Achieving Higher Dealership Profits by Knowing and Watching Costs: Part II
By Jim Eagan
Auto Dealer Alert, March 2006

This article is the second in a series of Auto Dealer Alerts, specifically targeted toward dealership profit improvement. Its author, Jim Eagan, has more than 25 years of experience serving automobile dealerships and their advertising associations. He has significant experience in dealership accounting, auditing, fraud prevention and detection, procedural design, operational consulting, acquisition consulting, succession planning, and tax consulting.

As discussed last month, every dealership department has a gross level and an appropriate costs structure. The largest components of dealership costs (the “Big 3”) are:

1. Employment costs — by far the largest expense category in any dealership (typically more than 60 percent and heavily influenced by headcount, pay plans, and fringe benefits)
2. Floor plan interest — influenced by market interest rates, inventory levels, selling rate, and the propensities of the dealership for ordering the right inventory units with minimal mistakes
3. Advertising expenses — influenced largely by personal preference, but subject to increased spending when dealing with inventory mistakes and/or “hot” manufacturer incentive programs

Are you the only one not smiling when paychecks are handed out? Are pay plans for key employees being overridden on a regular basis? Are you unhappy with the net profits of the dealership (your own paycheck)?
If you answered “yes” to any of the above, chances are, you have compensation problems in your dealership. You’re likely paying out too much in relation to the gross profit levels of your departments, shorting your net profits and return on investment. If compensation
problems exist and aren’t rectified, the financial viability of the dealership can be pushed too close to the edge of failure, jeopardizing all the families relying on dealership paychecks — including your own.

Is there an expedient way to identify compensation problem areas?
There certainly is. The best way to quickly get your arms around employee compensation is to perform a multi-year, Form W-2 analysis, on a departmental basis. On an Excel spreadsheet, summarize the following information for 2004 and 2005: 1) employee name, 2) hire or fire date for partial-year employees, 3) position,
4) department, and 5) compensation from Box 5 on Form W-2.

Typically, Form W-2 lists are arranged alphabetically by name. For the sake of simplicity, go ahead and input your staff alphabetically; with Excel, you can later sort the information by department and compare each department’s compensation levels to the gross profit in that department.

What are the benefits of departmental Form W-2 analysis?
The primary benefits of departmental Form W-2 analysis are that they raise awareness levels of items that need further investigation and action. For instance, trends, such as departments with declining gross profit levels yet compensation that’s declining more slowly or not at all, are frequently identified. If this is occurring in your dealership, it’s a big part of why you may not be smiling with regard to your paycheck.

The analysis is also helpful in revealing the variability and total compensation of each person within a position category over a two-year period. Frequent dealer observations include, “I didn’t realize George made 35 percent more this year than last year. He’s certainly not worth it,” “Why do I have some service advisors making so little and others making so much more?” and “How can that W-2 be right for that guy? His pay plan, as I know it, shouldn’t produce such a total.”

How can employee performance/productivity evaluations
interface with Form W-2 analysis?
Once you’ve completed the Form W-2 spreadsheet, evaluate the performance and productivity competencies for each employee. A good initial step is assess (and note on the spreadsheet), whether an employee’s individual performance/productivity is in the top, middle, or bottom 33 percent of his/her position category. We call this a “TMB” assessment. You can also assign employees into the “Nice to Have” and “Must Have” categories. If you desire, you can get more sophisticated and summarize statistics for most employees. For example, for vehicle sales personnel, you could summarize units sold and gross profit generated for each of the last two years.

If you were asked to describe the pay plans in effect within your dealership, could you describe them accurately?
In too many instances, we’ve found that how a dealer thinks the pay plans are structured is different than how the office is determining pay. We highly recommend that you perform an internal review to verify that your understandings correspond to written pay plans, which should be kept in personnel files. These pay plans should be the ones used by those computing bonuses and payroll.

What should be your expectations of an effective pay plan?
A wise individual once said, “To be successful, you first have to be motivated.” A well-designed pay plan should motivate and reward staff to successfully accomplish what you want them to do. Well-designed pay plans should:

• Cause an individual to be highly motivated to perform tasks which, if done right, will enhance his or her own financial success and that of the entire dealership.
• Result in a fair overall compensation paid to the individual based on their economic worth in the marketplace.
• Not reward those who are riding the wake of others.
• Incorporate specific performance expectations and reward their achievement and/or penalize for the lack thereof.
• Reward an individual fairly for what you want them to accomplish, not necessarily based on what they say they need.
• Reflect your overall management philosophy.
• Be understood by all parties and documented in personnel files.
• Be reviewed at least annually for effectiveness; this review should consider both individual and dealership performance expectations and results.

Are there any dangers to worry about when changing pay plans?
Too often dealers changing their pay plans act impulsively, sometimes out of desperation, and end up making a bad situation worse. However, dealers who think things through, perform competitive market analysis, and perform pro forma analysis of the “what ifs” usually have great results.

Are there any overall golden rules with respect to pay plans?
Yes, there are two big ones:

1. Keep it simple and, if you can avoid it, don’t change your pay plans frequently. (We’ve witnessed many examples where complex and ever-changing pay plans lead to low employee morale and motivation, higher turnover, and cheating.)
2. The pay plans must deliver a dealership compensation cost structure which, when applied to departmental gross profit levels, leaves a reasonable and satisfactory net profit and return on investment level for the dealership owners.

Conclusion
Investing your time and resources in evaluating your dealership’s employment costs can offer significant paybacks. Use your ingenuity and business sense to overcome hurdles — in time to protect 2006 net profits. Remember, paying out too much today and tomorrow in costs will decrease your 2006 bottom line, dollar for dollar.

We’d be happy to assist you in considering the above recommendations for your dealership or in performing an overall review of your dealership cost structure. Generally, such reviews can be done within a matter of days. If we can help, please call Jim Eagan at 800.544.0203, extension 3257, or you can e-mail jim.eagan@plantemoran.com.