The goal is to have the highest level of Parts and Service Department absorption possible, with 100% being the minimum aspirational goal. The Absorption Rate or percentage is a way for the dealership to measure if the gross profits produced by the Parts and Service departments can “absorb” the entire dealer’s overhead expenses. This may seem “unfair” at first glance but there are many good reasons for it. First, it is a measurement of business health and the ability of the dealership to survive when the economy slows. Second, it answers the question if parts and service are taking advantage of the potential for business created by selling new equipment. Third, customers may stop buying new equipment when there is uncertainty, but they still need to maintain, repair, and update their existing fleet of equipment. Forth, it is a logical way to measure how engaged the aftermarket group (parts, service & services) in your organization is, as they maintain and build long term relationships helping the dealership’s customers. There are many other reasons for this goal. An expert in the area can share others with you. However, the bottom line is that the dealership may not be viable long term without working toward this goal and is not taking advantage of some opportunities for financial gain.
How does a dealership calculate parts and service department absorption?
Parts & Service Department Absorption Formula:
**Variable expenses should not be included in the equation.
Absorption is a method of allocating the costs associated with operating the business and apportioning them to individual products or departments. In a manufacturing environment, costs are typically assigned to each product that is manufactured. For a service business, there should be similar consideration to how costs are allocated as it is helpful to gauge the health of the company and what steps should be taken to improve performance. Fixed and variable costs are typically both allocated by department in a service business.
Absorption costing has several benefits:
- It is consistent with GAAP accounting guidelines and identifies costs associated with a department or product
Ultimately, any changes to the accounting approach should be made based on diligent research by your accounting team.
Many dealerships, including RV dealerships on average, are below 45% Parts and Service Department absorption. Many equipment dealerships perform at a similar level. If you have been in the industry for a while, you have seen dealerships come and go and may have wondered why. One reason why this frequently happens is because of the failure to understand, measure, or improve absorption.
High performing dealerships are well beyond the performance level noted above. With changes, including clear strategy and marketing plans specific to your sales of labor, parts, services, and accessories, significant improvements can be made. Aftermarket (Service & Parts Departments) must be considered a profit center, not a burden required to sell new equipment.
In some cases, the perception is that the technicians on staff are already busy, so all must be good. This approach is flawed. We must acquire available business then staff to support the business. Consider your favorite restaurant. If you visited this weekend and the host told you that they were not interested in your business because they only had two servers. The servers were already busy assisting other customers, and they had no plan to add staff or help the staff serve more customers. Would you be impressed or make it a priority to return to the restaurant? Be careful that your approach does not mirror this example.
A good test to determine the status of your service department and estimate if your dealership is performing well is to look at the machines/vehicles in your shop right now and see the ratio of machines that are in for warranty repairs versus those that are not then check if the service department is the largest customer of the parts department. “Customer” repairs should significantly outnumber “Warranty” repairs, and the service department must be the number one customer of the parts department; otherwise, there is cause for concern. If the service department is not #1 for parts sales, then we should view this as lost sales opportunities. Remember that all those missed opportunities to sell service labor have a 50% or higher margin associated with them. This is likely the highest margin business within your dealership.
In addition to observation, the other key next step is to look at your financial report to determine current Parts and Service Department absorption. Depending on your business system and available reports, it may require some work to gather the information to calculate it. Once it is done for the first time them updating monthly to determine what improvements have been made should be more straightforward.
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