Know Real Cost of Business

“It's one thing to watch our volume drop, but that decrease, coupled with the erosion of our margins is creating real issues in our industry (for dealers) today.”

That's what a long-time dealer friend told me when discussing the challenges of dealer profitability.

“Today, probably more than ever, it's not just about selling in volume, but about the real cost and ultimately the margins generated vs. your costs of doing business,” he said.

Competitive factors, either real or perceived, often dictate the discounting of our prices in order to generate more sales.

But when we factor in the actual costs associated with these discounts, are we really accomplishing what we set out to do? By factoring I'm not only referring to the cost of the product but also the cost to sell the product.

To find everyday examples of this, look no further than your parts or service operations. Competition in the local marketplace may require me to discount my prices but, do I take the next step? Do I, or can I adjust costs to ensure my margins are adequate to cover my overhead.

When analyzing service department profitability, one of the first steps is to identify/calculate our actual costs using the following formula:

Total Labor Sales $____ ÷ Shop (Combined) Effective Labor Rate $____ = #_____Hours Sold

Total Department Expense = $____ ÷ #____ Hours Sold = $____ Expense per Labor Hour

Expense per Labor Hour $____ + Average Technician Wage per Flat Rate Hour $____ = Cost of a Labor Hour $____

For an example, let's use an expense per labor hour of $65 per hour and a weighted average technician cost of $18 per flat rate hour. Those equals cost of $83 per sold hour.

If we want to run a quick/express service or maintenance promotion featuring a lube, oil and filter for $14.95 as the leader, can we, based on our known costs, do this profitably?

We will pay the technician .3 hrs or $5.40 for this labor operation which leaves a gross of $9.45 compare to our cost of the labor operation of $19.50 ($65 expense per labor hour × .3 hrs) excluding parts.

Our DOC or financial statement will show a labor gross profit margin of 63.9% but what our statement doesn't show is the $9.95 loss. So, from a margin management standpoint if we want to make this a profitable promotion, our options are limited.

We must adjust the cost of our labor, reduce our departmental expenses or increase the sale price of the operation. Or is there another option available to help accommodate the needed discount for this promotion?

When we look at the gross profit per new- and used-vehicle sold, we realize this is strictly an average based on multiple transactions with different gross profits.

In sales, we learn early that we don't want to miss a deal and that there will be some higher grosses. To cover our costs, we need to be at a certain average.

That same principle applies in service where, based on our vehicle mix, we can generate different levels of gross profit based on the skill level required for the job. Doctors charge more for brain surgery than for a routine check-up.

Many of the financial exercises used by consultants and manufacturers calculate the cost to break even in individual operating departments. We aren't in the business of breaking even, but it is imperative we know real cost of doing business.

If we don't know our costs, how can we competitively price our products to ensure there is adequate gross generated to cover our overhead?

As we embark on the new year, please make it a priority spend time with your comptroller or CFO calculating your costs by department and then comparing those cost to the gross profit you are generating.

Should you have questions on this process, or need formulas, please let me know and I will be happy to provide them.

Good selling!

Tony Noland is a veteran dealership consultant. He can be reached at [email protected].

Questions or comments about this column?
Send us an e-mail at [email protected].