Fixed absorption rate, an essential metric for an essential business

For many of us the term essential business will forever be ingrained in our memories.  In New York state our governor signed an executive order in March known as the PAUSE act, whereby all non-essential businesses were ordered closed.  For our New York Auto Dealers this meant sales floors were ordered closed and you could not deliver vehicles.  In an instant, showrooms went dark, the music stopped and salespeople were furloughed.  The silver lining was that repair facilities were considered essential.  Cars were still were breaking down and people made sure they had reliable  transportation even if it would simply be parked in the driveway.

We began fielding phone calls from dealers all over that were concerned about sustainability during these uncertain times.  The first question we had was what the historical fixed absorption rate was.  Many dealers had to do some work to find out what their rate was.  For some reason the focus on this age old metric gets lost in times when the SAAR is steady and car sales are good but it proves to be an essential metric when times are tough.

So what is the fixed absorption rate and how is it used?

Fixed absorption is the percentage of dealership operational costs that are covered by the net income of your fixed operations departments.  If you have a fixed absorption rate of 75% essentially you have to rely on your sales department to consistently generate enough net income to cover 25% of your expenses (i.e. if your sales department is shut down you need to find another source to fund the 25% of bills that need to be paid).  The key is to try and maintain a fixed absorption rate of at least 100% when times are good, this allows you to breathe easier when times are tough.

There are two components that drive this percentage, total income produced by fixed operations and total operational expenses.  Dealerships who have good fixed absorption ratios do focus on maintaining consistant income in fixed operations but typically more emphasis and time is spent keeping operational costs down.  This is because controlling operational expenses is typically much easier to manage.  This isn’t rocket science but it is tedious and takes time.  Run a vendor report and go through the expenses vendor by vendor.  How many sales applications are you paying for that are hardly used,  when was the last time you performed an audit to make sure your uniform company isn’t charging you too much, etc.  It is a constant battle to manage these costs and is not something that is done once and forgotten about.

For us in New York the showroom lights are back on, the music is playing once again and salespeople are on the floor.  Cars are being delivered again and there is hope that unit sales will get back to a normal level.  Will you lose sight of your fixed absorption rate?  I hope not.

For questions or comments please don’t hesitate to reach out to me at lwerzinger@teamdkb.com.