[CVNA – Carvana] Fat tail investing

CarMax sells more cars in a single year than Carvana has sold in its entire existence and yet has half the latter’s enterprise value as the market has come to appreciate that buying cars online is becoming a real thing and Carvana is best positioned to profit from this channel shift.

CarMax was version 1.0 of revamping the car buying experience.  As I explained in my March 2018 post, at a time when most used car dealerships consisted of unctuous salesmen roaming small plots of land with limited inventory, trying to the hit the limit of what shoppers could afford, CarMax, incepted in 1993 as a subsidiary of electronics and appliances retailer Circuit City, applied the best practices of professional retail.  It pioneered a no-hassle, data and technology heavy approach to selling cars, and was arguably as disruptive to the car buying process at the time as Carvana is today. 

I recently shopped at CarMax.  Neither of the Portland locations had any late model Honda Odyssey’s on hand, so I had to pay $700 and wait 3 weeks for the van to be shipped from a lot in Reno, Nevada, a process that entailed a 15-minute phone conversation and whose completion will require that I drive to the local CarMax to test drive the vehicle and fill out paperwork.  Though sprinkled with minor frictions, this experience would have been a huge improvement relative to the best alternative car buying experience 10 years ago, but it is noticeably kludgy today.  As Carvana’s management often points out, not only do 97% of car purchases researched online, but 75% of consumers “would consider” purchasing a car online and 52% only test drive one vehicle. 

And in today’s internet-first world, when traffic is funneled to a process with reinforcing feedback mechanisms, small differences in user experience can lead to tremendous disparities in outcomes.  In theory, CarMax has the infrastructure and brand to fast follow in online delivery, but in practice the company is optimized for on-premise buying and management’s tepid response to online retailing over the last few years suggests that the company sees it as a complement to on-premise buying.  Mutating into an online-first retailer would mean cannibalizing its profitable store footprint and re-configuring its logistics…closing down stores or converting them into fulfillment centers, laying off onsite employees, centralizing inventory, building out last mile delivery, and upgrading its technology. 

While the “omni-channel” strategy announced at the end of 2018 and now available in ~70% of CarMax’s markets, is showing glimmers of traction, it’s still clear that stores remain the focal point.  Omni-channel is often framed as a superior arrangement to either online or physical stores because it gives consumers to ability to shop the way they want, but it often comes across as a reluctant compromise between how an incumbent is set up to sell and how consumers want to buy, and my concern is that if or when online buying becomes more the norm for used car purchases, CarMax, by assuming an agnostic view on channel, will find its network and cost structure sub-optimally configured for the channel that matters.

Version 2.0

Sometime around 2012-2013, a handful of online concepts emerged to offer a modern version of seamless car buying that CarMax pioneered 27 years ago.  Among the group, Carvana distinguished itself with an asset-heavy, vertically integrated approach.  In my last Zillow post, I talked about how, in response to Facebook and Google extracting ever more value at the top of the funnel, online lead gen companies have been forced to differentiate by vertically integrating more services.  TripAdvisor and HomeAdvisor launched Instant Booking; LendingTree and Zillow began curating leads.  Zillow, of course, has gone a step further in purchasing and re-selling homes, a proposition in which I think it has an inventory sourcing advantage by virtue of its brand and well-trafficked portal but whose scale economies have yet to be born out.    

But there is little doubt that scale economies are the regnant source of competitive advantage in online car retailing.  The key to winning over customers is having the cars they want and delivering those cars as fast as possible.  By in-housing logistics and inspection & reconditioning centers (IRCs), Carvana minimizes the distance between its inventory pools and car buyers, which leads to faster delivery times, happier customers, and more car sales.  More car sales means leverage on the fixed costs of IRCs, car vending machines, logistics, and advertising, which translates into lower unit costs that get passed on as lower selling prices and reinvested in more inventory, IRCs, and advertising, which in turn leads to greater site visits and sales conversion and so on.  The reinforcing feedback between sales volumes <-> inventory and infrastructure eventually gives rise to scale economies that would be difficult for smaller competitors, especially asset light ones, to compete against.

To make the same point in picture essay form: