CarMax's Deteriorating Earnings and Strategic Turnaround: Assessing the Long-Term Viability of Cost-Cutting Amid Margin Pressures

CarMax's third-quarter 2025 earnings report painted a stark picture of the challenges facing the automotive retail giant. Revenue fell 7% year-over-year to $5.79 billion, driven by an 8% decline in used unit sales and a 6.2% drop in wholesale unit sales, as market depreciation eroded both volume and gross profit per unit according to the report. Gross margins contracted to 11.21%, net margins to 1.98%, and operating margins turned negative at -0.89%. These figures underscore a sector-wide struggle with inventory devaluation and shifting consumer demand. Yet, amid the downturn, CarMax has launched an aggressive cost-cutting strategy targeting $150 million in selling, general, and administrative (SG&A) savings over 18 months, anchored by AI and technology investments. The question for investors is whether these measures can reverse the earnings slide-or if they merely delay a deeper reckoning.

The Earnings Deterioration: A Perfect Storm of Market and Operational Pressures

The root of CarMax's woes lies in a confluence of external and internal factors. Used vehicle gross profit per unit fell by $116 to $899 in Q3 2025, a direct consequence of steep market depreciation. This trend, exacerbated by a surplus of inventory and softening demand, has squeezed margins across both retail and wholesale operations. While CarMax Auto Finance (CAF) provided a bright spot-posting a 9.3% year-over-year income increase to $174.7 million- it could not offset the broader decline.

The company's operating margin, which had shown modest improvement in earlier 2025 quarters according to Q1 2025 data, deteriorated sharply by Q3, reflecting the compounding effects of lower unit sales and margin compression. By August 31, 2025, operating margins had stabilized at 3.08%, but this figure masked underlying fragility. With net income per diluted share dropping to $0.43 in Q3 2025 from $0.81 in the prior-year period, CarMax's ability to sustain profitability without structural changes became increasingly questionable.

Cost-Cutting as a Strategic Lifeline: AI and Operational Overhaul

CarMax's response to these pressures centers on a dual strategy: aggressive SG&A reduction and a pivot toward AI-driven operational efficiency. Executives have outlined a $150 million cost-cutting initiative over 18 months, with a focus on reducing SG&A expenses. Key components include retiring legacy IT systems, consolidating platforms, and deploying AI-powered tools like the virtual assistant Skye and its advanced version, Skye 2.0. These tools are designed to streamline customer interactions, reduce labor costs, and automate back-office functions.

The early results are promising. By Q2 2026, SG&A expenses had already declined 1.6% year-over-year, a sign that the cost discipline is taking hold. CFO Enrique Mayor-Mora emphasized that technology investments would enable "substantial reductions in spend," with some savings reinvested into sales-driving initiatives. This approach reflects a shift from the company's earlier "omni-transformation" phase-focused on growth and digital integration-to a more defensive posture prioritizing efficiency.

The Long-Term Viability of AI-Driven Cost-Cutting: Promise and Peril

The sustainability of CarMax's strategy hinges on the scalability of its AI investments. The company has automated content generation for 45,000 vehicle listings, producing descriptions, customer reviews, and comparison guides at an 80% editorial approval rate. This not only cuts costs but enhances customer experience by delivering consistent, high-quality information. Similarly, AI tools are being used to renegotiate third-party contracts and reduce licensing fees, a move that could yield recurring savings.

However, industry benchmarks suggest both opportunities and risks. Retailers adopting AI have reported up to 29% reductions in selling and administrative expenses, alongside 51% sales growth and 20% margin improvements between 2023 and 2029. Yet, the automotive sector faces unique challenges. For instance, AI models in autonomous driving and predictive maintenance require high validation costs and fragmented regulatory standards, which could delay ROI. CarMax's focus on customer-facing AI (e.g., chatbots, virtual assistants) may sidestep some of these hurdles, but it remains exposed to broader economic risks, such as elevated credit losses and a potential recession.

Balancing Cost Discipline with Growth

A critical test for CarMax will be its ability to balance cost-cutting with reinvestment in growth areas. While Mayor-Mora noted that some savings would be redirected to sales-driving initiatives, the company must avoid over-optimization that stifles innovation. For example, the automotive retail sector is increasingly leveraging AI for personalized recommendations and predictive forecasting, areas where CarMax's current tools are less developed. If the company prioritizes short-term savings over long-term differentiation, it risks falling behind competitors who integrate AI more holistically.

Moreover, CarMax's reliance on AI raises questions about workforce adaptation. While the technology can reduce labor costs, it also necessitates reskilling employees to manage AI systems and interpret data insights. Failure to address this could lead to operational bottlenecks or employee resistance, undermining the cost-cutting agenda.

Conclusion: A Strategic Pivot, But Uncertainties Remain

CarMax's cost-cutting measures represent a necessary and well-structured response to its earnings slump. The $150 million SG&A reduction target, coupled with AI-driven efficiency gains, offers a clear path to restoring profitability in the near term. However, the long-term success of this strategy depends on CarMax's ability to scale its AI investments beyond cost savings-leveraging them to enhance customer loyalty, optimize pricing, and differentiate its omni-channel model.

Investors should monitor two key metrics: the pace of SG&A reductions and the return on AI investments in growth areas. If CarMax can demonstrate that its cost discipline does not come at the expense of innovation, it may yet emerge from this downturn stronger. But if the focus remains narrowly on trimming expenses, the company risks repeating the mistakes of past cycles, where short-term fixes failed to address deeper structural challenges.