CarMax – The way network effects should be
CarMax’s business model creates network effects and it’s market leader position strengthen these network effects.
CarMax, the United States’ largest used-car retailer, has a very different business model than other user car dealerships: Its sales teams are paid on a commission per car (no-haggle pricing), leading to less aggressive sales tactics and more trust with costumers. In addition, the company will buy any car on the spot after a short appraisal, regardless of whether or not the seller intends to buy a car at CarMax.
However, CarMax’s real competitive advantage, in this highly commoditized space, is how they leverage network effects:
- As CarMax grows its number of stores, the total number of vehicles in inventory goes up. By linking its nationwide inventory to its online platform, CarMax enables its customers to transfer any used vehicle to the preferred local store. This causes every additional new car dealership added to provide a better service / product to its customers (value creation). As a result, chances of selling a car to potential customers browsing the website or visiting their stores increases (value capture). Customers do enjoy this value add – in CarMax’s fiscal year 2015, 31% of its vehicles sold were transferred at customer request.
- In addition to the linkage of individual dealerships, their inherent business model of selling AND buying helps strengthen the network effect: CarMax offers the largest selection of used cars in the country. As this model attracts new purchasers, more of them sell their old cars to the company, which enhances the selection further and leads to even more customers.
- Once the network effect is in place, it is becoming more difficult for competition to catch up. As Tom Gayner of Markel Group puts it: “…Being the number one dealer, and having the number one market share in the used car arena gives you great information on what transaction prices are. Then you work on the process to be as quick and as cost efficient in fixing the car and getting it sold, and have the confidence from customers when you offer warranties on the products. Those factors create a virtuous cycle. The more you do, the more you can do, the better the pricing is, the more the customers like you, the more your brand matters…”
Going forward, Carmax is in a strong position due to its business model that creates positive network effects, and because of its position as number one in a market where scale matters. Moreover, CarMax have started to look at other revenue generating opportunities, with an interesting area being CarMax Financing (CAF). Through CAF, the company can “expand the pie” of potential car buyers by giving loans to people that otherwise would have struggled to make a purchase. CAF already makes up 13% of their revenues and it is already the 7th largest originator of used car loans in the United States. CarMax can further strengthen its network effect by providing cheap loans for a used car from CarMax, if the customer sells his old car to CarMax. This leverage of the existing network increases revenue for CarMax (more buying and selling traffic) and creates value for customers (gets access to cheap financing).