The Wal-Mart of Used Cars
Unlikely big-box chain CarMax has transformed the world of auto retailing.
By Michael Myser, Business 2.0 Magazine

(Business 2.0 Magazine) -- A small team of Circuit City execs met in 1991 to formulate a plan for a top-secret new business, code-named Project X. For nearly a year, the group worked clandestinely, finally pitching a proposal for a revolutionary new big-box retail chain with the potential to earn tens of billions of dollars in annual sales.

The industry to be tapped? Used cars.

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Right about now, you're probably conjuring up images of white shoes, smarmy smiles, bait-and-switches - or William H. Macy's morality-challenged character Jerry Lundegaard in Fargo. The Circuit City board, however, had a different response, doling out $50 million to test-drive Project X.

It hasn't always been a smooth ride - CarMax bled money for its first seven years-but today the company stands as an unlikely American success story: Its supercenters, which now number 71 and are concentrated in the Sun Belt, sold 290,000 used cars in the last fiscal year, ringing up $6.3 billion in sales and $148 million in profit.

Through a blend of technology and an inspired reimagination of how to treat customers, CarMax (Charts) has managed to outsmart any credible competitors. Now it has Hummer-size ambitions, with plans to build at least 300 more stores in the next 12 years.

How it works

When the first CarMax Auto Superstore opened in Richmond, Va., in 1993, it immediately encountered skepticism from insiders and analysts alike. First there was the ambitious size: The lot was stocked with more cars than some dealerships sell in a year.

Then there was CarMax's nonnegotiable sticker price and the fact that commissions were flat, so there was no incentive to push the priciest models. That, says CarMax CEO Thomas Folliard, was the most crucial element: "When you set up incentives that align your salespeople with the customer, everybody wins."

Customers haven't stopped flocking to the lots since. CarMax says sales reached nearly 5,000 cars per store last year-five to 10 times the industry average, according to Manheim, a provider of wholesale auctions and other services for the used-car industry. "Customers go for the choice, the nonthreatening environment, and the obvious price," says George Hoffer, an economics professor at Virginia Commonwealth University who has followed CarMax since it opened.

But it's the operation's high-tech backbone that truly differentiates it from competitors. In the same way that Wal-Mart revolutionized the logistics of retailing, CarMax set out to nail the perfect mix of inventory and pricing through exhaustive analysis of sales data. Its homegrown software helps CarMax determine which models to sell and when consumer demand is shifting.

Each car is fitted with an RFID tag to track how long it sits and when a test-drive occurs. Showroom computers give customers access to CarMax's nationwide catalog of 20,000 cars, so if a customer in Tampa, Fla., is set on a green 1999 Camry sitting on a lot in Los Angeles, CarMax can transfer the car cross-country for a fee. "The analytical strength has led to its success," says Sharon Zackfia, an analyst with Chicago-based firm William Blair.

Without the data, stocking CarMax lots would be a logistical nightmare. Each store carries 300 to 500 cars at any given time, and unlike Wal-Mart (Charts), the company has no vendors to stock its "shelves." Instead, CarMax depends on 800 car buyers, who draw on the company's reams of data to appraise vehicles. Trade-ins represent half of CarMax's inventory; the rest arrives via wholesale auctions.

The buyers are people like Mike Decker, who on a recent morning emerges from CarMax's showroom in Hartford, Conn., to appraise a 2005 Ford Escape with 27,000 miles.

After taking the SUV for a spin and checking out recent sales, Decker returns with an offer of $15,000. It's less than the Kelley Blue Book value but more than the customer would get on a dealer trade-in. A glance at CarMax.com reveals comparable Escapes priced well over $15,000, making it likely that Decker will meet the company's average gross of more than $1,800 per vehicle.

While natural disasters and gas prices could stall the company's growth, Hoffer, for one, doubts that outcome. "Sept. 11 should have been the end of CarMax," he says. But because the stores empty their inventories every month, the company got rid of its high-priced cars in time.

Another risk could be the recent retirement of founding CEO Austin Ligon. Zackfia was initially concerned that the new CEO might attempt to alter the model, but now she says she's happy with the choice of Folliard, who previously headed operations and thus far has made very few changes. "I've already made my mark on the company over the last 13 years," Folliard says.

Given that CarMax currently controls less than 2 percent of a fragmented but huge market-U.S. used-car sales totaled $367 billion in 2005-most analysts share Folliard's confidence that the company can expand to 300 stores, maybe more.

"They have an extremely profitable model," Zackfia says. Folliard, meanwhile, sees potential for CarMax to become a $20 billion operation within a decade. That is, as long as the new chief remembers the mantra Ligon laid out in Project X: "If you don't offer the customer something special, then you're just another used-car dealer." Jerry Lundegaard couldn't have put it better.

Michael Myser is a freelance writer based in New Jersey.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.