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Since the 1960’s absorption has been one of the key metrics in this Industry. It has almost become the Holy Grail to many dealers. The sum of the net income developed from the parts and service departments should exceed all of the expenses of the sales department, the administration group and interest. (This was before the rental business arrived on the scene.) How about a brief review of what this is all about?

The net income of the parts and service department is pretty clear isn’t it? One would think so until we get into how different dealers account for different things.
The first thing is that the selling price for all activities in parts and service are supposed to be recorded at retail prices. This has been an item of contention for some time so how about we clear it up. Many dealers discount, how I hate that word and action, to the sales department and other internal departments. The sales groups get subsidized by parts and service. So when absorption was first designed it was a management metric not a financial reporting metric.

The absorption that I was taught was from Bill Blackie, who is reputed to be the “father” of absorption when he was Chairman of Caterpillar Tractor. He required everyone to “report” all sales activity at retail prices. After all he was interested in price points for equipment too and if different dealers reported the cost of the machine in different ways how could anyone determine what the correct price point was for a machine?

So back to the calculation of net income, there is one other anomaly to eliminate and that is allocated expenses. The only expenses that are supposed to be applied to parts and service are the “actual” expenses they incur. Not some arbitrary allocation that eliminate head office, or accounting, or the ownership; the personnel, operating and fixed expenses of the part department and the service department.

Alright that is the net income side or the numerator of the equation. Now we move to expenses for the sales group and the administration group. First the sales department, we can not include any of the expenses for the rental group. They were not included in the original absorption calculation as there were no rental activities of significance when the measure was designed. So eliminate all of the expenses for the rental group. Then there is administration. One of the lessons that Mr. Blackie taught me was that absorption was not just about increasing the net income of parts and service departments; it was also about constraining expenses of sales, administration and interest. Think about it. Without controls on the expenses we can drive the dealership crazy trying to catch up to expenses that are out of control. Administration expenses should not exceed ten percent of the sales of parts and service. That makes sense with a little thought after all the parts and service departments are the transaction drivers of a dealership. The majority of the A/R and A/P and personnel activities are caused by parts and service so the metric on cost should be tied to the sales levels of parts and service. If your administration expenses are more than ten percent something needs to be done.

And finally interest costs. Inventories, for new and used machines (exclude rental again), parts, supplies and work in process, and receivables should be the majority of the interest bearing assets, (I am excluding mortgages as there is such a variation on how land and buildings are handled across the Industry) and they should be managed as well. Inventory turnover is a real metric and needs to be managed. So is the amount of money owed in receivables.

So there you have it. Net Income from Parts and Service should be equal to or greater than the expenses of the sales department (excluding rental), administration group and interest. Pretty simple isn’t it?

So why is it that we struggle trying to get it done? I believe it is because we pay lip service to parts and service when we really are interested in selling machines.
Parts and service pays the bills. Parts and service keeps customers coming back, or not. But parts and service is not easy. It is tough work that is dependent on talented and caring individuals, people that know how to do their jobs and are supported with effective systems that allow them to serve customers in the manner that the customer deserves.

The market is soft, the economy is struggling, we are in the funny season of an election, we are finding it harder and harder to attract and retain good people in all areas of our business, this is a perfect time for a challenge isn’t it? No I am not being flip about it. I am deadly serious. When there is a need, a fear, what better time than now to get a “focus” on what we need to do? Everyone will get to work supporting the changes that are needed. If not now, when?

Good luck.