Your Service Department, Is it Profitable?

Do the math. Does your service department cost you more to operate than it bills? A key to dealership profitability is a service department where sales revenue outweighs expenses. And the keys to such performance are found in your labor rate and department efficiency.

How did you come to your current service labor rate? Most service managers tell me they started with an existing rate which they have increased gradually over the years, typically adding three percentage points and rounding up about every year or so (although a year or so often becomes two years or longer). An alternate approach involves raising labor rates in conjunction with raises for technicians, but technician wages are not the only departmental expense and such an approach can create big problems for the dealership over time.

The first problem with increasing labor rates periodically by some flat percentage is that service department expenses grow at different, higher rates. Your DMS system, health insurance, manufacturer training – such expenses need to be considered as you determine a labor rate. Most dealers expect a 70 percent gross profit margin; but, maybe your service department expenses are such that you need a higher gross margin to be profitable. So how do you go about setting your labor rate to both stay competitive and increase profits?

Steps for Setting an Effective Labor Rate

  • First, review your financial reports to see the impact of expenses on your department’s bottom line – that is, do the math.
  • Second, determine what labor rate the market will bear. Many dealers call around to find out both the effective and posted labor rates of other local dealers and independent shops, especially those with whom you compete for service business and those with a similar service offering. (Caution: don’t fall into the trap of just setting your rate based on some rate in the middle of your competitors. Do you know their expense structure? Do you know if they are even profitable?)
  • Third, set a reasonable rate that leaves enough margin for the department to be profitable. But don’t stop there. What if the rate that you need to be profitable exceeds that which the market will bear? Use efficiencies and technician incentives to bridge the gaps.

A Scenario to Consider
For example: A technician earning $12 per clock hour with 50% of the technician’s time charged on work orders is really costing the shop $24 per charged hour, so to maintain a 70% gross margin, you find you need an $80 per hour posted rate. But what if the market will bear only $70?

First, look at your parts department. Increasing efficiency by having a ready inventory of parts to reduce technicians downtime is good for profitability and also good for customer satisfaction.

Second, look at your technician payplan. Providing productivity incentives, such as a bonus based on the technician increasing the percentage of chargeable hours will likely increase the technician’s pay while increasing the profitability of your service department.

Using the example above, if we can raise the productivity of the $12 per hour technician from 50% to 60% the effective cost of labor drops from $24 to $20 per hour and the $70 posted labor rate yields an acceptable gross profit margin slight above 71%.

So do the math. Find areas and ways to improve productivity. Then set your labor rates accordingly. The process will allow you to achieve your desired gross margin while staying competitive in your marketplace.

About the Author(s)
Rex is a Principal of HBK CPAs & Consultants and directs the firm’s Dealership Group. He has worked extensively in the dealership industry since 1984 as a department manager, a general manager and an owner, as well as providing tax, accounting and operational consulting services exclusively to dealers as an independent CPA. This experience includes working closely with hundreds of dealers from coast-to-coast since 1987 on creative tax planning and financial statements issues. He provides clients with a wide range of transaction work services, and consults for them in specialty areas such as operations, government regulatory compliance, valuations and M&A feasibility studies. Rex is active in many professional associations. He is the current Chairman of the BDO Dealership Industry Group, contributes articles and commentary to dealership industry publications, is frequently called upon to speak to industry associations and conferences, provides expert testimony, and is regularly quoted by industry and the general media.
Hill, Barth & King LLC has prepared this material for informational purposes only. Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.