It is easy to dismiss Carvana’s rapid fall from grace, with its shares down nearly 90% in the past year, as another victim of the recent financial turmoil. Carvana could be seen as a poster child of tech-enabled, but still highly physical businesses – perhaps somewhat similar to WeWork.
After all, the Arizona-based online used-car retailer now moves nearly half a million vehicle units a year, so it is one of America’s top sellers. This means its unit economics, or the cost and profits associated with each car sold, should also be solid to sustain its growth. Like the co-working company WeWork did in its early days, Carvana has proven customer demand for its products, namely, buying and selling used cars without visiting a physical dealership. While car manufacturers and their dealers are entangled in franchise wars (e.g., Ford reportedly enforcing tougher rules on its dealers with the onset of electric vehicles), Carvana’s customers were rushing to its website – and revenues rose by a factor of almost 15 between 2018 and 2022.
But while customer demand for online car buying is solid, the economics of delivering on that promise are tricky.
In simple terms, Carvana makes its money on the spread between its purchasing costs of a used car and its sold price, while in the middle it also pays for the transport, reconditioning and insurance of its sold vehicles. Plus, its revenue gets a significant boost from financing (up to 50% of the gross profit per unit).
Buying a used car has always been a risky business. First, one needs to establish market price, which is moving rapidly and influenced by geographical supply and demand dynamics. Next, sophisticated buyers need to calculate the cost of repairs and preparation for sale. Carvana seemingly has skipped these steps and decided to offer customers a binding offer on their vehicles without seeing them.
Indeed, the convenience of selling a car to Carvana is second to none. Sellers simply type in a few details about their cars, disclose any mechanical or body issues and receive a guaranteed cash offer. With a few more steps the transaction is approved and a pick-up is arranged. This is all great from a customer perspective, but it results in higher risk to Carvana. An expensive one.
Like WeWork, which had to cancel its 2019 IPO after its valuation tumbled, Carvana’s economics were not adding up. A closer look at Carvana’s financials suggests it was likely overpaying for used vehicles. A Bloomberg report shows Carvana was losing $3,255 per vehicle sold. Meanwhile, industry leader Carmax turns a profit of more than $400 per vehicle. This in part is the result of a mismatch between Carvana’s purchase prices and sale prices as the market moved downward quickly, leaving it with expensive inventory. However, the operating costs of handling their purchased vehicles also played a role.
Specifically, when Carvana buys a vehicle unseen, the potential to miss damages means the repairs needed to bring it back to retail-worthy condition are not considered. Body damage, worn tires, even a scratch on a leather seat can make a seemingly good vehicle quite a bad deal.
For experienced dealers, this is a basic concept of used-car trading. The book value of a vehicle is only a starting point; to establish a potential retail price, one needs to assess the actual physical condition. This is done by “walking the car” in front of the customer as part of negotiating the final price – not a great experience for the customer.
It’s also the reason why most industry instant-cash offers have tried to mitigate the risk by providing relatively conservative offers. But in most of those cases, the dealer still calls the seller and asks them to come in with their vehicle for an inspection.
So how can we enjoy the best of both worlds? Offer an instant, competitive cash offer like Carvana, but still make money like a dealer would?
Enter virtual inspections. Using artificial intelligence and mobile phone cameras, it is possible to get sellers to “walk the car” in the comfort and convenience of their home and expose any physical damage that would need to be addressed before retailing the vehicle. This allows the buyer – often a dealer – to figure out the exact price that needs to be paid. For sellers with cars in good condition, it helps demonstrate their vehicles’ quality and encourages buyers to compete for it rather than coming into the used-car dealership and enduring tedious negotiations.
As Carvana’s rise and fall shows, the inspection step cannot be skipped – or profits will be sacrificed. But with virtual inspections, this previously time-consuming step can be integrated into a seamless customer experience. The industry is moving forward with online buying and selling, but it needs to make sure it leverages the right tools to make it profitable.
Eliron Ekstein (pictured, above left) is co-founder and CEO at Ravin.ai, which uses AI and computer vision to track the condition of vehicles.
