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Management

Rethinking Shop Profitability

The collision repair climate has changed a lot over the past 20 years. A look at your
numbers can reveal a new strategy for making money in this new environment.

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Hank Nunn is a 35-year collision industry veteran. He is now retired.

“We’re repairing more cars than ever, sales are great! But I’m making less money than I did a few years ago. I’m working harder, longer hours too. We’re barely scraping by. What’s happening?”

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That’s a common question I get asked when visiting collision repair shops across the country. Somehow, shop profitability seems to have vanished. Where did it go?

Things have changed. Technological changes to the vehicles we work on combined with a shrinking labor pool have increased overhead requirements and driven up our labor costs. The industry overcapacity combined with continued insurance industry efforts to contain its costs has reduced our ability to increase labor rates at the same pace that our costs have increased. Although there are more vehicles on the road than ever before, fewer of them are making it into our shops due to high total loss ratios. Approximately 30 percent of wrecks don’t even get repaired today!

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So how do we make money in this new environment? First, let’s take a look at what has happened over the past 20 years.

Figures 1 through 5

Figure 1 is an illustration of the Gross Profit (GP) capability of a well-run collision repair shop in 1987. Ah, the good ol’ days! Parts to labor ratios were 60 percent. In other words, for every $100 in labor sales, parts sales were $60. GP percents were good, and labor GPs were in the 60 percent range, including benefits and taxes.

As figure 1 illustrates, a well-run shop 20 years ago could achieve an overall Gross Profit of 44 to 45 percent.

So, what happened? There have been two issues that have significantly impacted shop profitability: Parts to Labor Ratio and shrinking Gross Profit Margins.

Figure 2 illustrates the impact of nothing other than the shift in Parts to Labor Ratio. Remember, in 1987, we had a 60 percent Parts to Labor Ratio. Today, it’s about 100 percent. In other words, for every $100 in labor sales, there’s about $100 in parts sales. Why? Look at airbags and other safety related items that can’t be repaired for a variety of reasons. An airbag may sell for $700, but the related labor for that airbag installation may be as little as $75.

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The effect of the shift in Parts to Labor Ratio has reduced our industry Gross Profit percent by 3.3 points. That’s roughly a 7 percent drop, due entirely to the shift in Parts to Labor Ratio!

Figure 3 illustrates the collision repair industry today. Note that the Parts to Labor Ratio is 100 percent. Also, note the current Gross Profit Percentages by Profit Center. Those percentages have dropped over the past 20 years for a variety of reasons. Labor costs are up due to the shrinking labor pool and increased complexity of the job. Parts discounts are down and many shops have given parts discounts to DRP providers, which results in lower Parts Gross Profit Percentage.

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The combined impact of the shift in Parts to Labor Ratio and reduced Gross Profit Percentages has dropped the industry overall Gross Profit Percentage to 36 percent. That’s a 20 percent reduction of Overall Gross Profit Percentage in the past 20 years.

Now, let’s consider overhead. Over the past 20 years, we’ve seen a huge rise in overhead expense. On the technical side, we’ve had to buy plenty of new equipment to repair the new vehicles. Frame racks, measuring systems, welders, AC recyclers, parts handling systems and heated downdraft booths all cost money, and that money comes from overhead. On the administrative side, computerized estimating systems, management systems, increased insurance and benefits have increased overhead substantially. The increased administrative expense involved in processing DRPs has increased overhead expense as well.

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In 1987, overhead was 25 to 30 percent of sales. So a shop that has a GP percent in the 44 percent range could pay its 30 percent overhead and still net 14 percent. Everything was good!

Today, overhead is running 30 to 33 percent of sales. The same shop in 2007 with a GP percent of 36 percent can still pay it’s 33 percent overhead factor, but the remaining net profit is only 3 percent. That’s not very exciting!

Now, we can answer the question that started this article: “Why can’t I make money even though my sales are up?” Answer: “The increased Parts to Labor Ratio combined with shrinking Gross Profit Margins have reduced overall Gross Profitability by nearly 20 percent. At the same time, Overhead has significantly increased. The overall effect has been a significant reduction in shop profitability.”

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Conventional wisdom says to
maximize the overall GP percentage by selling lots of labor. That makes sense as you still gross 55 percent on labor and only 20 percent on parts. So, fix stuff, and lots of it!

The problem with conventional wisdom is that it focuses on something that we have little control over. The shift in Parts to Labor Ratio is not due to shop management’s decision to replace things instead of repair them. It’s due to the change in the vehicle!

We should look to improve labor sales whenever possible through a more effective damage analysis process. With tight margins, we can’t afford to give things away. That part of conventional wisdom is true. But that’s only part of the solution.

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Embrace Change
Many fight the shift in Parts to Labor Ratios. To win in the industry today, we need to embrace that change.

Let’s assume that we have a late- model vehicle with four hours of damage to its $200 fender. We can replace it or repair it, and our shop efficiency ratio is 150 percent.

Figure 4 illustrates the sales and profitability of both options. If we replace the fender, we increase paint sales a bit as we get paid to paint the inside of the fender.

At first glance, it looks best to repair the fender as we gross a healthy 51 percent on the job compared with the 37 percent we gross on the replacement. Plus, we don’t have to buy
the fender.

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Interestingly enough, the overall Gross Profit in Dollars is nearly
identical.

But let’s go one step further.

The next question to be asked is, “How long will it take to make the money?”


Replace
the fender:
Gross Profit Dollars per Clock Hour = $26.07. At a 150 percent Efficiency Ratio, the 7.0 Billed Labor Hours will take 4.67 Clock or Worked Hours to produce the $182.50 in Gross Profit Dollars. Divide the $182.50 Gross Profit Dollars by the 4.67 Clock Hours and the Gross Profit Dollars per Clock Hour is $26.07.


Repair
the fender:
Gross Profit Dollars per Clock Hour = $22.34. At the same 150-percent efficiency, repairing the fender will take 5.33 Clock Hours. Divide the $178.75 Gross Profit Dollars by the 5.33 Clock Hours and the Gross Profit Dollars per Clock Hour is $22.34.

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The key factor not reflected in figure 5 is dry time. In reality, it will take three days to process the repaired fender due to the dry time of fillers and primers. The replacement may be completed in one day.

A shop can complete three replacement jobs in the same space and time required for the fender repair! That would be $547.50 in Gross Profit Dollars compared with the $178.75 generated by repairing the fender.

Please don’t think I’m suggesting replacing parts that can and should be repaired. The recommendation is to consider profitability and cycle time when considering the repair or replace decision, as well as any DRP guidelines under which you may be working.

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The above illustrations provide some insight into the tactics required to maintain profitability in today’s collision repair industry business environment. Today, the focus for all shops must be to maximize sales, increase productive efficiency, eliminate waste in all forms and maximize administrative efficiency to control overhead. Yes, all at the
same time!

In the example above, we developed the concept of Gross Profit per Clock Hour. That’s a Key Performance Indicator (KPI) that should be tracked, monitored and measured consistently for success in the current collision repair business environment.

Maximize Sales
All shops should have a strategy, or multiple strategies, to increase sales. Increasing sales without increasing overhead expense is frequently possible and results in a lower overhead percentage.

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One need look no farther than Wal- Mart to see how retailers earn a profit with low individual Gross Profit margins: They focus on volume. With the shift in Parts to Labor Ratio in the collision repair industry, like it or not, we have much in common with Wal-Mart. We have to figure out how to bring more work to the door. Plus, we’re working in a much more competitive environment.

Bringing more work to the door can be accomplished by using three strategies. First, create a marketing plan. Marketing is everything done to bring a customer to the door. But it’s much more than doughnuts and calls to adjusters when it’s slow. Marketing should be a constant activity and performed within an overall plan targeting multiple sources of business.

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Second, increase your close ratio. The close ratio is the percentage of estimates that convert into Repair Orders. The industry average hovers around 60 percent. That number can easily be moved into the 70 percent range through the training and implementation of sales skills.

An average estimator, with a 60 percent close ratio writing $900,000 per year in repairs, can increase annual sales by $105,000 by increasing his or her close ratio to 70 percent!

While close ratio is one of the most important KPIs, few shops track it. It should be tracked constantly, by estimator, and the scores should be reviewed on a weekly basis.

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Third, create a better damage evaluation. Many of us leave serious money on the table when writing estimates in the parking lot. Increased damage evaluation skills can increase sales, reduce supplements and speed production with no increase in number of units repaired. Check the “P” pages constantly, write damage evaluations after the vehicle has been torn down and make sure all of the nuts, bolts, clips and materials needed for the repair make it onto the
damage evaluation.

Increase Productive Efficiency
The most expensive activity in any collision repair shop is starting and stopping the repair process. How often do your techs bring a vehicle in, perform an initial teardown, review the estimate and then stop and wait for additional parts, insurance re-inspections or supplement approvals? If that’s a common occurrence in your shop, read the Lean & Mean articles that appear each month in BodyShop Business.

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Constantly look for ways to keep the units moving. This is just as important in small shops as it is in large shops. Whenever a vehicles stops in production, for any reason whether it be parts, hidden damage or quality issues, it’s costing you lots of money.

The KPIs for production efficiency are generally efficiency ratios. Those change from shop to shop and market to market since they’re labor rate dependent. Cycle Time measurement is a great KPI that should be measured constantly with the goal of constantly reducing the number.

One of the key tenets of “lean production” is the elimination of all forms of waste. If a vehicle is sitting waiting for parts, supplement approvals or a piece of equipment, that’s waste. So is having to order parts three times and technicians working for free due to poor damage evaluation skills. And don’t forget re-keying estimates and writing supplements.

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If we really look at our processes, we’ll see many wasteful operations in most collision repair shops. There’s no way any of us can wave a magic wand over the shop and fix every problem out there. The way to streamline the process, both productive and administrative, is to commit to a process of continuous improvement and develop solutions for our problems one at a time.

Measure Everything
To properly and profitably manage a collision repair facility today, we need to measure and monitor many factors. Today, margins are so tight that we can’t just run our shops by the seats of our pants anymore. The days of “fixing a bunch of cars and seeing if we made money” are over.

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The need for accurate and timely management information is more important now than ever. We need to track costs and profits on every job, every day. We need to know profitability by source, by make, by technician, by severity and by service writer. We need to know work in process by both dollars and by hours so that we can schedule efficiently.

We must limit the administrative time required to gather the information we need and reduce our estimators’ and administration team’s workload.

That’s done through the use of a good management system. With today’s margins, we need a tool capable of measuring everything. If you haven’t committed to a management system, begin the process today.

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Budget for Training
Virtually every problem faced by collision repair shops today has been faced by someone else before. If we simply stay in our shop, working from inside the same four walls, we probably won’t get that outside perspective, nor the skills and ideas that will help solve our daily problems.

There’s great, industry-specific training on estimating systems, damage evaluation techniques, sales, marketing, cycle time reduction, standard operating procedures and accounting available to all. All of us need to take advantage of these opportunities and improve our businesses.

Hank Nunn is the president of H W Nunn & Associates, a collision industry consulting company. Hank is the Sales and Marketing Manager and Facilitator for DuPont SMART Seminar series. Hank may be contacted at [email protected].

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