How to Develop Financial Competence In Your Management Team

By Walter J. McDonald

Executive Summary

Absorption Rate is one of the most important performance ratios equipment dealerships should measure. The really big, profitable dealers demonstrate the significance of what improving Absorption Rate can do for the health and success of the dealership.

The absolute number representing “Recovery Rate” is interesting, but not a call to action. It only indicates your current position relative to the target performance score of 100% Absorption Rate. This Newsletter Article will help you review the components of Absorption Rate and discuss each component with your management team. Then, you can use these guidelines to Build Your Dealership’s Financial Strength

Here’s What We Will Cover in This Article:

Increasing Gross Profit Components

SERVICE LABOR Gross Profit Improvement

Management Actions to Improve SERVICE LABOR Gross Profit

PARTS Gross Profit Improvement

Management Actions to Improve PARTS Gross Profit

RENTAL Gross Profit Improvement

Management Actions to Improve RENTAL Gross Profit

Control/Reduce Fixed Operating Expenses

Management Actions to Lower SERVICE DEPARTMENT Cost

Management Actions to Lower PARTS DEPARTMENT Cost

Management Actions to Lower RENTAL DEPARTMENT Cost

Management Actions to Lower USED EQUIPMENT Department Cost

Management Actions to Lower NEW EQUIPMENT DEPARTMENT Cost

Summary

Two Dealer Case Histories

Building Dealer Financial Strength

Absorption Rate is one of the most important ratios an equipment dealership should measure. The really big, profitable dealers demonstrate the significance of what the Absorption Rate means for the health and success of the dealership. A high Absorption Rate helps assure company survival in times of volatile, uncertain equipment sales because more stable revenue from Parts, Service and Rentals cover company Fixed Operating Expenses.

The Absorption Rate formula defines the ability of Gross Profit from Service, Parts and Rentals to absorb all of the operating expenses of the dealership including the expenses of Service, Parts and Rental departments. The only operating expense exception is for variable commission expenses in the Sales and Used Equipment Departments.

Why also is pursuing a goal of 100% Absorption Rate so healthy for your machinery dealership management team? Just think about the management skills that must be developed in order to achieve this financial target.  Here is the Holy Grail of the machinery distribution business:

So, why is pursuing a high Absorption Rate such a powerful management development tool? Achieving high scores in each element of the formula requires a competent demonstration of management skills by every manager in your business. They are the bus drivers to get you where you want to go.

This formula challenges your management team to build Gross Profit streams while minimizing Fixed Operating Expenses.  And, some leading industry professionals believe when you include Rental Gross Profit, the ratio should be in the 125 – 140% range.  And, they also emphasize that as a dealership gets larger the importance of the Absorption Rate formula becomes even more significant.

Increasing Gross Profit Components

Let’s break it down and look at each component of Gross Profit in the formula. In each of these next three sections we will examine processes and procedures that can contribute to higher Gross Profit Margin % and increased Gross Profit $ in Service, Parts and Rentals.

Remember, no matter what performance improvement strategy to enlist, you must establish a specific quantitative target. If you want to control it, you must be able to measure it.

Service Labor Gross Profit Improvement

Service Labor Gross Profit is derived from the basic Gross Profit formula:

Management Actions to Improve Service Labor Gross Profit

1. The quickest and easiest way to increase Service Labor Gross Profit is to increase Billing with the same number of technicians. This is an increase in labor productivity. A $100 increase in billing through productivity improvement incurs no additional cost. That $100 goes to Gross Profit.
2. Utilize Apprentice Labor where possible on a repair order to decrease average cost of labor.
3. Increase External Customer Billing Rate to at least 3.3 times average technician wages and benefits to increase labor gross profit.
4. Control discounting on internal repair orders.  Labor rate charges for rental maintenance or used equipment reconditioning should be at no less than the rate charged to the best external customers.
5. Improve the volume of Service Labor Billing through a consistent machine inspection program and/or Planned Maintenance Program and the resulting 2^nd segment work.
6. Increase Service Labor Sales through twice-monthly email promotions, web site promotions, off-season maintenance programs, and direct sales efforts to large, high-potential accounts.
7. Promote major overhauls to “pull” shop work into the dealership.
8. Do weekly customer service follow-up calls to monitor satisfaction levels and ensure repeat business.
9. Develop a colorful Product Support Brochure for sales rep use.
10. Increase Service Labor Sales to at least 15% of Total Dealer Sales.

Parts Gross Profit Improvement

Parts Gross Profit is derived from the basic Gross Profit formula:

Management Actions to Improve Parts Gross Profit

1. Improve the volume of Parts Sales through a consistent machine inspection program and/or Planned Maintenance Program and the resulting 2^nd segment work.
2. Increase Parts Sales through twice-monthly email promotions, off-season web site promotions, maintenance programs, and direct sales efforts to large, high-potential accounts.
3. Train parts counter people to “up-sell” and offer “related Items.”
4. Control discounting on internal repair orders.  Parts charges for rental maintenance or used equipment reconditioning should be at no less than rate charged to best external customers.
5. Establish stock replenishment disciplines, placing regular stock orders with vendors to take advantage of discounts and freight programs. Keep freight costs under 1% parts sales.
6. Work closely with Service to pre-order special parts for upcoming work to avoid high-cost emergency orders.
7. Set up 100% parts fill rate program for ten large customer accounts based on a specific set of their parts requirements. This skill will positively impact all parts customers.
8. Offer large parts direct customers a non-discounted consignment inventory program. Items must be kept in a secure area. All items are tagged or in baggies with labels. As customer takes parts out of the storage area, each item tag or baggie label is put in a Priority Mail box. The box of tags and labels is sent to the dealer weekly for replenishment and billing. The dealer conducts a physical on-site inventory count every three to six months.
9. Offer Kits of all needed parts, including gaskets, for common repairs.
10. Offer 1^st maintenance kit for new models and include cost in new machine price.
11. Perform a Margin Mix Contribution Analysis every year using this spread sheet data below. Just do it for your top 20% parts line items in annual $ sales.  Sort and rank the report by Gross Profit Contribution, large to small.

1. Review each line item. Make sure there are never any stock outs on these top performers, your best new buddies.
2. Can you increase belt retail price from $6.12 for example to $6.99, up to the nearest dollar? The difference is $841.29 increased Annual Gross Profit.
3. Investigate leading competitor prices on larger components such as starters.  Your OEM product can be at or slightly higher than theirs, but not 20% more. Call the competitor and ask for their price.
4. Can you reduce item cost through better purchasing procedures and minimize inbound freight?

12. Increase Parts Sales at least 22% of Total Dealer Sales.

13. Update vendor price increases immediately.

14. Improve accuracy of required Safety Stock levels based on changes in delivery lead times by specific vendors. Is your min-to-bin time being extended by some vendors without you recognizing it?

15. Establish draconian controls on discounts. A 10% discount off a part with 25% Gross Profit Margin requires a 167% increase in volume to recover the lost Gross Profit. Does this sales increase ever really happen?

Rental Gross Profit Improvement

RENTAL Gross Profit is derived from the basic Gross Profit formula:

Management Actions to Improve Rental Gross Profit

1. Measure and track monthly Unit or Time Utilization as well as Dollar Utilization. Unit or Time Utilization is percent of days unit is rented. Performance Target for both types of Utilization is 75%.  It is important to track both Dollar and Time Utilization.  It is possible to have a very high Time Utilization but a very low Dollar Utilization through discounts and/or free loaners.

2. Best practice is to focus on dollar utilization. You can never control Gross Profit growth by Time Utilization. The dealership will generate substantially more Gross Profit if it moves dollar utilization up by 5% points. But, you must also analyze low time utilization units. If they can’t be rented at rates that meet your financial model, you must liquidate them.

3. Short-Term Rental Revenue Multiple, also known as Rental Return on Assets, must be at least 54%.  This analysis can be done for single units and whole fleet.  (60% = Excellent,   48% = Fair,   35% = Poor)

Short-Term Rental Revenue Multiple

4. Basic short term monthly rental rates must be at least 10% of acquisition cost.

For Example:  Unit Cost is $25,000.00.

Multiply cost by 10%:  $25,000 x .10 = $2,500.00 Monthly Rental Rate

This would yield a very attractive $22,500 in Annual Revenue at 75% dollar utilization:  

$2,500 x 12 months = $30,000

$30,000 x .75 Utilization = $22,500

To Calculate Weekly and Daily Rates

Begin with Monthly rate = $2,500.

Divide Monthly rate ÷ 3 = Weekly rate of $833.00.

Divide Weekly rate  ÷ 3 = Daily rate of $277.00.

Plus cost of value added services for incremental sales.

5. Offer “value added” services to maximize rental revenue, e.g., loss damage waiver (typically 12-15% per month), purchase options, attachments, full maintenance package, plus charge an environmental service fee (typically $10.00).

6. Increasing Rental Sales can be achieved through twice-monthly email promotions, field visits to job sites, rental intention phone surveys of larger accounts, colorful statement stuffers, and current photos of units available on dealer website.

7. Develop an adequate system for advising all employees and customers on rental availability.

8. Build a comprehensive rental customer profile of market data for each Iarge rental account including key contacts, requirements, financial issues, special needs, plus strategy to obtain/keep the account?

9. Carefully review and establish policies for returns, loaners, delivery, pricing, financing (dealer and customer), disposals and, commissions.

10. Establish a strict procedure for handling customer abuse on rental units.

11. Establish special rates for high usage, e.g., over 44 hours/ week as follows: 1^st shift 100% rental rate; 2^nd shift + 60% rental rate.

12. Establish a firm procedure for check-in, check-out for abuse, accidental damage, safety, etc.

Control/Reduce Fixed Operating Expenses

Each of the five Revenue Center Managers must effectively control expenses to minimize Operating Expenses and optimize the Absorption Rate formula. Here are suggestions for each Revenue Center.

Management Actions to Lower

Service Department Cost

There are hundreds of ways to reduce Service Department Expenses. Here are just a few taken from my new Service Management: The Machinery Dealer Manager’s Handbook.

1. The biggest cost reduction opportunity in the Service Department is fixing anything that impedes Technician Productivity: Disorganized tool crib, excessive snack truck or tool truck visits, personal phone calls, poor off-shelf fill rate to Service, waiting at the parts counter for parts, inability to order parts from “yellow box” and get them promptly delivered.
2. Field service costs can be greatly reduced through more intelligent pre-call diagnostics and dispatching methods. Ask me for my “Dispatch Authorization Form” that helps get the right information before dispatching the technician. You may also want to look at this new service request secure digital connection platform: HIVEQR.com. It is proving to be a big cost saver with huge gains in field service technician efficiency.
3. Age warranty claims and provide a warranty recovery incentive.

Management Actions to Lower Parts Department Cost

As in the Service Department, the Parts Department offers numerous cost reduction opportunities.

1. The most serious profit drag in Parts is often Obsolete Parts. We have seen as much as 38 – 45% obsolescence in some mismanaged dealerships. The cause is usually a poorly managed Stock Status Report because either the Parts Manager does not take the time to do it or they are poorly training on the basics of safety stock, reorder points, ABC stock analysis techniques and other critical management stock controls.
2. Analyze back orders.  What is the cause:  inadequate restocking  procedures, manufacturer stock outs, customers with old equipment, customers with new models you are not supporting?
3. Review Emergency Orders each week with Service Manager.  What were the options?  Why not in stock?

Management Actions to Lower Rental Department Cost

1. Big Rental Cost issues include excessive maintenance over 18% of rental revenue. Field rental maintenance should be like an Indy 500 pit stop, “In and Out.” Replaced components can be remanufactured items, not more expensive new parts.
2. Unrecovered customer damage can be a significant cost. Photographic evidence at check-in or driver pick-up is essential for collections.
3. Invalid credit card for 2^nd or 3^rd month is a frequent issue. Process the billing every month and retrieve the units immediately if there is a payment issue.

Management Actions to Lower Used Equipment Department Cost

Excessive “over-allowance” on a trade-in unit is rarely recovered when the used unit goes up for retail or wholesale.  Follow the trade-in used machine purchase policy outlined in my Master’s Program in Dealer Management Book Set. This procedure will also help you get up to 30-35% Gross Profit Margins on used equipment sales.

Equipment trade ins over 90 days old cost more and more depreciation every month. These problems are usually caused by poor purchase practices. Your policy should be “90 days and out!”

Management Actions to Lower New Equipment Department Cost

Machinery Sales Reps face the same productivity challenges as the dealer’s service technicians.  The service technician is challenged to bill 95% of available hours to Repair Orders.  The Machinery Sales Rep may or may not even have any specific activity performance targets.

A good day-to-day productivity target for a Field Sales Rep is 75 customer touches per week or 300 per month. This 5-5-5 daily “sales velocity” includes 5 personal visits, 5 teleprospecting calls and 5 mailings. This level of territory coverage intensity will yield higher deal visibility and significantly more sales volume. A touch includes a personal visit, email, phone call, personal mail or a trade show meeting. We see many machinery sales reps with productivity scores of only 7.5 -10%.

A Sales Rep who hits the end of his/her driveway on Monday morning and is not sure whether to go left or go right is in big trouble. What is the weekly call plan (personal visits, phone calls, emails, etc.)?

Strictly speaking, increases in Sales Velocity will not reduce Fixed Operating Expenses. It will, however, reduce the cost of antacid needed by the Dealer Principal.

Summary

The absolute number representing “Recovery Rate” is interesting, but not a call to action. It only indicates your current position relative to the target performance score of 100% Absorption Rate or more.

Managers look at it and say, “WOW!” But, many have little insight into how to make necessary improvements.

Hopefully, with this Newsletter Article you can review the components of Absorption Rate and discuss each section with your management team.

I would conduct these reviews weekly if you can produce a weekly flash report illustrating your sales, gross profit and expenses by department.

Excellent support resources to help you achieve 100% Absorption Rate include our Master’s Program in Dealer Management distance learning seminar and our 11-volume Master’s Program book set.

Each of these powerful Management Development resources are described on our website: www.McDonaldGroupInc.com.  The tab “Training Programs” highlights our dealer management curriculum.  And, the tab “Management Sets” details our complete 11 volume Master’s Program book set.

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Please contact me if you would like to discuss any of these Machinery Dealer Best Practices. Your Bus Drivers will benefit greatly by mastering these vital dealer management tools. Walt@McDonaldGroupInc.com.

I’d welcome hearing from you if you would like to discuss any aspect of this article: Walt@McDonaldGroupInc.com.