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Know your margins to earn a fair profit

Wednesday, July 11, 2012 - 08:41
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ONE OF MY favorite TV shows is "The Shark Tank." If you've seen it, it may be one of your favorites as well. If you haven't, it's a show that brings together five wealthy investors who get original, money-making ideas pitched to them each week by budding business people. The goal is to get one or more of these investors to invest their own money into the venture. It's an interesting show.

One thing I notice when watching it is that the investors, the super rich men and women, all know their numbers very well. They understand valuations of businesses, return on investment (ROI) and the profit margins every prospective business needs to reach its real goal – making money.

Most of you are probably like me – you love the collision industry and approach every day with the passion that your love of the business generates. Our passion for the industry usually is what keeps all of us going when times are a little tough.

But really, at the core of it all, we need to make money at what we do to sustain our lives outside of the industry. The collision industry is not different from any other business in that way. They all exist to make money.

What is different about many other industries, however, is that there's often a set of general profit guidelines tied to them that aren't secret. By this I mean if you were going to start a retail business, for example, you would generally know what the expected profit margin on the merchandise you were planning to sell should be before you started the venture. At least you would have a range. The "sharks" know what they need to make on every deal before they commit. Why is it then that the expected profit margins on collision repair work seem to only be communicated in darkened corridors? Are we are supposed to, as an industry, do what we do for free? Let's see if we can change this attitude.

Break even

In a prior article, I explained what a break-even number was. Judging by the number of requests I received for my spreadsheet, which I offered in that article, many of you must have read it. If you haven't had the opportunity to see it, I suggest you click on this link and take a look: www.abrn.com/myb8.

Understanding what you need to make each month to keep your business running is elemental. It is no different than knowing what you need to make personally to pay all of your bills at home. Unfortunately, knowing what you need to make isn't going to generate revenue, but it will help you plan how you are going to do it. If you pay attention to the overall gross profit on every single job you do, one job at a time, you will have a much better chance at getting a handle on this important issue.

Let's break it down by taking a closer look at gross profit, labor, sublet, paint and materials, and parts.

Gross profit

Gross profit is simply the profit you make on each department of a particular job, added together. This number is based on repair orders only. It does not include overhead expenses like mortgages, taxes and utilities.

Examples of average departments we are going to look at would be parts, labor, paint and material and sublet. In each department, what you charge to do the repairs versus what you pay by department equals that department's profit. It's pretty simple.

Here is an example: You sell $100 of labor on a job. You pay your technician $50 to perform the labor. Your profit is 50 percent, or $50. Is 50 percent a good margin to make on your labor sales? Is it great, average, above average or just OK? Fifty percent isn't terrible, but it shouldn't be your goal.

In general, I have always tried to attain at least a 45 percent to 50 percent overall gross profit margin on each job that my shop does. The individual departmental profits combined create that average. Let's look at each department and suggest an average that you should look for.

Labor

Always keep in mind that selling labor is one of your greatest opportunities to generate profit. It is also one of the easiest areas to give it away as well. You should set your profit goal in the labor department at 60 percent. The best way that I know of to maintain that level of profitability on labor sales is to pay your techs a 40 percent commission. This way, no matter what the labor rate is on any job you are doing, you will always be assured of a 60 percent margin.

Of course, other factors like poor cycle time and low efficiency can affect that margin dramatically, but sticking to the basics here will help you get a handle on those other factors later on. Don't try and create complicated pay plans with all kinds of incentives built in. Just keep it simple. You and your staff will find it much easier to manage that way.

Obviously, if you have a management system, you can easily see what your labor gross profit per job is at a glance any time you want. If you see a lower-than-expected level of profit while doing so, dig deeper to find out why. Maybe a tech was over flagged or you paid more than one person on the same job. Whatever the reason, fix it before the job is closed and committed to record.

You have to be vigilant and aggressive and take care of each issue right away, job by job. If each job produces at least 60 percent or more on labor, your overall labor profit has to be at 60 percent as well. If you don't have a management system, you must track these metrics, by department, manually on every job. Doing so job by job breaks the task down into manageable bites.

If you pay your techs hourly, or on a flat rate, cycle time, labor rates and inefficiencies will affect your profit percentages more than if you pay by commission. Think about this – your lead tech is making $18.50 per flat rate hour. If your door rate for body labor is $44 an hour, you are making about 57 percent on labor sales. If you accept a job, let's say for $42 per labor hour, your tech still makes $18.50, but you are only making 55 percent gross profit on labor. If there are any parts on a repair order like these examples, you don't stand a chance of making 45 percent overall gross profit on them.

Remember, 45 percent should be the minimum acceptable number. More is even better. In addition, make sure if you are performing a mechanical labor operation, charge the mechanical labor rate. You will generate more profit. I always suggest that you try to sell as much labor as possible. If you can repair something rather than replace it, do it.

Sublet

Many shops working under insurance direct repair provider (DRP) contracts have limits on their allowable sublet mark up. Generally, a 25 percent to 30 percent markup is the industry norm. This markup generally works out to be about a 20 percent to 25 percent profit. In the retail industry, this margin would be considered way too low. Yet in our industry, we accept it. I am not going to comment about DRP policy. I follow it in my shop, and try my best in most instances to get the proper and fair markups on it whenever I can.

In a non-DRP environment, you can charge a little more, but in general, if you can maintain the 25 percent to 30 percent numbers, your overall gross profit will be OK. The only thing I can suggest here is to try not to sublet much. The more work you can do in-house, the greater profit you will retain. You can even buy equipment if you don't have it for, let's say, air conditioning, and get trained on it with the extra profit you will make over subletting. Once the equipment is paid for, that profit will be yours, boosting your gross profit nicely.

Paint and material

I love my paint line. It's really great stuff, which helps my shop excel in several areas because of how good it really is. But it costs a lot of money. My guess is that you feel the same way. Again, most of us are limited in the amount of material that we can charge per job. This issue becomes compounded by waste in the paint and body departments, and a lack of inventory control at the management level.

I could write a complete article on how to manage your inventory in your materials department. For now, however, ask your paint supplier for help getting your numbers under control. You should be making at least 35 percent on paint and materials. Fifty percent is better.

Your material costs, at least for liquids, are readily available from your mixing system computer. You can quickly look at your profit margins by taking your mix costs per repair order and comparing them to what you are collecting on the job. Of course this number is for liquids only, but your jobber will be able to give you an approximate allied use percentage based on their product line and your particular shop situation. If you are not making 35 percent, you need to look at usage, over mixes, waste and estimate quality. Charging too little for paint labor will affect your material sales number.

Parts

Parts issues have become a huge topic of discussion lately, especially with some of the new DRP programs that are being piloted involving the insurance company in the parts process directly. Time will tell how this issue will be sorted out, but suffice it to say, it has always been a challenge for shop owners to make an acceptable margin on parts.

We as an industry have always tried to beat up our vendors for better-than-average pricing so we could make better margins.

Recently, the vendors have been lowering the retail prices and raising the wholesale ones, shrinking the profit margins. In addition, many DRP agreements require parts discounts on certain OEM parts. The combination of all these cost-saving efforts has made it very difficult for most shops to make an acceptable margin on parts, which is why repairers often battle with the vendors over part costs.

However, maintaining good relationships with your vendors is very important.

If you watch your returns and pay your statements in a timely manner, most vendors will bargain a little with you on negotiated discounts.

Aftermarket, LKQ and reconditioned parts are all a huge part of the industry. In general, shops have a greater opportunity to make a larger profit percentage on these types of parts. They have their time and place, so don't be afraid to use them if the situation is right.

On average, you should be making about 28 percent to 30 percent on most domestic original equipment parts, and more than 40 percent on aftermarket parts.

Your LKQ vendor should be able to work with you to get your LKQ profit around 25 percent. Again, your LKQ markup is spelled out in your DRP agreements, but with the help of your vendor, you can generally do OK on LKQ parts.

If you maintain averages by department in the same general area as the suggestions state, you should be able to consistently reach the 45 percent gross profit percentage average that I try for in my own shop. Attaining these averages is very important, especially knowing how difficult it is in today's economy to capture repair work.

It doesn't make any sense to work so hard to get a job, only to give away most of the profitability by simply not paying attention to these important details.

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