This article is the second of a two part series of Auto Dealer Alerts we will publish during 2010, specifically targeted toward dealership profit improvement. Its author, Jim Eagan, has 31 years of experience serving automobile dealerships. 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 in Part I of this series, every dealership department has a gross level and an appropriate costs structure. The largest components of dealership costs (the “Big 3”) are typically employment costs, floorplan interest expense, and advertising expenses.
Just because a dealership may face a significant decline in total gross profits, this does not necessarily condem that dealership to have a disastrous year from a net profit perspective. For example, lets assume that in 2008 your dealership had total gross profits for the year of $4,000,000 and net income of $600,000. Your cost structure for 2008 was then $3,400,000 and your net profit percentage on gross was 15 percent. Now lets assume that in 2009, your dealership’s total gross profits were 25 percent lower, for a total $3,000,000. You have lost $1,000,000 of dealerships gross profits coming in the door. However, if you sought to preserve your 2008 net profit percentage of 15 percent on the lower 2009 total gross, your net profit goal in 2009 would have been $450,000. To attain this goal, the 2009 dealership cost structure would have to be no more than $2,550,000, which is an $850,000 reduction from the 2008 level. Is such a reduction realistic? Ask yourself honestly, how much of the walk between your dealership’s total gross profits and your target net income goal can be changed by you? When you really drill into your costs, the correct answer is the vast majority of it.
Are you the only one not smiling when paychecks are handed out? Are payplans for employees being overridden on a regular basis? Are you unhappy with the net profits of the dealership (your own paycheck)? If you were asked to describe the pay plans in effect within your dealership, could you describe them accurately?
In too many instances, we have found it to be the case that how a dealer thinks the pay plans are structured is not, in fact, how the office is determining an individual’s 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 an individual to successfully accomplish what you want him or her to do. The following is a summary of certain features common to well designed pay plans:
Are there any dangers to worry about when changing pay plans?
- Pay plans can range from simple to complex, but to be truly effective, they must 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.
- Pay plans should result in a fair overall compensation being paid to the individual based on their economic worth in the marketplace.
- The pay plan should result in the individual’s compensation being fair to them and to you.
- Pay plans should not reward those individuals who are riding on the wake of others, who are truly the ones making it happen.
- Pay plans should incorporate specific performance expectations and reward their achievement and/or penalize for the lack thereof.
- Pay plans should reward an individual fairly for what you want them to accomplish, not necessarily based on what they say they need.
- Pay plans should reflect your overall management philosophy.
- Pay plans should be understood by all parties and documented in personnel files.
- Pay plans should be reviewed at least annually for effectiveness and this review should consider both individual and dealership performance expectations and results.
Too often dealers changing their pay plans act impulsively, sometimes out of desperation and end up making a bad current situation worse. It certainly does not have to go that way. Dealers who think things through all the way (do their homework), 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. They are, first, keep it simple and if you can avoid it, don’t change your pay plans frequently. (We have witnessed many examples where complex and ever changing pay plans lead to lowering of employee morale and motivation, higher turnover, and cheating.) Second, 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.
Floorplan expense problem analysis
How do you minimize the burn from floorplan interest?
Floorplan interest expense is one of the largest components of dealership costs (along with employment costs and advertising expenses), especially if you’re not turning your inventory rapidly. It can be very costly for a dealer if inventory ordering mistakes are made. It costs a domestic dealer on average, $200 per vehicle, per month in interest expense (juice) for all vehicles generally over 45 days old. Obviously, ordering the right inventory is easier said than done. Dealers rarely have optimal inventory levels. They either have too much or too little of the right inventory. To minimize the chances of floorplan interest expense eroding your net profits unnecessarily, we offer the following recommendations:
- The number of individuals authorized to order inventory should be limited to responsible managers, and their pay plans should have features to penalize them for mistakes.
- If a truck shows up on your lot carrying an unordered unit, don’t accept it.
- Determine the monthly floorplan interest expense for aged units (over 60 days), and use this information to determine any special pricing or in-store incentive and promotion programs to move these units. (Remember that the floorplan assistance funds you received on these units are used up by now.)
Advertising expense problem ananlysis
Advertising expense is frequently a big dollar category of cost which may or may not have direct linkage to gross generation. When considering expense problems associated with advertising, it is important to first focus on the three golden rules of business sense with respect to advertising:
- 50 Percent Rule - It is said that half of what is spent on advertising is wasted. The difficulty is that it is hard to tell which half is the wasteful half.
- The Fishing Rule - If the fish aren’t biting, why waste the bait.
- The Do It Now Rule – If a dealership is losing $30,000 per month and they are spending $20,000 per month in advertising, you must ask yourself, “Are these expenses really necessary?” Typically, if a dealer is in these circumstances, cuts his advertising significantly, and lives “less large”, at least for a while, the bleeding can be reduced quickly and in a big way.
It is typically much easier for a dealer to reduce advertising, especially if it is not working, than to reduce headcount.
Getting a handle on dealership expenses
A dealer should be well aware of what types and amounts are being spent for dealership purchases. Preferably, purchases should be controlled at least at the department manager level and, optimally, centralized with one person.
What can be done when a relatively fixed cost increases substantially?
Let’s consider the negative trend in utility expenses as a representative example of many other potential fixed or semi-fixed expense variances that could be eroding your net profits. A dealer could legitimately ask him or herself, “Aren’t utility costs a relatively fixed cost? Can anything really be done?” Too many dealers throw their hands in the air and give up. Wrong answer!
The correct answers are 1) yes, utilities are a relatively fixed cost, and 2) yes, something can be done about it. First of all, we recommend that you assign someone, if you haven’t done so already, to be the watchdog over unnecessary wastes of electricity or heat due to carelessness. You may want to consider providing a financial incentive to this person if consumption levels are minimized to certain targets. Second, investigate whether your current utility providers are really the only game in town. We’re aware of dealers who are participating in consortiums who buy electricity at lower prices than they could on their own. Finally, if after all your best efforts, you conclude that a cost area (utilities in this example) is going to be escalated permanently, don’t automatically assume that it has to come out of your bottom line. We recommend at this point that a dealer refer to his or her “Nice to Have” and “Must Have” lists.
What are your “Nice to Haves” and “Must Haves”?
We suggest that net profit-minded dealers carefully analyze all dealership costs and place the individual categories and their annual costs on “Nice to Have” or “Must Have” lists. Net profit-minded dealers know their costs, have a very good handle on what these expenses amount to on an annual basis, and know which list they belong on. Dealership data processing reports can easily print off every expense category, each month. It is highly advisable that these printouts be produced and reviewed on a monthly basis by department managers, your CFO/controller, and yourself. The “Must Have” versus “Nice To Have” mindset should be in everybody’s head when the reports are reviewed.
For example, many manufacturers no longer reimburse a dealership to deliver a new vehicle with a full tank of gasoline. With the rising gasoline costs incurred by dealerships, even at wholesale prices, many dealers have concluded to consider a full tank of gas with each new delivery in the category of a “Nice to Have” versus a “Must Have.” However, assuming waste is minimized, the utilities are certainly a “Must Have.” If the utility net profit erosion is estimated to be $2,000 per month or $24,000 per year, then the dealer has to make a choice.
You could take the hit and make less money (money that you probably had to work harder than ever to earn), or you could eliminate the bottom-line net profit erosion of $24,000 by eliminating other costs from the “Nice to Have” list. Once you start categorizing your cost elements, you’ll be amazed at how many items are really “Nice to Have” versus “Must Have.”
Walking to improved profits
It is fairly easy to prepare on a pro forma basis what the financial results of a dealership will be if no changes are made to a dealership’s cost structure during challenging
A healthy exercise to do is to assemble an analysis along the following format:
|Pro forma anticipated net profits – No Changes =
||($$$$) Loss or Poor Results
|Implemented Corrective Action Changes:
|Employment Costs (headcount, payplans, fringes)
|“Nice To Have” versus “Must Have” Expenses
|Additional Corrective Actions Being Considered:
|Employment Costs (headcount, payplans, fringes)
|“Nice To Have” versus “Must Have” Expenses
|Pro forma anticipated net profits - “The way it could be”
|| $$$$$$$ “How sweet it is!”