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[an error occurred while processing this directive]   Management Feature

Realizing Your Capacity and Unlocking Profitablity

Posted 5/13/2006
Thom Tschetter

Calculating your shop's 'adjusted capacity' can help you discover your limitations and find ways to overcome them for maximum productivity.

A common mistake in our industry is ignoring that there are limits to a shop's capacity for both sales and production. We simply proceed blindly ahead just selling and hoping that the sales will overcome our lack of profit. But we can only produce so much. Intuitively, we all know this, but until now, little has been done to study and understand how to measure and calculate capacity. Even more important is how to use this information to make better business decisions. Without knowing your shop's capacity, it is impossible to accurately determine targets and standards for critical things like production, shop labor rate, parts margins, pricing and most important, profit.

There is a way to determine your shop's "adjusted capacity." It's called adjusted capacity because the capacity of your shop is limited by a number of factors, and it is essential to make allowances for these limiting constraints. Limiting constraints include such things as facilities, equipment, crew size, technician proficiency, and how the market affects sales. These and other limiting factors are keys for calculating a shop's adjusted capacity.

Before I explain how to calculate your shop's adjusted capacity, I want to illustrate why it's such an important concept. Imagine that we're going to start a new business; let's say it's a business that makes something that we'll call a "widget." Before we even decide whether to open our doors and sell our first widget, logic tells us that we need to know the answers to the following questions.

  1. What is our profit goal? This is the amount of money we want to make with our widget business expressed in actual dollars.
  2. How much will it cost us initially and on an ongoing basis just to open for business ... even if we never make or sell a single widget? This is called overhead or fixed costs.
  3. How many widgets can we make with our current staff within the structure of our existing facility, and without having to add new equipment? This is production capacity.
  4. How much will the market be willing to pay for a widget? This is the market price.
  5. How many widgets can we sell at that price? This is sales capacity.
  6. Are our sales and production capacities in balance? In other words, can we produce more widgets than we can sell or can we sell more widgets than we can produce? The result of this balancing act is your "adjusted capacity."
  7. How much will it cost per widget to make as many widgets as we can to both sell and produce?
    • Cost of materials per widget.
    • Cost of labor per widget.
    • Cost of overhead and operating expenses per widget.
  8. Can we sell and produce enough widgets at the market price to pay all of our overhead, parts/materials, employee wages, loan payments and achieve our profit goal?

It's pretty obvious that we would be foolish to invest our time and money in the widget business unless we could answer question No. 8 with a confident "yes."

By now, most of you have already figured out where this is leading. The problem with our industry's business model is that many of us opened for business and continued to operate our businesses without having ever answered these questions. In the past, most of us were intuitive enough or maybe just lucky enough that we got profitable results in spite of the fact that we were just "winging it."

So where and how does adjusted capacity fit into our widget business, and how will this help us with our shops? In its simplest form, adjusted capacity is the number of widgets that the business is capable of both selling and producing within an established time frame.

Now let's relate the widget business to our business. Instead of widgets, our units will be billed labor hours. There are a number of reasons why billed labor hours make more sense than other units of measurement. But the main reason is that time is the only thing that is common to every job. Not all jobs consume parts, not all jobs produce revenue, but all jobs do consume some amount of production time. Due to significant variations in parts and materials costs, using units of measurement like numbers of jobs or total average repair order (TARO) no longer make sense.

To calculate the production department's capacity to produce, first determine how many technicians your facility can comfortably handle. You might find that you have more technicians than your facility can hold. Next, determine how many hours of technician time you are buying each week by multiplying the number of techs by the number of hours worked. Now, for each technician, adjust those hours by deducting the number of hours of time they will lose on average each week for vacations, breaks, interruptions, free road tests and other free services, cleaning the shop, comebacks and other reworks. Now multiply the remaining hours by each technician's proficiency against the flat rate manual.

To calculate the proficiency factor, divide the flat rate time by the actual time the tech takes on average. If he can do a one-hour job in 45 minutes, you would divide 60 by 45, which equals 1.33. Now multiply his remaining available hours by his proficiency factor, which in this case results in an increase. Of course the opposite is true if he is slower than the book times. In our widget business, questions 2 and 3 determined the production capacity.

However, just because we have the capacity to produce a certain number of hours, it doesn't mean we can sell them. In fact, in most cases, we find that shops have excess capacity. That is, they have the capacity to produce more than they can sell. They feel like they are operating at capacity because what actually happens is the work expands to fill the time.

The ultimate limitation to capacity is sales. In our widget business, question No. 5 addresses sales capacity. If you can't sell all the production capacity, the amount you can sell becomes your capacity by default. Granted, it can go the other way, as well, and in this case, we need to consider options for increasing production capacity.

The net result of balancing or blending sales capacity with production capacity is your shop's adjusted capacity. Without knowing your shop's adjusted capacity, you cannot accurately answer questions 6, 7 or 8 because the answers to these questions can only be calculated by using your shop's adjusted capacity as one of the factors in the calculation. Does it make any sense to try to run your business without knowing the answers to these eight questions?

Many of you have heard of the profit index factor (PIF), a financial model introduced to our industry a little more than five years ago. PIF uses adjusted capacity to determine things like shop labor rates, parts profit margins, price estimates, breakeven point, gross profit and net profit on a job-by-job basis.

I am offering AutoInc. readers a free financial analysis, which includes:

  • Calculating your shop's adjusted capacity.
  • Calculating your shop's PIF.
  • Calculating your shop's break-even point using PIF.
  • Identifying possible factors that limit your shop's adjusted capacity.
  • Performing an analysis of your shop's pricing structure.

Don't keep operating in the dark ... make sure you know the answers to the eight key questions above before it's too late. You cannot go back and make a new beginning, but you can begin now to make a new ending.

Editor's note: This article is one of several management articles that will be contributed to AutoInc. this year by Automotive Management Institute (AMI) instructors. To learn more about AMI, its courses and instructors, visit www.AMIonline.org.

Thom Tschetter has more than 30 years experience in the automotive industry. He is an AMI instructor and an author, speaker and business consultant. For more information about his employer, ProfitBoost, visit www.profitboost.com. To obtain your free financial analysis, send an e-mail to thom@profitboost.com or call (888) 274-3776, ext. 830.

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