Absorption:What’s All The Fuss About?Written By Ron Slee
Article Date: 08-01-2005
Copyright(C) 2008 Associated Equipment Distributors. All Rights Reserved.
Changes to the bsic metric have weakened the power of measurement.
I have several strongly held beliefs relative to the role of parts and service in the dealership:
Without strong parts and service performance,
It's this last one that I want to discuss - dealer absorption. What is absorption? The original definition came from Caterpillar: The operating net income earned by parts and service departments should be 100 percent of the administration and sales department expenses plus interest. In other words, the dealership would break even if the sales department made no money at all.
- Machine market share is at risk
- Dealer profitability is at risk
- Customer retention is at risk
- Dealership absorption is at risk
Over the years, this definition has changed and been modified just as operations have changed and been modified. However let's get back to the traditional absorption definition - operating net income from parts and service divided by sales and administration expenses plus interest. We should note here that there are no allocated costs applied in this operating net income.
This is strictly a measure of the operational profits of the parts and service departments. This is where most dealerships pay attention and push hard on the profit side of the equation. But, there is more to the story than that. The operating expenses in the sales department and administration have a practical limit. So does interest expense. There should be a limit on spending in sales and administration. There should be a limit in interest costs.
Dealers everywhere would do well to study absorption and how it relates to their dealerships, if only because they would find they are spending too much money on the sales and administration departments. It's interesting to observe manufacturers using different definitions for absorption. The cynic in me sees this as changing the rules so that success will be realized and we can move on to other things. This has been the reaction by many to the growing importance of
the rent-to-rent business.
Change the definition to reflect the current business realities. It would have been far better to develop a similar measure for the rent-to-rent business and leave the traditional absorption calculation alone.
These changes to the basic metric have weakened the power of the measurement and that is a shame because the measure of absorption is a critical metric in the successful management of a dealership. Ignore it at your own risk.
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