Keys to Dealership PROFIT
Fixed Absorption vs. Total Absorption
Fixed absorption is the “go to” metric in the commercial dealership industry. Successful operators know that the better the absorption, the better the dealership profitability. Our experience and research will support this, but fixed absorption does not tell the entire story for a dealership that aspires to be “Best of Class.”

Dealership PROFIT is the most important profitability metric for truck dealership. The PROFIT calculation mixes the income statement and balance sheet. If the purpose of the dealership (from an investment standpoint) is to maximize the return on the investment the owner makes in the business, PROFIT must be at the forefront of every decision that is made (financial, customer, employee, etc.) The calculation is simple – operating income annualized less the “carrying costs” of owned assets (total assets less cash/equivalents less new/used floor plan. The carrying cost is typically in the range of 20% of the owned assets. A positive indicates that the dealership is producing a return, a negative return the opposite. As PROFIT increases, the value of the business increases. However, while PROFIT measures overall performance very well on an annual basis, it truly is a results-based number, not a leading indicator.

Fixed absorption is a strong driver of PROFIT. While it is not a daily leading measure, it has a significant impact on PROFIT.  Fixed absorption is calculated as Fixed Gross Profit ÷ Total Dealership Expenses (not including new and used variable expenses i.e. sales commissions, policy and delivery expenses.) The target is 115%+. The higher the absorption, the stronger the profitability of the dealership – in theory. However, there are drawbacks to the Fixed absorption calculation.

The first drawback is that negative used truck gross profit, while it impacts overall dealership profitability, does not impact fixed absorption. While not an everyday occurrence, negative used truck gross profit is not uncommon. Secondly, fixed absorption that is below 100% puts a burden on the new truck department to generate strong gross profit $’s. While this is not a bad thing (and maximizing gross profit $’s should always be a focus of any department), it can lead to poor strategic decisions for the new truck (and used truck) department.

Total absorption (target is 130%+, calculated as [Used Truck Gross Profit + Fixed Gross Profit] ÷ Total Dealership Expenses [not including new variable expenses i.e. sales commissions, policy and delivery expenses]) accounts for negative used truck gross profit. In addition, the research we have done indicate that the used truck market is remarkably stable in terms of demand (not supply) year-in and year-out. The concept of absorption is based on the concept that sales are fairly predictable (not cyclical like new truck sales.) This does not mean that every used truck sale is profitable, but our best practice/goal is to buy and sell in the same market. It is a challenge to do so, but the closer this can happen, the better the used truck performance is. It will never be perfect, but the goal is to buy and sell in the same market. In addition, the better the Used Truck Department, the Better the Fixed Ops Department. Increased Used Truck sales lead to increase internal parts and service opportunities as well as potential retail parts and service opportunities (the goal is to retail Used Trucks in the dealership AOR).

Total absorption is a strategic number since it is based on all the departments of the dealership other than new trucks. KEA’s goal is to remove the need (not goal) for the new truck department to have to have high margins on every truck. KEA believes that market saturation is the #1 priority of New Trucks. While this should not be done at a loss, the dealership should not rely on New Trucks to make the dealership profitable. In addition, the higher the Total Absorption, the more flexible New Trucks can be on pricing and Used Trucks can be on trade valuations.

It is our belief that any sale needs to be at what the market will allow. However, there are times that a used truck must be stretched on or a new truck deal can be done at break-even that will improve our market share (key words are our market, not pumping trucks into someone else’s market.) Because of the enormous impact that parts and service gross profit have on the overall profitability of any dealership, it is vital to get as many of your OE trucks into your market. You want those trucks in your shop.

Fixed absorption is very important metric to know and measure. Total absorption does not take its place, but fixed absorption support total absorption and, ultimately, PROFIT The stronger both #’s (fixed and total absorption), the more flexibility and opportunity the new truck department has to build market share. In addition, strong total absorption performance combined with exceptional “Big 8” asset management (new/used/parts/WIP inventories and customer/warranty/factory/other receivables) will lead to strong PROFIT .
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KEA Advisors
785-842-6498
PO Box 1229
Lawrence, KS 66044