Dealerships can boost key fixed absorption metric to survive and thrive

U.S. new-vehicle sales fell 14 percent last year, and many dealerships suffered greater declines in states where businesses were locked down because of the pandemic, temporarily idling sales.

That shifted more pressure to service departments to pay the bills and keep the lights on, and it made fixed absorption — the ability of fixed operations to cover a dealership's expenses — more of a priority for many managers.

"Fixed absorption guarantees they're going to be in business tomorrow without the need to sell new cars," Bob Atwood, a management instructor at the NADA Academy, told Fixed Ops Journal. "One of the things we've learned during the pandemic is that service is the backbone of the dealership. Not the back end, but the backbone."

Fixed absorption is often preached as a necessary tool for dealership success, but definitions vary. Some say service departments should cover 100 percent of a dealership's fixed costs, leaving out variable expenses such as sales commissions. Manufacturers often set other guidelines for their dealers. The NADA Academy says fixed operations should cover 60 percent of all costsand used-vehicle sales 40 percent to reach 100. The national average among NADA members is 56 percent absorption from fixed operations.

"If I get to 100 percent, then all new-vehicle sales are pure profit, then I can sell more cars at lower gross, thereby putting more cars over the curb and have more vehicles come back into the service department," Atwood says. "If all of a sudden we go on lockdown again and you can't sell cars but you can service them, you better be close to 60 percent absorbed with service, or you aren't going to survive."

If a dealership lags well below 60 percent, Atwood advises looking first at gross profits from fixed operations. Ideally, dealers should be retaining 38 percent of the gross from parts they sell, 74 percent of service labor and 65 percent of body shop labor.

Atwood says most dealership managers and owners come from sales and may not fully grasp the gross profit potential of fixed operations.

"When they sell a new car, they make a whopping 5 percent gross," he says. "If you sell [service] labor, you make 74 percent gross. That's where the money is made.

"As [dealership managers] go through the academy, we show them that if they aren't at 100 percent efficiency — hours billed or produced divided by hours available — they are not maximizing their grossing opportunities in service because they are not selling all the hours they have available every day."

Lee Harkins, CEO of M5 Management Services, a fixed ops consulting firm, defines fixed absorption as gross profit from fixed operations being able to cover all expenses. Reaching 100 percent is a worthy goal, he says, because any revenue outside of fixed operations becomes profit. He doubts many dealerships can achieve that, however, especially ones in regions where real estate prices, labor and other costs are higher.

He thinks fixed absorption is often a misused buzzword that steers dealerships in wrong directions, such as cutting costs instead of building revenue. Instead of shooting for a number, Harkins suggests looking at fixed absorption as a cause-and-effect scenario: The amount of fixed absorption is the effect, and how well a service department operates and treats customers is the cause.

"Our efforts focus on what will cause a dealership to get to 100 percent," he says. "We're talking about maximizing the production of technicians, maximizing the customer experience."

If a dealership calculates that its fixed absorption is 50 percent or lower, Harkins says a poor customer experience and low customer retention are probable causes.

"The first thing I would do is evaluate the service operation," he says. "Are you maximizing the opportunities, are you earning [customers'] business and keeping them coming back?"

Harkins also advises looking at the average mileage of the vehicles serviced.

"If the average mileage is 40,000, but some [competitors] are averaging 60,000, then you probably have an opportunity to improve your experience to keep that customer coming back," he says.

Atwood says a Cox Automotive service study shows that service customer retention also boosts vehicle sales.

"We tell our students that 74 percent of those customers that service with you on a regular basis will buy another car from you, as opposed to only 35 percent who do not service with you will buy another car from you," he says.

Atwood says fixed absorption is a key metric for dealerships to monitor against independent repair shops, which have fewer expenses to cover.

"I tell my students, the independent shops that are open seven days a week, trying to steal your customers, they're 100 percent absorbed," he says. "If they weren't, they wouldn't be in business tomorrow, so why are you so far behind?"