Many of you that have followed this column over the years will recognize that I have a serious bias on the side of all things parts and service. You also know that I have several strongly held beliefs relative to the role of parts and service in the dealership.

• Without strong parts and service performance machine market share is at risk
• Without strong parts and service performance dealer profitability is at risk
• Without strong parts and service performance customer retention is at risk
• Without strong parts and service performance dealership absorption is at risk

It is this last one that I want to discuss this month - dealer absorption. What is absorption? The original definition came from Caterpillar Tractor during the Bill Blackie era. Mr. Blackie was a strong believer in the value of parts and service in the dealership and during his tenure as Chairman at Cat several important things happened for the Cat dealerships and indeed for the Industry.

The definition is quite simple. The operating net income earned by parts and service departments should be 100% of the administration and sales department expenses plus interest. In other words the dealership would break even if the sales department made no money at all.

Over the years this definition has changed and been modified just as the business operations have changed and been modified.

During recent years the business model used in the Industry and the profitability of dealerships has changed dramatically. Don Fites during his term as Chairman at Cat is known to have said that the profit on equipment, new and used machine sales, would become zero. That the dealerships would make profit on parts, service, rentals and finance.

Further changes have been caused by the arrival of the rent to rent business. This is a completely different business model and most of you by now know that I would have been happier if the rent to rent business had been a company standing on its own merits rather than a department within the dealership. The distribution business is an operating statement and balance sheet measure business while the rent to rent business is a cash flow business. There are many substantial and significant differences. For instance asset turnover as a business metric is critical in the distribution business while it is next to useless in the rent to rent business.

However let’s get back to the traditional absorption definition - operating net income from parts and service divided by sales and administration expenses plus interest. We should note here that there are no allocated costs applied in this operating net income. This is strictly a measure of the operational profits of the parts and service departments. This is where most dealerships pay attention and push hard on the profit side of the equation. To refer to Paul Harvey - there is more to the story than that.

The rest of the story is that the operating expenses in the sales department and administration have a practical limit. So does interest expense. One of the many things that I learned from Bill Blackie was this –and it is important! There should be a limit on spending in sales and administration. There should be a limit in interest costs. That is the rest of the story.

Dealerships everywhere would do well to study absorption and how it relates to their dealership if only because they would learn that they are spending too much money on the sales and administration departments, let alone interest. Bill Blackie had a bias too in his views on business and it wasn’t only to parts and service. It was to the proper management of the resources available to dealerships and the continuity of dealership during good and bad times.

It is interesting to observe that many manufacturers have used differing definitions of absorption. The cynic in me sees this as changing the rules so that success will be realized and we can move on to other things. This has been the reaction by many as a result of the growing importance of the rent to rent business. Change the definition to reflect the current business realities. It would have been far better to develop a similar measure for the rent to rent business and left the traditional absorption calculation alone.

These changes to the basic metric have weakened the power of the measurement and that is a shame as the measure of absorption is a critical metric in the successful management of a dealership. Ignore it at your own risk…. to ignore it is to perish.