Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

We know that Carvana buys cars from either auctions or customers. The first step would be to understand how Carvana places bids to buy cars from both.

Over the last 12 months, especially post-Covid, the dynamics have drastically changed for Carvana in terms of the percentage of cars they are purchasing at auctions versus directly from consumers. From my observations at auctions, it's clear that both Carvana and CarMax's participation and volume have significantly reduced. They are now primarily sourcing their inventory directly from consumers.

To answer your question, Carvana does have a purchasing team, but they mostly rely on an algorithm to screen through all the vehicles available at auctions when they place bids. The purchasing team then fine-tunes this process. Currently, they are likely only searching for very specific vehicles to fill gaps in their inventory, since they are getting the majority of their stock from consumers. They are not relying on auctions as their primary source of inventory.

In my opinion, their strategy has slightly shifted. For instance, around nine months ago, in the third or fourth quarter of 2022, if their mix targets indicated they needed, say, 50 Honda Accords, they would bid aggressively on these Accords at Manheim, the world's largest auction facility. They would often bid 102% to 105% of the average price, as indicated by the Manheim Market Review (MMR), to ensure they secured the vehicles.

However, their current approach seems more opportunistic. They might bid up to, say, 95% to 97% of the MMR price. If they win the bid, great; if not, they work with what they have. So, their strategy has evolved somewhat.

Why has this change occurred? Why are Carvana and CarMax now purchasing more vehicles directly from consumers?

The dynamic has shifted due to the increase in consumers submitting online appraisals. Previously, consumers were accustomed to physically visiting dealerships for appraisals. Even CarMax would only provide an appraisal if the customer visited their location. One of the most significant changes CarMax has made recently is offering online appraisals without physically inspecting the vehicle.

Now, a larger volume of consumers can conveniently submit appraisals from their couch and receive a response. The efficiency of the follow-up process, such as contacting the customer and arranging pick-up, plays a crucial role. Both Carvana and CarMax have the infrastructure to handle this process, so they are focusing on purchasing cars directly from consumers.

When purchasing from an auction, you bid a percentage of the MMR price. How do you determine your bidding price when purchasing from consumers?

Many companies use the same MMR targets. Say their current strategy is based on the condition of the car, options, colors, mileage, and so on. Instead of focusing on specific numbers of certain car models, they're adopting a more opportunistic approach, aiming for a 92% to 97% range across the board.

This allows us to stay within the market price of cars. While we're not holding as many cars as we did at the end of 2022, we still have a significant inventory. If the market adjusts quickly, we don't want to be left with overpriced inventory. Now that we're in a better position, the market is less likely to turn on us quickly.

Is it Manheim that provides the MMR, which is the average price of a certain car model with a specific mileage?

Yes, the MMR is the average price. However, this can be misleading. If someone pays over 100%, it's not necessarily wrong. The average might include cars in poor condition or with significant damage. If you're focusing on cars in good condition without damage, paying over 100% isn't necessarily wrong.

In today's market, it's more expensive to purchase at an auction than directly from consumers.

Why is that the case?

It's due to the competitive market. There's less inventory and many dealers are competing for the same products. Not everyone has the scope or infrastructure to make offers on every consumer vehicle available online and then physically pick them up or arrange for drop-offs at their locations.

Carvana has the best infrastructure for physically picking up cars from consumers. CarMax also has numerous locations across the country where consumers can drop off their cars. Carvana is expanding this service as well. ADESA is also opening up offices where consumers can drop off their cars for appraisal. This broadens the market and makes it easier for consumers to sell their cars.

It's cheaper to buy from consumers today because there's a rush on auction inventory. Few players have the capabilities and infrastructure to buy directly from consumers, so they all rush to the auction inventory, which drives up the prices.

Indeed, that's a significant part of it.

Dealers are less likely to sell a car through an auction if its price is below the market value. On the other hand, consumers are more likely to sell because they prefer not to deal with the hassle of selling it on their own or meeting potential buyers. Essentially, they're paying for the convenience of not having to advertise, sell, and take calls from other people, effectively acting as a retailer.

This is why consumers would sell at a lower price to companies like Carvana and CarMax, who can come and pick up the car.

That's correct. Dealers, on the other hand, may not be as willing to sell it through an auction at a lower price because they have the option of selling it at their dealership or lot.

So, for simplicity, if we consider a car that can be bought at an auction for $10,000, what would be the auction fees?

That's a broad question, but let me address it.

Each auction, regionally, may have a different fee schedule. Auction fees for cars increase. However, for the purpose of this project, Carvana and CarMax, being large buyers, have negotiated a flat fee, regardless of the car's location or price. Carvana's auction fees are probably around $300. I would imagine CarMax's fees are less, but I wouldn't be surprised if they change. CarMax buys hundreds of thousands of cars from Manheim auctions every month, and Carvana's volume is also high.

Both companies seem to be getting the majority of their cars directly from consumers and are not buying many cars at auctions. Their activity in bidding at auctions has significantly decreased. I would imagine their rate is up for renegotiation because their lower rates were due to the volume they bought. If that volume decreases, I expect that to change.

Considering Carvana, post ADESA acquisition, could they eliminate these $300 auction fees for cars that are in auction at their facilities?

That might be possible in the future, but I don't think it's part of the agreement at this point. Carvana, even after purchasing cars from ADESA auctions, hasn't changed its approach. They still buy cars like any other buyer. Just because they own the auctions now, I don't think they're saying they won't pay auction fees. They're still operating as two separate businesses. I do expect something to change in the future.

When a car is purchased, whether it's from an auction or from a consumer, what happens to the title?

The vast majority of cars purchased directly from consumers still have a lienholder; they don't have the title in hand. I estimate that only about 15% of cars purchased from consumers actually have the title in hand. This number might be decreasing. The title is simply signed over during the transaction, either when the car is picked up or dropped off. If the title is with a lienholder, by law, the lienholder has 30 days to provide the title.

There have been articles written about Carvana and the issue with titles, which I believe has been somewhat exaggerated. They were simply the ones that were focused on. For instance, the state of Illinois made a big deal about Carvana's titles being late, past the 30-day mark. However, if you look at it from a percentage standpoint, they were the ninetieth worst offender in the state. Because of their high volume, they were made an example of.

To address this, Carvana has made some changes. They are now using a third party to help process titles more quickly. They are also titling the cars in the state of Arizona, which is fairly uncommon. Each state has a dealer reassignment on the back, allowing the car to be sold from dealer to dealer without having to pay taxes and get a reprinted title in your name. Carvana has taken steps to get the majority of the titles in their name to help solve this issue.

If I understand correctly when buying a car from a customer, the title exchange happens automatically. The title goes from the consumer to Carvana. But when there's a lienholder involved, this process takes more time. Is that correct?

Yes, with a lienholder involved, it generally takes more time. If the customer owns the car outright and has the title, it must be present for the transaction to happen for Carvana to buy the car. If the customer has paid off the car but can't find the title, they have to apply for a copy of the title before they can sell it to Carvana. This is one of the biggest time differences.

When it comes to auctions, a car can't be sold through the auction without the title. This process usually happens fairly quickly. The seller doesn't get funded until the title is received. It's in their best interest to get the title work done as quickly as possible.

Why does Carvana need a team for this? It seems to me that it's the consumer's responsibility to handle the title. Whether they're selling directly to Carvana or at an auction, they need to have the title ready. If there's a lienholder, they have 30 days to present the title. What is Carvana's team doing in this process?

Technically, you're supposed to have the title on your premises before you can put a car up for sale. This rule isn't necessarily followed by the majority of groups. However, the larger your group, the more scrutiny you face. CarMax and Carvana, for instance, won't post a car on their website until they physically have the title. In Carvana's case, since they're selling everything online, they can have the title at the home office. CarMax, on the other hand, will usually have the titles at the location where the car physically sits.

What does a title look like? Is it a paper document?

Yes, it's a paper document. They vary in appearance and size across different states, but they're generally the size of a piece of notebook paper. At Carvana, lienholders mail the titles to the home office. There's a team there processing them, ensuring everything is signed correctly. It's a lot of paperwork and there's a lot that goes into the process to make sure it's done right. If someone signs in the wrong place or puts the wrong mileage on it, there are a lot of addendums and things that have to go through to get it all correct.

How long does this title transfer take on average?

Once you physically have the title, four to six business days is pretty reasonable. However, waiting until you physically have the title usually takes the longest amount of time.

Are there any costs involved in registering the car in the name of Carvana?

From dealer to dealer, no, other than the labor cost of your title team. Once the title is reassigned to a consumer and it's sold retail, yes, there are fees for the title reassignment that the DMV will charge. Every state's fees are a little different. Generally, these fees are passed on to the customer. When you purchase a car, you've got your taxes and then your title and document fees. It's usually one fee that covers that. Let's say it's $99. In some states, it costs $75, in others, it costs $50. In some states, it's going to cost closer to $100. It's more of a flat add-on fee rather than specific to each transaction.

So, Carvana pays these fees once it acquires the car to put it under its name, and then when it sells the car to a consumer, the consumer has to pay the fee again to register it in his name.

Correct. The consumer pays now, and that's generally where Carvana uses a third party because you physically have to go to the DMV office and give them the titles and get the plates. You've got someone that could go with 100 cars every day. There are third parties that only do that business. They'll go and take all the titles down there, get the plates, and pay the check for everything. Carvana will pay for it, but then it's also recouped by the charge amount to the customer. This is a common practice with every dealer.

When Carvana purchases a car and titles it under its name, this cost is not passed on to the customer?

Correct. That cost is covered by Carvana, but it's primarily a labor cost.

And a new plate is issued every time?

When a car is sold to a retail customer, the title is reassigned. If Carvana bought the car from another dealer or directly from a consumer and gets it titled in their name, they don't receive plates for that. They only get a title printed in their name.

You mentioned there's a team that goes to the DMV with the titles to get the plates. This happens when the car is sold to the consumer, before it's delivered?

After the car is delivered and the paperwork is signed, by law, we have 30 days to provide the physical plates for their cars.

Who is responsible for getting the plates? Carvana?

Yes, Carvana. A third party will go to the DMV, process all the paperwork, get the physical plates, bring them back to Carvana, and then Carvana will mail them out to the customer.

When Carvana places a bid on an auctioned car or buys it directly from a customer, wins the bid, and then transports the car to the IRC, how long does a car typically travel?

I was considering this when looking at the graph you provided.

It's not a number we usually track, but if I were to estimate, it's probably around 150 miles on average. Some are in the market and are 20, 30 miles away. But since there are only 17 or 18 IRCs, some cars are moved a couple of hundred miles to reach them.

When a car is bought from a consumer, it's one car per trailer. But how does it work when Carvana buys 10 cars from an auction?

Previously, third-party services predominantly moved the vehicles from the auction. But since the volume has decreased significantly, and Carvana has capacity within its logistics network and owns trucks, they've been utilizing more of that to pick up the cars at the auction instead of paying a third party. They generally try to pick them up on routes they're already on to optimize their travel. Otherwise, they would use a third party, but that's not happening as often now.

Could you explain how the cost varies when Carvana's own trucks are used versus a third party for transporting the car to the IRC?

Indeed, the cost of using a third party is typically higher, and it varies from market to market, auction to auction. There are numerous variables in this scenario.

However, generally speaking, if it costs you $400 per unit to move your cars with a third party, it's likely half that, if not less, to handle it internally.

How has the transportation process from the auction to the IRC changed since the ADESA acquisition?

Currently, there hasn't been much change. However, it will play a significant role in their future growth. When wholesale cars are purchased directly from consumers, they often go to the nearest location, which is now, in some cases, an ADESA.

The Carvana wholesale cars are sold on an online platform, so they don't physically run through ADESA's auction. They just run through an online closed dealer auction, so they can physically sit at the ADESA auction instead of at one of the IRCs. This has been the biggest change so far, as it allows for shorter trips and helps with space constraints.

As Carvana returns to growth mode, they won't grow at the same rate or speed as they did in the previous nine years. If they reach a point of profitability or at least positive EBITDA, I don't believe we'll see them grow at the same rate. At 300,000 cars a year, the current IRCS aren't maxed out or even close. However, they now have the capacity to grow much more due to the availability of ADESA locations. The biggest cost was property and the expenses of building out the facilities for reconditioning.

With the current IRCs, they can handle up to 500,000 units. Anything beyond that can start utilizing the ADESA locations, some of which are larger than the current IRCs. This allows for significant production and a wider distribution throughout the country. The ADESA locations in California alone are a big deal due to the difficulty of buying and building in California. Having the infrastructure already in place and being able to simply flip a switch makes a significant difference in entering a market.

What happens when the car arrives at the IRC?

How detailed would you like me to be in my explanation?

I'm interested in understanding the different steps involved, the duration of each step, and the associated costs. This will help me gauge the average cost of inspecting and reconditioning a car.

I'll start by commenting on the grid you sent me. The actual reconditioning cost fluctuates from month to month and even week to week. It also varies from location to location, as different sites require different levels of work. However, the figure you've included is quite accurate.

When a car arrives, it gets stocked in and the inspection process begins. Carvana's setup is similar to lean manufacturing principles, but it's not entirely the same because we're not dealing with raw materials. Instead, we're dealing with a multitude of unique vehicles each week, each with its own make, model, condition, and mileage.

The inspection process involves six different stations, each manned by one to three technicians who specialize in a specific task. This process takes about an hour and a half. After that, a lead reviews the inspection results to determine what needs to be repaired or replaced and what parts need to be ordered.

While waiting for parts, the car undergoes cosmetic work. This could involve painting the bumper, paintless dent repair, or interior repair. Ideally, by the time the cosmetic work is done, the ordered parts have arrived.

The car then moves to the mechanical group of technicians. Here, each car undergoes an oil change, except for electric cars. A group of technicians then work on minor issues, such as windshield wipers or trim pieces. If necessary, the car is then moved to another group for brake or tire work. If there are more significant mechanical issues or larger parts that need to be replaced, the car is moved to another group.

Once all the parts have been allocated and installed, and everything has been verified to work properly, the car is detailed. This process is similar to the initial inspection, with six different stations and multiple people at each station working on the same part of each car as it moves through.

After detailing, the car undergoes a quality control check before moving to the photo stage. Ideally, the car is photographed at its cleanest point, immediately after being detailed.

You mentioned that the inspection alone takes about an hour and a half. What about the other processes, such as reconditioning, cosmetics, mechanical work, and wear and tear repairs? How much time do these add to the initial one and a half hours of inspection?

There are many variables, but typically, another two hours of labor goes into the mechanical part. The cosmetic part is even more variable due to the different conditions a car can be in. However, you're generally looking at adding another one and a half to two hours of labor for cosmetics.

It's important to note that a car doesn't go through all these processes in one day. After the inspection, it gets staged up in a first-in, first-out order for whatever cosmetic work needs to be done. The different zones, whether it needs paint, interior repair, or PDR, fluctuate based on the cars that came in that day or week.

Generally, parts take around 72 hours to arrive.

Some things can be turned around in a couple of hours if a car comes through inspection and only needs minor work, like windshield wipers and filters. In such cases, we prioritize getting that car through quickly.

During these 72 hours while waiting for the parts, the car is just sitting in the IRC and getting cosmetic work done, like brakes, tires, and such?

Only the cosmetic work is done during this time. The car won't be moved to the mechanical shop until all the parts have arrived. We don't start any work until we can do all the necessary work.

On average, how long does a car stay parked at the IRC?

Generally, from start to finish, it's 10 to 14 days. However, this can vary. The rate at which consumers sell cars and our ability to pick them up fluctuates.

To clarify, you mean 10 to 14 days until it's sold?

No, that's just for the reconditioning process.

There's a lot of ebb and flow to it. For instance, if a facility is processing 50 cars a day and one day they receive 200 cars, it will take them four days to even start working on the last group of the 200 cars. So, there are days when you're just trying to balance it out as much as you can. Carvana, for the most part, doesn't operate on Saturdays and Sundays, which also affects the numbers. Additionally, some cars will take longer due to parts, while others will take longer to get through cosmetic repairs. There are many variables, but on average, it takes about 10 to 14 days.

Does the number I have per car include labor or just parts?

It includes both. Once a car is through the photo process, it gets sent to an annotation team at the home office. They do another check to ensure all the photos are correct and of good quality. However, even after this process, the car doesn't necessarily go straight onto the website. If we don't have the title, which can often be the case if the lienholder takes 30 days and we've processed the car in 10, it could still wait another 10 to 13 days on the lot before it's put up for sale.

Is the inspection and reconditioning process different for a car bought from an auction versus one bought from a consumer?

No, the process is exactly the same. The only difference is that with an auction car, you have a window in which you can arbitrate it. If you bought the car and they said there's no major damage, and you discover frame damage during your inspection, you can arbitrate that. With a consumer car, there's no such window. Once you've bought it, it's yours.

And the time and cost of reconditioning is the same for both?

Yes, it's the same for both. The biggest factors are age and mileage, not whether it's an auction or consumer car.

Some people think that a consumer car takes longer, but generally, a car bought directly from a consumer tends to be older and have more miles. This is because you can focus on what you're buying at an auction and tend to buy later model cars with lower mileage.

So, when you collect the data, it might show that it costs less and cars get through the system faster when bought from an auction. However, it's not necessarily a difference between an auction and a consumer car, it's the year and mileage.

How does the inspection and reconditioning process differ when it's conducted at an IRC compared to a local dealership?

There are several ways local dealerships handle this. For instance, CarMax has a process that is extremely similar to ours. Both Carvana and CarMax are quite thorough in their approach. However, new car franchises often operate differently. They may charge themselves a full retail price for reconditioning due to the emphasis on their service and parts department's performance. In some cases, they have a set budget per vehicle for reconditioning, and they have to find creative ways to stay within this limit.

I didn't fully understand, can you elaborate?

Let's consider tires as an example. Carvana, CarMax, or any dealer generally buys directly from a tire distributor, which significantly reduces the cost compared to retail price. However, some dealers focused on new cars will charge full price for tires on the used side. This practice inflates the margin on the service side. It's not necessarily incorrect or uncommon, but it shows that their focus is more on building their service drive and parts department volume than on the margin of a used car.

They would still buy the tire from the distributor at the same wholesale price as CarMax or Carvana, but they would charge it higher to the consumer?

On paper, they're charging themselves a higher price.

But they're passing it on in the retail price, correct?

Yes, that's correct.

Regarding efficiency, how much more efficient is an IRC compared to a local dealership, on average?

An IRC is typically three to seven days faster in processing vehicles.

Different dealers calculate this in various ways. Some start the clock from the moment of purchase, especially if they're paying interest on a car. Others, like CarMax, focus on efficiency and time and use Little's Law. According to this, the clock starts when the inspection process begins, not when the purchase is made or when the car arrives on their property. So, it's not always a direct comparison.

Regarding the cost, I have a figure for Carvana per car. How does it differ per car at a typical dealership?

Based on the reports from AutoNation, Sonic, Asbury, and similar groups over the last few quarters, they're in the range of $1,700 to $2,000. The cost has definitely increased. Much of what they're saying aligns with our previous discussion. They're having to purchase older cars with more mileage because that's what's available, and it's costing them more to process these cars.

That's interesting. So, the car stays in the IRC for 10 to 14 days before going to photo, correct?

Actually, that's up to the end of the photo process.

So, it's up to the end of the photo process. Then what happens? At which point do you list the car on the website, and how long does the car stay in the IRC waiting to be sold after it has been reconditioned?

If you exclude the 10 to 14 days and consider the time from when the car arrives on the property to when it's staged and transported to a customer, a 45-day range is probably realistic.

If the title is there, the car can be listed on the website within an hour or so from when it's completed through photo and annotation. However, if you're still waiting on the title, you're just waiting until it's done.

The 45 days include the 10 to 14 days in the IRC, correct?

Yes, that's correct.

If you compare this to CarMax, from the moment the car is fully reconditioned and ready for sale, who turns over the inventory faster and by how much?

It's really close, but I would say CarMax is probably a bit faster, maybe around 35 to 40 days.

However, it's important to note that these averages are subject to a lot of seasonality. For instance, during what's commonly referred to as tax season, which is mid-January through late-March when people are getting their tax returns and are more likely to purchase a car, the turnover time could be less than 30 days.

The turn time is from the moment it lands at the IRC until the moment it's sold?

Yes, that's correct. CarMax was the pioneer in implementing this strategy on a large scale. Cars, later in the year, from around now until the end of the year, are generally at their lowest point of value. For over 20 years, CarMax has been buying cars during this period, knowing that they might have to hold onto them for around 90 days. This way, they have all the inventory ready to sell during the tax season without having to pay a premium to acquire the cars. The 45-day number has a lot of fluctuation and seasonality to it. Carvana has also adopted a similar strategy, albeit not to the same extent. So, during this time of year, they are likely holding onto a larger number of cars that will age a bit more, but they will have all the inventory they need, at least theoretically, by late January.

How does this 40 to 45-day period for Carvana and CarMax compare to a regular dealer or a smaller dealer?

Your average dealer typically likes to hold onto 60 days' worth of inventory. Most of these dealers are on a floor plan, meaning they have to make a payment on the car at 30 days, and then the car has to be paid off at 60 days. I would imagine that for many of these dealers, their cycle of days or turn rate would be even longer if they weren't, in many cases, taking their cars to auction on the 60th day to sell them.

Because they have to pay.

Correct. This is certainly a strategic advantage for Carvana and CarMax as they don't have a specific date by which they have to pay off the car completely. This is because they are either non-collateralized with their inventory or it's their own bank, their own money.

How does Carvana decide which car to sell to consumers versus auction?

Indeed, from the outset, there are certainly going to be barriers related to the year and mileage of the vehicle. Carvana, which finances the vast majority of its sales—around 80% according to the last report—can determine how far back in years they are willing to approve a loan. Most lenders set this limit at seven or eight years.

If Carvana decides to extend loans for cars up to nine or 10 years old, any vehicle older than 10 years will go straight to wholesale. The same applies to vehicles with mileage over a certain limit, which can vary depending on the company's current need for vehicles. For instance, during periods of high demand, Carvana has been known to sell cars with 115,000 to 120,000 miles, a practice they hadn't previously engaged in. However, as sales slow down and the company can be more strategic with its inventory, they might lower that limit to 100,000 or 90,000 miles.

Then, there's the matter of the vehicle's condition. Certain types of damage are non-negotiable. For example, if a car has frame damage, flood damage, or fire damage, it's not going to be sold. The same goes for any major safety concerns.

Some cars are purchased with the intention of retailing, but upon inspection, it becomes clear that they won't make good retail vehicles. Or, the cost for Carvana to recondition the car might not be worth it. These are the main factors that determine whether a car is sold or sent to wholesale.

Seasonality can also play a role. For instance, if the company is already holding all the cars it wants and can afford to be picky, they might decide not to sell a certain model that isn't selling well. In such cases, those cars would go straight to wholesale. It's a very fluid decision-making process, and that's where the buying team comes in, managing that algorithm.

I recall from one of their presentations that they included the advertising cost per car for the cohorts.

Yes.

Do you have an idea of what this average number might be?

The number you have there, around 500, is pretty accurate, and it aligns with what they've said. However, I believe it likely includes other costs, such as post-sale customer service and marketing. This is another number that can fluctuate as budgets change from quarter to quarter, affecting the amount added to the cost of a vehicle.

Once a car is ordered, how long does it typically take for the car to reach the customer?

Once the purchase is completed on the website, Carvana aims to finalize everything within 72 hours.

One of the significant changes in their operation over the last six to nine months is directing customers to purchase cars that are physically present in their markets. For instance, if there are two identical Honda Civics on the website, one in Georgia and one in Texas, and the customer is in Texas, they might unknowingly choose the one in Georgia. This adds unnecessary transportation costs.

To avoid this, Carvana now shows customers the cars closest to them based on their zip code or IP address. If they don't find what they want, it then shows cars that can be transported to them, but with a longer delivery time. They have also started charging a fee for this service.

Do you know how much it costs Carvana to transport the car to the end customer?

The cost varies per market, but it's generally around the 200 range, which is what they budget for. This includes cases where the car needs to be transported slightly out of market, like from Dallas to San Antonio.

What's the average return rate for cars within the seven-day trial period?

The last figure I saw was roughly 5% of cars being returned. Half of these were exchanges. Despite the costs associated with exchanges, it's still a relatively encouraging number.

Even with exchanges, there are labor costs involved. For example, driving the next car out, picking up the returned one, and bringing it back. However, in the grand scheme of things, this cost of doing business is well worth it.