Do You Know Your Profit Margin?

Posted 11/11/2010
By Bob Greenwood, AAM

As the independent vehicle service sector of the automotive aftermarket moves forward, it is time to step out of the traditional ways of shop gross profit measurement and take a look at what your numbers are really telling you about the business.

Consider a few points that explain the history of the aftermarket service sector:

1. On average, independent shop owners have a high school education. From there, they usually go on to earn their technician certifications. No formal business education was ever introduced to them in technical school that focused specifically on independent automotive service shop business management.

2. The service shop owner was taught by the commodity sector how to look at profitability in a shop business. The focus was on selling more parts/commodities to be successful. Well, that works great for the jobber, and if it is the right answer, then why are too many shops today unable to pay their jobbers' statements in full each month? "Sales are up, but I'm still broke."

3. Many jobbers speak to shop owners in terms of "markup" of their products. Markup forces you to think in terms of "cost" as taking your cost and multiplying it by a markup percentage to determine a selling price.

Consequently, shop owners are always on the prowl for a better cost to all the commodities they purchase, and they try to beat their jobbers down on price, thinking they are winning and doing things right. Jobbers sell to shop owners based on the price (cost) of their products. Both the shop owner and jobber are wrong; each should be selling based on value they bring to the table. In essence, shop owners have been taught that by acquiring a better cost, it will make or save them a lot of money and this kind of management will make them very successful. "Put on sales and move volume to drive more traffic in the bays," seemingly is the message.

Question for consideration: Why then did this thinking and process management not save the bottom lines of shops from collapsing, as they have done across the country?

Answer: If I bought a part last year for $20 and marked it up 50 percent, I would sell it for $30 and make $10 gross profit. If, this year, that same part cost $16, and I'm still holding on to old thinking and mark it up 50 percent, then I will sell it for $24 and make $8 gross profit. Wait a minute. I pay my bills out of gross profit dollars, not sales dollars. Do the math; you cannot discount yourself into prosperity.

Shop owners must understand that they are in the preventive maintenance business today, not the "breakdown and repair installer" business of yesterday. Stop focusing on cost and look at the profit dollars per transaction, including the service labor.

Let's do some more math: You can take another 10 percent off all the commodities you buy in your service shop, and it will not save your business. But if you increase your shop productivity by 10 percent, your bottom line would soar.

4. Ninety-eight percent of all accountants do not understand the service shop business. They talk to you in terms of tax cost/savings, increasing overall sales and reducing operating costs. They think in terms of cost accounting principles. They give you reports with technician wages as a cost to the labor revenue category. Rarely can we find accountants who understand and talk about shop productivity measurements and "profit" margins within the business' labor component, much less how they work within the independent sector. If they did, it would move the shop to "management accounting" principles.

Try this one change in your numbers to achieve management accounting principles. Take all wages and any wage-related numbers out of the cost of the labor component. Insert, as the only cost to labor, "sublet work" you had done outside of the shop by another peer.

For example, you don't own an alignment rack and you subbed out the alignment on your client's vehicle to another shop you trust. Your shop may make its 15 to 20 points on this contracted work, and you report that in the labor sales category. Take the cost of that job and any other work subbed out, and insert it as your only cost to labor for the month. Recalculate your gross profit labor dollars for the month: Labor sales minus sublet costs equals labor gross profit dollars. Gross profit dollars divided by labor sales dollars equals labor gross profit/margin percentage achieved.

You should be averaging, over the course of a year, above 90 percent - always. If you are not averaging well into the 90th percentile (95 percent to 97 percent is good) and are in the 80th percentile or lower, then an examination must be carried out as to what investment is required to keep those labor dollars in your own shop. That is another topic all its own.

Now, realign your total shop numbers to show total sales for the month for everything - fluids, tires, batteries, aftermarket parts, dealer parts, maintenance labor and diagnostic labor. Subtract from your total sales the cost of goods sold (opening inventory plus purchases minus closing inventory) for the commodities for the month. Then only add into the cost number the sublet costs for the labor. Now do the following steps:

Total sales less total costs equals gross profit dollars made. Total gross profit dollars divided by total sales dollars equals your gross profit percentage earned.

Under this format, your independent automotive service shop should be averaging a minimum of 70 percent gross profit. If you take the tires out of the mix, the shop should be at a minimum of 75 percent.

If you are not achieving these total gross profit percentages, the problem is not in the overall commodity profits of the company but in the average billed hours per invoice for the shop. Improving billed hours per invoice can dramatically improve a shop's total gross profit. Improved gross profit dollars improves bottom-line performance.

Let's do two more tests. First:

Take total labor dollars sold and divide it by your shop's door rate. The result equals total billed hours sold.

Take total billed hours sold and divide it by the total invoices written in the shop for the same period. In a maintenance service shop working on consumer vehicles, the average billed hours should be 2.5 hours.

If the shop does a lot of one-ton cube van commercial-type work, etc., the average should be four to six billed hours per invoice. If heavy-duty work is the name of the business, then 10 to 12 hours per invoice should be the average.

Second, if you were able to slow down your front counter processes to the point where one more hour per day per technician in your shop was sold, how many additional gross profit dollars would it bring in for the next one-year period? Do the math, and you probably, at first, won't believe the answer.

For example, a shop is open five days a week, 50 weeks a year (to keep it simple), and - hypothetically - has a door rate of $85. It employs three ASE technicians and one apprentice, which equals 3.5 technicians (apprentices are counted as half a technician). Well, the math does not lie: $85 x 3.5 x five days a week x 50 weeks a year = $74,375 additional gross profit dollars into the shop.

Your margin now moves in the right direction. The shop's bottom line starts to improve dramatically. You are working smarter, not harder. You can change the quality of life for your employees and your family when the entire shop truly understands the business it is in today ... the knowledge business.

Determine your mix of business to see where you stand and study this new math to truly understand your shop's real profit margin and how it can be improved.

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

Robert "Bob" Greenwood, AAM, is president/founder of Automotive Aftermarket E-Learning Centre Ltd. He has more than 34 years experience working with the independent aftermarket sector. More can be discovered at www.aaec.ca. Read Greenwood's blogs, as well as his credentials, by clicking on the blue tab "Instructor Bio." He can be reached by e-mail at greenwood@aaec.ca or by calling (800) 267-5497.