By Rob Macklin, COO 1 & Fund
Here is a fact that seems counterintuitive but is true: Dealer finance fees – the cost of getting your customers financed – aren’t really that important to your bottom line.
I realize that may sound strange. Who would turn down the chance to save money on finance fees?
But chasing the lowest finance fee rate doesn’t actually help you, in fact just the opposite is true.
Let’s break down the numbers and take a look.
Doing the Math
Say a hypothetical bath remodeler is doing $10 million a year in revenue, with an average job size of $10K. Assume that they’re financing 20% of their deals and paying an average finance fee of 5%. So, they’re paying $100,000 a year in finance fees (in other words, 5% of $2,000,000 in financed deals is $10,000).
With me so far?
Now suppose that they get a screaming new deal on financing that drops their costs down to a 4% average fee. They’d save $20,000 (a 1% reduction of the $2,000,000 in financed deals). Twenty grand isn’t life-changing, but it’s still nothing to sneeze at!
But what does it cost to make the switch? Aside from paying back-office folks to do all the paperwork, and train on a new finance system, they also need to pull every sales rep off of appointments for a day to train on the new platform.
If they have ten reps, each selling $1 million a year, that’s about $4,500 in sales a day for each individual. That’s $45,000 in lost revenue to pull them in for a day of training.
Moreover, how effective do you think the sales reps will be on the new finance program for the first few weeks? They won’t be as capable as with a familiar platform, resulting in lost sales.
Our fictional contractor has saved $20,000 in financing fees. But they’ve lost three things:
$45,000 in revenue from having reps in the office rather than selling
Hours (five? ten?) of back-office time – call it $5,000 in labor to be safe
Lost sales from reps not being familiar with the new programs and platform when they do get back out in the field. Let’s be conservative and say you lose only one single sale from all 10 reps combined. That’s another $10,000 in lost revenue
So, they’ve lost $55,000 in revenue, and incurred $5,000 in back-office cost, just to save $20,000 in finance fees. At a 40% contribution margin, the $45,000 in lost revenue equates to $22,000 in lost profit (40% of $45,000). Add in the $5,000 in back office time, and switching costs you $27,000 to save $20,000. That seems like a bad deal.
A Better Deal
Let’s look at it a different way, though. Suppose that they made the switch to a different finance program, but increased dealer fees by 1%.
In that case, they’d spend another $20,000 in financing fees each year, plus another $5,000 in lost back-office time when making the change – and, of course, lost sales of $45,000. So in this scenario, switching finance programs would impose costs of $25,000 ($20,000 in increased fees and $5,000 in back office time), plus another $45,000 in lost revenue.
But, how about if those financing programs had higher approval rates, were easier to use, and were more attractive to customers? In that case, the math changes completely.
I’ve run the numbers and can prove that a good finance platform can increase sales closing rates by three points (say, from 35% to 38%).
In addition, a strong program also increased the percentage of customers who will accept financing (say, from 20% to 30% of clients).
And, as we know, financed jobs are bigger jobs – usually by about 15%.
So let’s look at this new scenario – here’s what that contractor would gain, if currently averaging 1,000 sales per year at $10K per job:
3% increase in closings - 1000 x 3% = 30 more closed sales, x $10K per job equating to $300,000 in sales
10% more customers accept financing and those jobs are 15% bigger – 1000 x 10% = 100 more customers accepting financing, x $1,500 extra per job (since $10,000 sales turn into $11,500 sales because they’re financed), yields $150,000 in extra sales.
That’s another $450,000 in sales, or another $405,000 when you consider the lost day of rep time. Now it’s true that this company will pay financing fees on those jobs that are now being financed that weren’t before (6% of $1,150,000, or $69,000), so your total costs will go up – by $116,000, to be exact. But you’ll get another $405,000 in sales.
In other words, paying 1% more in financing fees can actually make you $450,000 more in sales! If your contribution margin on sales is 40%, an industry standard, you’ll make $162,000 in profit against $116,000 in costs. So in other words, you’ll make $46,000 more in profit by paying higher financing fees!
Now that’s a pretty extreme example. Paying 1% more in financing costs usually isn’t how things go. But I wanted to illustrate an extreme example to show what we all know intuitively - that financing is a tool to sell products, nothing more. Simply finding the cheapest tool never makes sense in the long run. Fine the tool that makes you money by closing sales.
You don’t buy your installers the cheapest tool – you look for the best value – and sometimes the best value is the higher priced product. You need the best finance platform to sell your product, not the one that is the cheapest. So stop chasing low fees, and chase the best value!
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