A colleague in the industry recently shared what I thought was an insightful look at something I see a lot of shops fail to take into account: the overall cost to their business of parts returns. While the white paper goes into a little more detail than there is room here to include, here’s an excerpt that I think captures the essence of the message.
“The typical parts model is fairly straight forward: Parts are purchased wholesale by the repairer, with the difference being logged on the shop’s books -- above the line -- as their parts gross profit. For many shops, this is where the exercise ends. But in fact, this is where the financial analysis should actually just begin.
“For starters, every business has to reconcile the very real difference between dollars (profit) and percentages (margin). Margin percentages can look great, but only dollars can be put in the bank. For a comparable investment of shop resources, a 50% gross margin on $1,000 worth of list price purchases ($500 gross profit) is not as valuable to a repairer as a 45% gross margin on $1,200 worth of list price purchases ($540 gross profit). Clearly, when looking at above-the-line factors, both list price and discount must be considered.
“Which leads to the below-the-line consequences of above-the-line decisions. Above-the-line items are the direct costs of a repair that will appear at or above the gross profit line. Below-the-line items are operational costs the repairer incurs to support the running of the business, a portion of which are very often incurred as a direct result of specific above-the-line decisions.
“In the parts sector, the most prevalent example of below-the-line consequences of above-the-line decisions is in the area of returns. Parts returns represent the largest variable cost in the repair process, yet they are rarely discussed or aggressively managed because they are below-the-line and often accepted as a ‘cost of doing business.’ But this should not be the case.
“The financial costs related to part returns can be tough to quantify, but they largely can be broken down into three areas:
1. Cost to the vehicle owner. If parts need to be returned on a repairable vehicle, repairs are delayed and the customer will be without their car longer, with potential higher rental costs and reduced customer satisfaction.
2. Cost to the insurer. If parts need to be returned on a repairable vehicle, cycle time climbs, loss-of-use charges go up, and customer satisfaction and adjuster efficiency go down.
3. Cost to the repairer. Direct costs include the time involved in processing the return, and the potential of not receiving a full credit due to not meeting the vendor’s requirements (original packaging, timely returns, undamaged.) There’s the sunk cost of any delivery charges, such as fuel surcharges, associated with the original delivery. There’s the cost of reordering a part if it is still required, and the cost of stopping production when a part is found to be of insufficient quality. In addition, nearly every time a return occurs, overall cycle time increases, potentially influencing future referrals and sales for the shop.
“Given all this, what should a shop do as it evaluates its parts options?
“First, let’s assume the cost to a shop to physically process a return averages $65 per part. This includes the labor associated with taking photos and documenting the reasons for the return, repackaging the part, contacting the vendor and interacting with the vendor’s driver. These costs are incurred on all returned parts.
“The cost of less than 100% vendor credit on a return averages 4%, meaning shops on average get a 96% credit on their parts returns. Most returned parts receive 100% credit, but there are enough examples of only 50% credit for damaged parts, or 0% credit for parts returned too late -- or never returned at all -- that 4% is not as bad as it seems.
“The sunk cost related to the original delivery is calculated to be $1 per return, tied principally to one or more vendors charging $5 or more in invoice fees for deliveries.
“The cost of a re-order when it is necessary is presumed to be $30. This includes the time spent researching the availability and pricing of the replacement part, physically processing and receiving the order, processing payment and paying any new delivery charges.
“Re-orders are assumed to be required 43% of the time. The other 57% of returned parts are not re-ordered because the car is either a total loss or has been taken to another shop.
“The cascading effect and cost of bringing production to a halt can depend on the capacity constraints and backlog of the facility, but can be assumed to average $150, and is assumed to occur 50% of the time there is a parts return.
“When all these below-the-line factors are considered, a shop’s gross parts profit is nearly always at least 15% less than it appears above-the-line, and can be as much as 50% lower if not well-managed.
“An example: Let’s say a shop orders 1,000 parts over time from Vendor A at an average list price of $175, and the shop is given a 40% parts discount. The vendor charges a fuel surcharge of $5 for every delivery they make. Initially, the shop generates a gross parts profit of $70,000 ($70 per part.) However, using the cost assumptions above and a part return rate for Vendor A of 25%, the below-the-line expenses end up costing the business $28,838 in additional overhead, reducing the effective parts profit to $41,163, or an overall parts margin of only 23.5%.
“Of course, not all parts vendors charge fuel surcharges, and discounts and return rates vary. But given the relatively high rate of vehicles that at first blush seem repairable but end up being total losses, return rates below 10% are few and far between.
“What actions can a shop take to soften the blow?
“A shop can decrease the probability of returns by ordering parts only when they are certain they have captured the job. Ordering “too early” to ensure the parts are available only increases the percentage of parts that will need to be returned if the vehicle is totaled, and increases the likelihood that a part is damaged while at the repair facility.
“Once it is determined a part is not needed or can’t be used, it should be returned quickly in its original packaging.
“A shop can also look carefully at its vendors’ return rates. A vendor with a 30% return rate can quietly eat up nearly 50% of a shop’s gross parts profit, while one with a 10% return rate consumes only about 15%.
“As vendors with high return rates dangle very attractive discounts, how should a shop evaluate the true value of the discount percentage vs. the return rate percentage? Using our assumptions above, holding all other factors constant -- list prices, availability, service, delivery time, etc. -- a 1% improvement in return rate is equal to a 0.65% increase in discount.
“Stated differently, if Vendor A offers a shop a 40% discount and has an historical 10% return rate on its parts, that is the financial equivalent of Vendor B offering a 46.5% discount if it has a 20% return rate on its parts.
“As the cost of parts continues to rise as a percentage of the total cost of repair, it’s critical that a shop evaluate its parts vendors carefully. The quality of a vendor’s parts, the efficiency of its service, its propensity to add surcharges, and most especially its return rates are just as important when analyzing the overall cost to the parts procurement process.”
Mike Anderson