:

Certainly, the ongoing squeeze on disposable incomes means the business of selling cars still isn’t an easy one, but a number of trends are actually likely to keep the market ticking over. For new cars, the premium market remains healthy and is benefiting from the rising cost of petrol and diesel, which is seeing owners trade in for an ever-increasing array of more fuel efficient vehicles. The industry is also in better shape financially, having recapitalised after the downturn and cut costs, which means the survivors are well positioned to continue consolidating this fragmented sub-sector. There's still much scope for self-help on costs and sales mix to keep profits steady, as Pendragon's increasingly successful internet business is proving, so with valuations still in the doldrums there is solid long-term value to be found.