The Truth About Fixed Absorption

Now, you came up with the idea about talking about fixed absorption because you feel like oftentimes.

It'S a term that's thrown around, but a lot of people don't understand what it means or even why.

But it's definitely a term that's coming up more and more in the field from our clients is that we're talking a little bit more about fixed absorption. I really like the opening of the discussion because one thing I think is great about it is it's fixed absorption. It's not service, it's not parts. It's what's happening in the back. Right. So I think that it naturally kind of brings those two departments together, which I think is something that we've been talking about here at the office a lot. And the other thing, do we have.

Like, we're just sitting around the office talking about it?

Yeah, maybe I'm just talking to myself, but it's really bloody important to me.

Okay, what'd you do this weekend?

Fixed absorption.

I was working on my fixed absorption. So great.

In my. In. What I understand about fixed absorption is that it came out of Henry Ford trying to scale Ford up.

Okay.

And what. What would happen is he had. He had a dealer network, but he would deliver the cars, they would sell the cars to the consumer, and then he would get paid. And to scale, he needed. He needed to.

Increase his cash flow and not have receivables.

And so what he did is he convinced the dealers to get a line of credit, which we call a flooring line, which means when the Model A's were delivered to the dealer, they were put on a line of credit with the bank. And then he got, you know, Ford got paid right away, but the dealers had to pay interest on their inventory.

So.

So, you know, an inventory at a dealership.

Can be, you know, 10 million, 20 million, depending on the brand. You could have $10 million worth of new cars in inventory, and then that dealership is paying interest on that money. And so let's say, you know, interest rates are 5%. So you're going to be paying 5% divided by 12 because it's an annual interest rate, right? You going to be paying that on that every month. So, you know, your flooring expense in a dealership can be 20,000 to 100,000, depending.

And so what he did is he encouraged the dealers to have service and parts departments, and they literally used to make these charts of what it would cost to build a Model A in parts and service. So if the. The Model A was $1,000 it cost $17,000 to build it in parts and service. Now, nobody in parts and service was ordering a wood frame model A and building it. But the point was, is if they serviced cars, they would be able to cover the overhead of the dealership. And if times got tough, they could give the cars away at cost and still be profitable because of their parts and service business. And so if you ever wonder like why, you know, cars back then didn't have a warranty, why does it, why do dealerships have parts and service? That was a big part of the plan on how Ford scaled was them having parts and service to cover the overhead. And then other manufacturers followed, followed suit. But it is, if you think about it, odd that dealerships have like five different businesses inside of one business. Right. They could be separate businesses. Warranty came later and then it made more logical sense. But it, it is, it is a measurement of how healthy is your, your dealership in a competitive market. Do you parts and service and if you have a body shop, so you know, fixed ops, parts service and body shop, do they cover the overhead? Whatever you're selling, could you just give them away it cost and still be profitable or you know, in some cases this has happened, you give them away at a loss and you're still profitable. Like really, if you think about the model of printers, like, you really could make a dealership profitable by giving away the car and charging for the maintenance. In a sense, which we, we might move to an economy where it's more of a lease maintenance type thing, especially if like cars don't depreciate as much as they have historically, which might change. They, they might just have more software updates and they might not appreciate as quick. Also, yeah, we might be more of a printer model where you're buying the printer at cost or even at a discount, but where we're making the money is, is and you buying the ink cartridges over time. And it's more of a subscription model that, you know, I know here, Porsche tries to do that here in Los Angeles. I think a couple other manufacturers are trying a subscription model. So fixed absorption, when you say 100% fixed absorption, that means that the fixed ops are covering 100% of the overhead for the dealership. There's two ways to do that formula. One would be all of the overhead. The other would be taking out the sales department's commissions, flooring expense and advertising.

Yes, they call it the variable selling.

Expenses, the direct expense to sell the truck or car.

That's probably the most common calculation that I see Yeah. I think the great thing is when you think about it, you know, as a parts and service department, you are definitely served well by doing everything you can to support the sales department to. Because the sales department is what gives you the most customers. So it's that huge circle. Right. So you want to keep as many cars going out of your sales department as you can because, you know, six months, 12 months down the road, those people are coming to see you. So focusing on the whole dealership health is exactly why fixed absorption exists.

Yeah. And understanding as we move forward that the customer sees us as one business or one manufacturer, they could care less that there's part service, sales, finance, whatever. They don't care. It's one experience and.

One payment. It's their budget monthly. And so we will, as an industry, adapt to that. And there'll be less walls in between departments. Also, I mean, it's conceivable that the service department could be selling the next car, especially when. When manufacturers start going to more of a subscription base. Like, for example, the Porsche subscription here in Los Angeles, you just call the concierge and they bring you a different one. So you have three levels, and if you, you know, subscribe, let's say, to the middle level. And in the middle level, I don't know, it's their middle SUV and the Panamera and something else. I don't know what it is. But you want a Panamera and you want to give back the suv, you call and then just swap it out.

Yeah. Sounds pretty darn easy, right?

Yeah. And you're not. So you're not also not going in for service either. And that will be something too, where as things evolve, the service departments will be more of a fleet type service department than a consumer type. Right.

This is definitely the time to start getting good at handling fleet accounts and.

Get good at tires, because you're going to tires, all these electric cars. Remember my rant about those clowns in Detroit saying that they wouldn't sell 40 trucks, electric trucks, like it was yesterday? Okay. So, you know, Biden, our new president.

Announced that he's going to replace all of the federal vehicles, which a lot of them are trucks. Right. It's close to a million vehicles, all electric.

So those four guys might not be.

On to something, which was originally my point.

Yes.

But Detroit wants to hear that. So to a man with the hammer, the world is a nail. But if you open up your. Your eyesight a little bit, you would understand that you might not be doing as much research as you should when you answer the question. I don't think anybody cares about that. I just want to make that point that I'm always right.

That's it.

That's a great point.

So that's fixed absorption in a nutshell. It is the health of the dealership. How healthy are you in a competitive market and even in good times.

Yep. And service and parts managers should be talking about that number every month. Like, how are we doing? Are we covering the Net?

Yep. Fun stuff. Thanks so much for watching this clip of Service Driving Revolution. We're uploading new stuff every day, so make sure you subscribe and click the bell icon so you don't miss out. If you have a question you'd like us to answer on the show, call 8333-ASK SDR and we'll answer your question on the show. That's 8333 Ask SDR. For special deals on our books and training, head over to offers.chriscollinsinc.com now that's offers.chriscollinsInc.com I'm Chris Collins, and I'll see you in the next video.