An article was written a few months ago in a different magazine that did a tremendous disservice to the industry and I’m furious. In the article, the author dismissed the idea of a gross profit benchmark of 60% as a myth and that most shops can’t attain it.
That is patently false, and the reasoning behind his statement shows a complete lack of understanding on how a shop’s financials are built, and how a shop produces net income. Further damaging the industry, the author rails against increasing labor rates that will sustain the shop and allow it to attract the best talent available to the market. Instead, the suggestion is to essentially let your customers tell you what your labor rate is and how much they should pay you. Let’s dissect this before my head explodes.
First: If your labor rate is $200/hr., people will complain it should be lower. If your labor rate is $150/hr., people will complain. $100? Complaints. $75? $50? Complaints. There will always be someone out there who thinks your rate is too high and should be lower. Furthermore, when was the last time a customer even brought up your labor rate? Two decades ago? If you have someone calling your shop asking what your labor rate is, it’s the shop down the street trying to sniff out what they should charge — not a customer. Today’s consumer, if price is their top priority, is looking at total cost of job, not an individual line item.
In the article, the author states that you charge what the market will bear and to not base it on costs. What??!?
So if I need a technician, and a good technician can demand $30 an hour, I can just charge $50/hr. labor because customers complain? Just because the shade tree guy down the street doesn’t factor in rent and is the cheapest guy around? I don’t have to worry about cash flow and hopefully I can reduce my expenses to nothing so there’s some net profit at the end of the month? Who runs a business this way?
Many factors go into setting a labor rate. How do you define what the market will bear? Sure, major players in the industry can spend a fortune on research and hire a firm to conduct surveys and run tests. But what is a small business in the tire and automotive sector to do?
You must account for several forces; this is not limited to but mostly concerning your customer demographics, your fixed costs, and how much you need to pay competent people to work on customers’ cars. What is the sense of lowering your labor rate to appease a handful of customers, when that means you can’t pay employees the right wage? You know what the best compliment a shop can ever get is? “I take my car to ‘blank.’ He’s expensive, but worth it.” As a small businessperson, you need to focus your efforts on the customers who understand that doing business is a two-way street. You provide superior service and exceed expectations, and they pay above average rates for that service and convenience. If a customer wants below average price, point them in the direction of somewhere else. What’s the old adage? Price, quality and speed: pick two? The only problem with that advice is as a small business, there is no more market for you in the price area. The big players have that space locked up. You must compete in quality and speed and focus on customers who align with that philosophy.
There’s no reasonable explanation why any ethical author would tell an industry, which has struggled with financial viability since inception, to just pick a price out of thin air based on gut feeling. For sure, a shop in New York City commands a higher rate than one in Norman, Okla. I would not call someone across the country and ask what their labor rate is. Why? Because our costs are different. Their rent is higher. My electricity is lower. We pay different amounts for various services, and we pay our staff differently. I set my labor rate based on what the business needs to create to remain viable. It’s relative.
But that’s the beauty of percentages.
We can have the Norman, Okla., labor rate at $100/hr. while the shop in NYC is set at $170. In the Oklahoma store the top tech is making $23/hr. while in New York it’s $36 (maybe even higher depending on which borough). Rent is cheaper in Oklahoma, fuel is cheaper… on and on. That’s why I don’t’ compare dollars. It’s precisely why I compare percentages, so I can see those businesses on a comparative level.
For a true understanding of what it takes to run a small business and charge the “right” prices, let’s take a deep look into how the 60% gross profit metric is created, and then let’s address why striving to get there is so important.
Sixty percent gross profit is driven by much more than labor rates and parts matrixes. Specifically, let’s start with what’s called “mix of business.” Your mix of business is the recipe of ingredients that makes your gross profit what it is. A shop, to even consider a target of 60% gross profit, must start with equal dollars in tire sales, labor sales and parts sales. Dollar for dollar for dollar.
To simplify, let’s just state a third of sales in tires, a third of sales in labor, and a third of sales in parts. Sure, there will always be miscellaneous items, but to keep the article short, let’s assume 33% in each category.
As an example, let’s say a shop is 50% tire sales, 25% in labor and 25% in parts. Well, if half of your sales are in tires, and tire sales generally account for 20%-25% in gross profit, you will not be able to achieve 60% gross profit. Tire sales margins are too low, and it will drag the overall GP% to closer to 50%.
Please understand, I am not recommending selling fewer tires to balance out your mix of sales. I encourage you to sell more service. Here’s why: The tire and automotive business naturally creates an even need of these services, by dollar. Historically, as tires wear out (which are expensive), a customer will have had several services performed out of requirement or suggestion prior to failure. This is not to be micromanaged, per se. You should not estimate every ticket to a balance of 33% in each category. You should estimate tickets based on customer desire and requirement. This is achieved by asking if a customer wants to have their car inspected, for convenience, while they are getting the service that brought them in the door.
There are multiple ways to manage this. You can offer a paid inspection which is in depth and has the wheels come off the car so the brake components can be measured and inspected. This also allows you to get a better check of the suspension. If the customer does not want to pay for an in-depth inspection, you can inform them of a “courtesy” check where you check bulbs, filters, fluids — something quick but beneficial to the customer. If the customer does not want this inspection, that’s OK! They either do not trust you yet, or their needs for speedy service outweigh the benefits of an inspection. If a customer doesn’t want an inspection, what are the odds they would purchase something anyway? As a reputable shop, you should always allow the customer to have the final say in anything that happens to their car. Our job is to educate and offer. The only exception to this is the federal law of “Failure to Inform” where without removing any items, something on a car is visibly dangerous like an axle has popped out.
Shops that tend to be “heavy” on tire sales (in reality, they are service light), and therefore unable to achieve 60% gross profit overall, typically do not offer an inspection consistently. They either don’t do it at all, or they do an inspection without consent (automatic on every car). This is not helpful to the customer (no one likes surprises) and not helpful to the shop (wastes technician time and slows down the flow of vehicles). Asking and informing of inspections is the only legitimate way to balance the needs of the shop (profitability) with the needs of the customer (professional service at a fair price).
Mix of sales is the first step of the recipe and the ingredient is inspections.
The next step of the recipe is to look at the gross profits of each sales category. As mentioned earlier, 20%-25% gross profit in tires is a baseline. There are plenty of statistics that show nationwide, this is achievable. Again, if a shop is in a position where they feel they can’t get that margin, I point to a simple fact: If you allow your front door (advertising, price shoppers, the internet) to control your tire sales, then yes, you won’t be in the 20%+ range. The least grossing tire you sell is the one you advertise. The highest grossing tire you sell is from inspections. You can have an educational conversation with customers on the condition of their tire(s), learn what features and benefits are important to them and recommend the most appropriate tire. Not debate which tire sells for what price.
Labor costs should be 100% gross profit. Pay technicians out of payroll, as an expense. Parts must be at or close to 50% gross profit. At the end of the month (not individual part items), if you are selling your parts for less than 50% you are putting your business at serious risk. With Amazon and other major players looking wide-eyed at the opportunity to get involved in selling parts, your margin will shrink when those players throw their hat into the market. If you are only at 40%, you will go down to 35%. If you end up selling parts for 30% margins, you might as well tell the customer to buy their own parts and you can just install them.
Just kidding, that’s another column for another day. Seriously, you need to make more margins on your parts. Why can every other industry in retail make better margins on parts than we can?
How do you get 50% parts margins? You guessed it, inspections. Dirty filters, dirty fluids, burned out bulbs: These things are not obvious to a customer, yet essential for safe driving and vehicle longevity. They also carry very high margins. If you let the door dictate your auto parts sales, you are letting vehicle breakdowns and marketing dictate your sales.
These are not high grossing products generally. You’re not going to make 50% margin on a transmission. Or an alternator on a foreign car. Or a battery. The mix of services, some high grossing, and some low grossing, are what account for your target of 50% parts gross profit margin. Yes, if your market advertises heavily in air conditioning or brakes, your margin on those items will be lower than an area that does not do that. This is why an inspection is so critical. It brings balance to the recipe. Not too salty, not too sweet.
Tweaking your parts matrix only takes you so far. But if you are not at 50% parts GP, that is not enough to throw your hands up in the air and give up.
If a shop does a professional job for a customer, the shop will balance the needs of the customer with the needs of the shop. That means pay good wages for talented employees, purchase parts and tires from reputable distributors, and charge the proper price to perform those services. If you are not charging the proper amounts, you are putting the employment of all the workers at risk. You are putting your own retirement at risk. You will start to make cost-cutting decisions that are detrimental to continuing business.
Sixty percent gross profit on your total sales is a metric that allows a shop to have enough money to first, pay their employees a decent wage as payroll is your first expense. After paying your employees, you have all the other expenses associated with running a business, and if you manage the business right, there’s enough money left over called net profit. That’s not for the owner to spend. It’s to reinvest in the business: paint the shop, buy new showroom furniture, purchase the next trailer load of tires. How much gross profit you make directly impacts whether you will be able to pay your expenses and reinvest in your shop.
Please, I beg all of you. This is not an easy life, this tire and automotive aftermarket. You wake up and it’s dark. You come home and it’s dark. You see your kids mostly when they are asleep. You unlock the door early when a customer is panicking about a flat on the way to work. You keep the doors open after closing to finish the brake job. Service advisors are getting screamed at for something they didn’t do. Technicians that do this their whole life have broken bodies by age 57. That’s a lot of sacrifice, from the general service tech to the owner who is scared to death the next worker’s comp claim will put them out of business on any given day.
It’s time we professionalize this industry, have standards, and get repaid for our sacrifices. We can’t just wing it anymore. If you’re not at the percentages you should be, figure out why and make changes. Talk to other owners. Ask questions. Get help. Send your people out for education on the industry. Send yourself out. Don’t give up. ■