Tuesday, March 6, 2018

March 2018: The Top 5 "Unseen" Costs Of Managing The Parts Inventory

In most automotive dealerships, the success, or demise of how well the overall profitability and performance can be determined each month in the dealers' financial statement. Profit and Loss Statements are the clear facts and the overall evidence that is used to manage the successes and failures month to month.

Each month, most dealers hit their peaks of anxiety in the first ten days as office managers and comptrollers prepare the numbers each month to meet their deadline by the 10th of each month. Once revealed, the "dissecting" begins with the dealer reading the profit and loss statement from the bottom up.

For the most part, the facts are the facts as the financial statement reveals whether they can keep the doors open, or advance to the next level of financial achievement. Along with soaking in all the information in the financial, most dealers are also carrying the burdens of many families employed at their dealerships.

So, with all this said and revealed about the dealer financial statements, shouldn't we also be looking at ALL the opportunities in sales and profits as well as expense controls that may NOT be revealed in the monthly dealer financials?

Dealers often look at the opportunities in all departments based on their potential, but when it comes to expenses, if it isn't right in front of them, the "unseen" expenses and opportunities go by the wayside and never even come up in any discussion or meeting.

These "unseen" expenses and potential opportunities can not be more evident in the dealership then they are in the parts department. 

The parts department is also the one dealer department that most dealer owners are least familiar. In fact, many dealers are only concerned with the parts department profitability and perhaps inventory obsolescence amounts.

I believe it's time to expose these "unseen" expenses and potential opportunities in the parts department as we will break down the actual cost of "The Top 5 Unseen Costs Of Managing The Parts Department". 

Keep in mind that after we review these "unseen" costs, they are real as we will use a "real life" dealer scenario to determine these newly found "seen" costs of managing the parts department. 

We can also view these "opportunities" as a potential "cost" to the dealer because there is a cost for not capitalizing on potential missed opportunities in my opinion. 

First, lets list all important information that we will need to drill down this scenario in this example dealership which I will refer to ABC Motors, Inc. in Anytown, USA....

  • Parts Inventory Value: $200,000.00, (Desired Inventory Level: $150,000.00 Based on Average Monthly Cost of Sales and NADA Guide of 8 Gross Turns Annually)
  • Average Months Parts Cost of Sales: $100,000.00
  • Average Months Financial "Discounts & Allowances": $3000.00
  • Obsolete Inventory, (No Sales Over 12 Months): $25,000.00
  • Overstocked/Excessive Parts Inventory: $25,000.00
  • Parts Inventory Gross Turns: 6
  • Parts Inventory True Turns: 3.5
  • Overall Off Shelf Fill Rate: 95%
  • Overall "First Time Off Shelf Fill Rate": 45% (Sales of Normal Stocking Parts)
  • Number of Technicians: 10
  • Combined Overall Shop Effective Labor Rate: $95.00
  • Parts to Labor Ratio: 85%
  • Total Average Number of Repair Orders Monthly: 1000
  • Overall Labor Gross Profit Retention: 70%
This information will be needed when we start to analyze these actual "unseen" costs when we drill down the at least three of our "Top 5 Unseen Costs Of Managing The Parts Department".

Number 5: "Overstock/Excessive Inventory Amounts"

Once again, based on what we see here at ABC Motors, the dealers value of overstocked/excessive inventory totals $25,000.00. 

As we will learn when we get closer to our number one "unseen" parts department expense, annual parts "holding costs" average 29% annually, (excluding obsolescence holding costs of 7%). This percentage does not even include obsolete parts as we will also see when we get closer to number one.

Net "Unseen" Annual Expense From Holding Costs On Additional Inventory: $7,250.00

Number 4: "False Profits"

Number 4 in our countdown in "unseen" parts department expense is "False Profits". Even though a profit account is not really an expense, but by inflating fictitious gross profit, it will lead to false bottom line. This category of "False Profits" refers to the parts monthly "Discounts & Allowances" account on the dealers financial.

We also have to remember that the "Discounts & Allowances" account is for the most part "paper money" and not tangible unless the parts inventory meets annual gross turn guidelines set by NADA of at least 8 annual gross turns.

Based on the above information from ABC Motors, the dealer is realizing an average of $3000.00 per month in "Discounts & Allowances", but only achieves an annual gross turn number of six turns. 

NADA Guideline for annual parts gross turns is eight. This money in the "Discounts & Allowances" account is only real if expected annual parts gross turn numbers are at or above NADA Guide.

Net "Unrealized" and "Unseen" Annual Profit From 6 to 8 Gross Turns: $9000.00

Number 3: "Inventory Holding Cost"

Inventory Holding Costs is probably one of the most "unseen" expenses in the parts department. "Investopedia.com" defines Inventory Holding Costs as follows;

"Holding Costs are the costs associated with storing inventory that remains unsold, and these costs are one component of the total inventory costs, along with ordering costs and shortage costs. A firm's Holding Costs include the costs of goods damaged or spoiled, as well as cost of storage space, labor and insurance."

Determining the actual cost of holding inventory is defined and detailed by "driveyoursuccess.com" where they determine that annual inventory holding costs are a staggering 36% annually. 

This annual percentage is broken down as follows:
  • Cost of Money: 3% - 5% (Difference From Interest Gains On Monies Invested In Inventory)
  • Ruined Inventory: 3%
  • Electricity Costs: 3%
  • Lost Customers: 3% (Due To Inventory Not Available)
  • Freight Costs: 7%
  • Employee Overtime: 3%
  • Damaged Inventory: 7%
  • Obsolete Inventory: 7% (Includes Theft)
Total Estimated Annual Parts Inventory Holding Cost Percentage: 36%

Even if these stated Annual Inventory Holding Costs are higher than actual costs as I have always estimated them to factor in around 25% - 30%, they are real and as we can see, they can add up to a substantial amount in the area of "unseen" dealer cost.

So, in the case of ABC Motors, if we just calculate the parts inventory annual Holding Costs, not including their obsolescence and overstocked/excessive amounts, the number is still quite staggering.

  ABC Motors has $200,000.00 in inventory, even if we exclude the obsolescence, ($25,000.00) and their overstock/excessive inventory amount, ($25,000.00), the results are as follows...

Net "Unseen" Annual Holding Costs Expense From Active Inventory: $43,500.00

Number 2: "Lost Service Productivity"

I would have guessed that most "Smart Parts" Managers out there would have thought that Lost Service Productivity due to low "First Time Off Shelf Fill Rates" might just be our number one, but not quite. Even though these numbers that we will drill down are also staggering, we still have an even bigger number one.

In order to calculate and put the "unseen" expense, or in this case lost profits opportunities, we have to rely on excel calculators to come up with a feasible number in this category. 

Using the initial information that we started with in ABC Motors, we are actually able to put a number on what low "First Time Off Shelf Fill Rates" actually costs. 

Lost Service Productivity due to not having the right percentage of stocking parts on the shelf on the technicians' first visit can add up quickly. Keep in mind that contrary to the parts inventory, or even the new and used vehicle inventory for that matter...the technicians' time is a perishable inventory that we can never get back.

Based on ABC Motors "First Time Off Shelf Fill Rate" of just 45%, which is about the average in most automotive dealerships today, falls far short of NADA's recommended guideline of 85% - 90% in the area of "First Time Off Shelf Fill Rates".

A recent survey study revealed that the average technician, (excluding Express) works on an average of 4.5 to 5.5 vehicles per day, or repair orders per day. We also learned in this study that the average technician spends at least 25 - 30 minutes at the back parts counter each day.

Excluding those dealers who have a parts delivery system to their technicians, this time spent at the parts department is in my opinion, pretty respectable, even though I have met many service managers say that this number is much higher. 

Even still, for the sake of coming up with a valid "Lost Productivity" number due to low "First Time Off Shelf Rates", I'm okay with using this latest information from the study. 

The basis of my calculations will be based on the additional time spent at the parts counter due to ABC Motors "First Time Off Shelf Fill Rate" at almost half, (45%) of the recommended NADA Guideline.

After putting the excel calculator to work, the result of the added time at the parts counter, extra technician steps, moving vehicles in and out of the shop, or waiting additional time for parts to track down the parts from outside sources added up to 3.2 hours of lost productivity each day for the 10 technicians on staff.

Once we added up the lost productive hours each day and the lost parts sales based on current ABC Motors parts to labor ratios, current parts and labor gross margins, and an average overall effective labor rate of $95.00, it didn't take long before the overall lost gross profit was finally revealed.

Total Net "Unseen" Cost To The Dealer In Unrealized Profits: 
Monthly: $8,299.00  Annually: $99,593.50

At last, we arrive at our number one "Unseen" Cost Of Managing The Parts Department. Actually, our number one should not be a surprise to "Smart Parts" Managers. What may be a surprise is the actual net "unseen" cost AND missed opportunity that really costs the dealer due to simply "not knowing"....

Number 1: "Obsolete Inventory"

So!...how could "Obsolete Inventory" be numero uno when ABC Motors only has $25,000.00 in obsolete inventory over twelve months?

First of all, based on the information from "driveyoursuccess.com." we already know that we have annual holding costs of 36%, so that cost alone represents an annual holding cost of approximately $9,000.00, but that's not nearly enough to surpass our number two sitting at over $99,000.00.

Well, we've saved our best and biggest "unseen" net cost to managing the parts department for last. This $25,000.00 sitting in obsolete status not only costs ABC Motors annual holding costs. This $25,000.00, if reinvested in parts with active movement is where the lost opportunity lies.

If reinvested, this $25,000.00, with annual gross turns at NADA Guide, (8 Gross Turns) would actually produce an additional $100,000.00 in parts gross profit at an overall retained gross percentage of 33%.

This lost net gross gain, or cost to the dealer, doesn't even include potential Lost Service Productivity. Definitely the number one "unseen" cost to the dealer, even though $25,000.00 may not seem that bad....

Total Annual Net "Unseen" Cost To The Dealer In Holding Costs And Unrealized Profits: $109,000.00

Net Annual Total Of All Of Our Top 5 "Unseen" Costs To The Dealer: $268,343.50!!!

"I guess the old saying that what you can't see can't really hurt you doesn't hold true in this case because that missed opportunity of $22,362.00 at ABC Motors each month can really hurt the dealer and could even be the difference between a positive or negative bottom line for the whole dealership."

Dave Piecuch is the Vice President of Automotive Consultants Group Inc. and is the Head Coach for Smart PartsTMThe only "Results Based" High Return Training, Coaching, and Consulting company in the world!  Dave can be reached at Cell 786-521-1720 or E-mail at dave@smartservicetraining.com Vist our Website at www.smartpartstraining.com