Today, we’re going to talk about fixed absorption. It’s a term that everybody thinks they know, but maybe they don’t. What is it? What’s the formula? How do you focus on the dealership health as a whole?
We’re also giving a history lesson on Henry Ford that you won’t want to miss!
We’ll answer questions, but first we’re playing ‘Would You Rather?’ This is where I asked Christian would you rather do this, or would you rather do that?
“Would you rather fire a single mom who’s a service advisor, who’s late all the time, and can barely pay her bills, plus the dad is a deadbeat, or would you rather interview a dealer’s friend who thinks he can be a tech, but he’s been selling insurance?”
Christian’s wants to give me an honest answer, so he has some follow-up questions.
How many kids does the woman have? Let’s say three. What’s the oldest kid’s age? 16 and he’s a pain in the ass. He knows everything. Does the woman have any tattoos? This question threw me off, but yes. How many times has the dad been to prison? Zero. And I have to explain to Christian that’s he firing her, not dating her. That’s a different game.
With the dealer’s friend, what kind of insurance? Car, home, that sort of thing. How many jobs has that guy had over the last five years? Two. Drinker? Yes, and let’s just say that they’re a straight up alcoholic.
Christian has a heart made of stone, because he’s going to fire the single mom. Why you ask? Because he’s never seen an insurance person become a technician before!
There you have it everybody. Please put in the comments what you would rather do. Are you cold blooded like Christian or do you actually have a heart?
Let’s go to questions from the audience.
It’s tough. In a lot of situations, the insurance company won’t cover you and so it really isn’t even the employer’s choice because they can’t hire somebody that they can’t insure. And it gets harder and harder with all of the lawsuits and claims that happen. The insurance companies have a pretty good handle on what you can and can’t do. A lot of dealerships just wouldn’t be able to hire you because of their insurance at the time.
Most of them probably wouldn’t even interview you because they know they can’t move forward. We’ve tried getting things like that pushed through and it has 100% been a no.
It’s more than just an uphill battle, it’s an impossible fight in those cases. It’s terrible because everyone deserves a second chance. Since the dealer world’s strict, it might behoove the caller to try an independent shop where there’s a little bit less HR red tape and he might be able to get in a chance based on his merit and his abilities as a service advisor. We would really like to see this guy get a chance.
Now Christian wants to talk about fixed absorption, because oftentimes it’s a term that’s thrown around, but a lot of people don’t understand what it means. It’s really bloody important to Christian. And it’s coming up more and more in the field from our clients.
One thing that’s great about fixed absorption is that it’s not service, it’s not parts, it’s what’s happening in the back. It naturally brings those two departments together.
What I understand about fixed absorption is that it came out of Henry Ford trying to scale up Ford. He had a dealer network, but he would deliver the cars and get paid after they sold the cars to the consumer. And to scale, he needed to increase his cash flow and not have receivables. So, he convinced the dealers to get a line of credit, which we call a flooring line. Which means when the Model A’s were delivered to the dealer, they were put on a line of credit with the bank. And then Ford got paid right away, but the dealers had to pay interest on their inventory.
Let’s say an inventory at a dealership can be 10M or 20M. Depending on the brand, you could have $10M worth of new cars in inventory and then that dealership is paying interest on that money. And so let’s say interest rates are 5%.
So, you’re going to be paying 5% divided by 12 months because it’s an annual interest rate, right? Then, your flooring expense in a dealership can be $20,000 to $100,000 a month.
We’re getting into the history lesson but stay with me. Ford encouraged the dealers to have service and parts departments. And they literally used to make these charts of what it would cost to build a Model A in parts and service. The Model A cost a $1,000, it costs $17,000 to build it in parts and service. Now, nobody in parts and service is ordering a wood frame Model A and building it. But the point is that if they serviced cars, they would be able to cover the overhead of the dealership. And if times got tough, they could give the cars away at cost and still be profitable because of their parts and service business. That’s why dealerships have parts and service.
It was a big part of how Ford scaled and then other manufacturers followed suit.
If you think about it, it is odd that dealerships have five different businesses inside of one business, right? They could be separate businesses – warranty came later and then it made more logical sense. But it is a measurement of how healthy your dealership is in a competitive market. Do you have parts and service and a body shop, essentially fixed ops, and they cover the overhead of the business? And could you just give away cars or trucks at costs and still be profitable? Or in some cases, and this has happened, you give them away to a loss and you’re still profitable. You really could make a dealership profitable by giving away the car and charging for the maintenance, in a sense. We might move to an economy where it’s more of a lease and maintenance type thing. Especially, if cars don’t depreciate as much as they have historically, which might change, they might just have more software updates and they might not depreciate as quickly. We might be more of a printer model where you’re buying the printer at cost or even at a discount, but where we’re making the money is in you buying the ink cartridges over time and it’s more of a subscription model. I hear Porsche tries to do that here in Los Angeles. A couple of their manufacturers are trying to have subscription models.
So fixed absorption, when you say 100% fixed absorption, that means that the fixed ops are covering 100% of the overhead for the dealership. And there’s two ways to do that formula. One would be all of the overhead, the other would be taking out the sales departments, commissions, flooring, expense, and advertising – the variable selling expenses.
You are definitely served well by doing everything you can to support the sales department, because the sales department gives you the most customers. You want to keep as many cars going out of your sales department as you can because six or 12 months down the road, those people are coming to see you. So focusing on the whole dealership health is exactly why I fixed absorption exists.
The customer sees us as one business or one manufacturer, they could care less that there’s parts, service, sales, finance, etc. It’s one experience and one payment in their budget monthly. We will, as an industry, adapt to that and there’ll be fewer walls in between departments. It’s conceivable that the service department could be selling the next car, especially when manufacturers start going to more of a subscription base.
For example, the Porsche subscription here in Los Angeles, you just call the concierge and they bring you a different one. So you have three levels. And if you subscribe, let’s say to the middle level, and in the middle level, I don’t know, it’s their middle SUV and the Panamera and something else. I don’t know what it is, but you want a Panamera and you want to give back the SUV, you call them, just swap it out. Sounds pretty darn easy, right?
And you’re not going in for a service either. As things evolve, the service departments will be more of a fleet type service department than a consumer type.
So, that’s fixed absorption in a nutshell, it is the health of the dealership. How healthy are you in a competitive market and even in good times? And service and parts managers should be talking about that number every month. How are we doing? Are we covering the nut?
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