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Fixed Ops

Increased Service Absorption: Rule #1

In last month’s article I asked: “Do you have a BHAG?” which is an acronym for BIG HAIRY AUDACIOUS GOAL (as written by Jim Collins in Good to Great). Collins believes that a BHAG can become the vision leading to a company’s success, as well as the driving force behind the entire organization. So, if you didn’t have a BHAG last month, you should have one now. The BHAG that I suggested for your fixed operation team was 100 percent service absorption.
In focusing on your BHAG, I suggested you must first have a solid basis (financial statement) for measuring your current performance in fixed operations; you can’t manage what you don’t measure. The next step is to determine how many additional dollars in gross profit you need in order to achieve 100 percent absorption. We will call this dollar figure the shortage.
 
Once you have determined what your shortage is, you must then prepare a business plan that will address the opportunities for gross profit improvement within your dealership that will enable you to eliminate the shortage. The opportunities for retail gross profit improvement exist in every dealership. Let’s call these opportunities the RULES.
RULE #1: Maintain your profit margins at 45 percent on parts and 75 percent on labor.
 
RULE #2: Maintain your hours per RO at 2.5 minimum.
 
RULE #3: Maintain a 6 to 1 ratio in RO count to total vehicle sales.
 
This month, we will focus on RULE #1. It is the first rule because it is the easiest to control, therefore, the simplest to positively affect. So, let’s begin.
 
First, look at your financial statement and find your customer pay parts (retail) gross profit margin as a percent of your customer pay parts sales, year to date. I have found that most dealers are averaging somewhere around 38 percent. RULE #1 states it should be 45 percent, so simple math shows us that we are short 7 percentage points. Now, how are you going to get those 7 extra points?
 
Here is an example: Let’s say you sold a part for $1 and it cost you 62 cents. Your gross profit would be 38 cents making your gross profit margin 38 percent with a cost of sale at 62 percent. To determine your desired sale price that produces a 45 percent gross profit margin, divide the cost of sale by 55 percent. (Sale of 100 percent, minus cost of sale of 55 percent, equals gross profit margin of 45 percent). A part that costs 62 cents divided by 55 percent equals $1.13 which should be the sale price. Subtract the cost of sale, 62 cents (55 percent), from the sale price of $1.13. Profit is now 51 cents or 45 percent. Now, divide the sales price of $1.13 by the cost of sale, 62 cents, and you get 182 percent which means that you must “mark up” your parts cost by 82 percent to achieve a gross profit of 45 percent. This is called a Cost Plus Parts Pricing Matrix.
 
I hope I haven’t confused you with the math, but you need to understand this and inform your parts manager of RULE # 1. He or she can make this happen with a few strikes of the keyboard by installing a Parts Pricing Matrix that will generate a 45 percent gross profit to sales.
 
Let’s say you are averaging about $100 in parts sales per RO at 38 percent gross, and you are writing an average of 500 retail repair orders per month. By simply installing the matrix I’ve shown you, your sales will then average $113 per RO for an increase of $13 on the 500 repair orders which is $6,500 per month or $78,000 per year. Take this math, apply it to your dealership and you will be able to see how you can take a step toward achieving a BHAG of 100 percent service absorption.
 
RULE #1 also states that your retail labor gross profit margin must be no less than 75 percent of sales. Again, go to your financial statement and get your retail gross profit as a percent of your retail labor sales. It is most likely less than 75 percent.
 
Next, compare your effective labor rate to your retail labor rate and calculate the difference between the two. Note, your effective labor rate should be no less than 90 percent of your retail rate. Most dealers have a retail rate that will generate a 72 to 75 percent profit margin, but their effective labor rate produces a final margin around 68 percent. Why does this happen? The answer is discounts.
 
Let’s look at how much discounting can cost a dealer in lost profits. If a dealer has a parts-to-labor ratio of 80 percent, then using the example above of $100 in parts sales per RO would give you average labor sales of $125 per RO. At a 68 percent gross profit you would have an $85 labor sale gross profit per RO. However, with a profit margin of 75 percent, the gross profit would be $93.75 for an increase of $8.75 per RO. Multiply $8.75 by 500 repair orders, and the additional gross profit per month equals $4,375 or $52,500 annually.
 
Now, let’s add that to the additional gross profit of $78,000 from our Parts Pricing Matrix, and your potential for profit improvement totals $130,500. Take this math and apply it to your dealership, and you can see how to take another step toward achieving 100 percent service absorption.
 
Sound good so far? If your answer is “yes” then why don’t you make RULE #1 a company policy? As such, that means it is not an OPTION since it is your POLICY!
 
If many of you already have a Parts Pricing Matrix and a retail labor rate that is 4 times your average technician’s wages but your gross profit margins are below 45 percent and 75 percent respectively, you have a cancer in your dealership called discounting, and it exists because of your service writers! Yes, service writers, not service advisors. These writers are giving away thousands of dollars of the dealer’s money, and most dealers continue to allow them to do it. Who controls the selling price of a vehicle, the salesperson or the sales manager? What do you do with salespeople who offer your customers discounts that are contrary to company policy (RULES)? What do you do with salespeople who can sell an average of only 5 vehicles a month? What do you do with a finance producer who can only average $200 PRU?
 
For a successful dealer, there are only two possible answers to these questions: You provide TRAINING to enable them to perform at acceptable levels, or REPLACE them with someone who is willing to follow the RULES. These are the only two options you have for service writers as well. Make RULE #1 your company policy starting NOW. Next month, we will address RULE #2 and demonstrate how to get even closer to a BHAG of 100 percent Service Absorption.

Vol 3, Issue 7
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