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What is Dealer Absorption Rate and Why is it Important?  

You are probably thinking, “great another number to remember and calculate every month.” We get it! You’re busy, you’ve got a lot to do, and working out mathematical equations probably does not seem to add immediate value to your business (or department).

No doubt, tracking a bunch of numbers that do not have a meaningful impact on the business or your department is a waste of time. But what if there was a single metric that stood apart from all the others that could tell you the overall health of your dealership (not just your service department). Would that number be an important number to pay attention to? What has been confirmed by our experience working with many dealers of all types and sizes is that the highest performing dealers understand the importance of and diligently track absorption rate.

Dealer Absorption Rate in our Operation

It’s an interesting term, and as recruiters, we’ve come to adopt a form of absorption rate in our operation. Many know what absorption rate is at a high level but may not understand its true definition. Our rudimentary definition is, the ability for a dealership’s parts and service gross margin to absorb the overhead (operating expenses) of the dealership. If you take our business, as an example, much of our income is derived from executive search fees. The challenge, though, is we don’t always know when we are going to pick up a new search or when an existing search is going to close. This makes forecasting a real challenge, which makes for very lumpy cash flow (and a lot of stress).

The same is true for dealerships that rely heavily on big-ticket machine sales (typically low margin). This likely creates a feast or famine financial outcome that can cause a lot of stress on a business, and not just financial stress. It also impacts culture, supplier relationships, banking relationships, and OEM relationships to name a few.

The Importance of High-Performing Product Support Teams

Parts and services are typically the highest gross profit-generating aspects of your business (not including used equipment sales). While top-line revenue is a sexy number, many businesses have fallen prey to top-line growth at the expense of profitability. Absorption rate is typically considered a financial metric, but the reality is, if your absorption rate is low this means your service department is likely impairing tomorrow’s machine sales. We’ve all heard the phrase, “Sales will sell the first, but Service (including parts) sells the rest.” OEMs know, too, that high-performing product support teams make all the difference in helping them gain market share and retain customers.

What is a good target dealer absorption rate?

The general rule of thumb is 100%. This means that your product support team (parts and service) are generating enough business to cover at least 100% of the dealership’s operating expenses. Now, perhaps this number varies depending on the type of dealership (small ag equipment dealer versus heavy dirt dealer), but generally speaking, 100% absorption rate is the industry’s best practice. This allows the gross profit from rental and equipment sales to go straight to the bottom line. The healthier the bottom line, the healthier the business because now it can invest in itself, build insulation from financial downturns or setbacks, create investment capital to grow, as well as drive healthy and thriving cultures.

Below is a simple absorption rate calculation example.

Parts & Service Gross Margin$1,300,000
Dealership Operating Costs$1,400,000
Absorption Rate Calculation$1,400,000 / 1,300,000 = .92857
Absorption Rate92.86%

In this simple example, absorption is below the target of 100%, but it’s still a great number and can likely be improved upon!

Ingredients to Success

If we’ve learned anything in recent years, relying on the profit of your machine sales to sustain your business is a risky proposition. Today, with constrained supply chains it doesn’t matter how great your sales reps are if your OEM can’t get you inventory. Lead times today can be as long as two years on some equipment. So, if your dealership isn’t maximizing the opportunities to drive parts and service gross margin, then it is never too late to start. If you need help let us know. We can start with an assessment of your parts and service talent.

In the end, your talent is the base ingredient to your success. If your talent and team are weak, then driving numbers to the bottom line will likely be a persistent problem.

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