Increasing dealership service revenue requires overcoming a number of challenges: higher-quality vehicles, longer service intervals, increased competition from independent repair shops and shifting customer expectations. But one of the main obstacles to growth is an overreliance on service absorption as a key performance indicator to measure service profitability.

Service absorption gained prominence at a time when warranty work and nominal customer-pay retention covered fixed costs for dealerships that generated strong new-vehicle profits. Times have changed. Front-end profit is in permanent decline. Now that fixed operations generate nearly half of dealership gross profits, it’s time to rethink the way we measure service department performance.

Service absorption is calculated by subtracting a dealership’s fixed costs from its service department profits. This is problematic because service absorption is composted of two unrelated measures. A store’s fixed costs don’t drive service profits. Most dealership fixed costs support vehicle sales, not service, so there is little correlation between the two metrics.

A better way

And service absorption doesn’t measure achievement relative to potential. Many vehicle brands have enjoyed high sales volume in recent years; in fact, their sales volume has expanded faster than service operations have grown. As a result, dealerships have 100 percent service absorption, so they believe they’re doing great. The reality is they don’t have enough service capacity and are losing market share to independent shops.

Finally, service absorption provides poor guidance. The only thing it measures is profitability, but how much you make today has nothing to do with how much you will make tomorrow. How can you use this metric to pinpoint problem areas and opportunities? It doesn’t give any guidance on how to maximize service yield from current customers.

As a metric, service absorption is not only limiting by dangerous to your long-term growth. It’s time to replace it with a metric that better measures service profitability.

Capturing service business

Revenue per unit in operation measures how much service business your dealership is capturing. To calculate this rate, take the number of vehicles you has sold in the past six years. Let’s say you average 100 car and truck sales per month. Over six years, that’s 7,200 vehicles.

Now calculate the total service revenue you have generated from those vehicles in the past six years — not conquest customers, just units in operation. Divide your total units-in-operation revenue by 7,200. The results equals your current revenue per unit in operation. This metric immediately gives you a measurable benchmark for improvement.

More important, revenue per unit in operation:

• Represents the true service potential for your dealership. What percentage of service business from units in operation have you captured? Most dealers capture just 20 to 25 percent of revenue potential from their units in operation. That leaves a lot of room for improvement.
• Gives dealers a  better view of strengths and weaknesses. Are you having a problem retaining service customers? Are you maximizing service yield from every vehicle? Perhaps you’re having trouble getting customers to come in for their first service visit, or retaining their business after their factory warranty expires. Revenue per unit in operation allows you to identify problem areas.
• Facilities meaningful cross-dealership comparisons and diagnostics. In a group, comparing revenue per unit in operation can identify problem stores. Are underperforming stores not seeing enough unique vehicle identification numbers? Are they not seeing them often enough? Are they not yielding enough revenue per VIN scan?
• Encourages scrutiny of all revenue leakage points. Revenue per unit in operation shifts a service department’s focus to providing superior value and convenience to customers. It encourages dealers to engage in meaningful dialogue with customers, change processes and take advantage of knowledge about vehicle service needs.
• Provides better data on return on investment. New investments in service marketing, service lane technology and loaner vehicles are no longer measured as an expense, but against their impact on incremental service gross profit.
• Perhaps most important, revenue per units in operation creates a fundamentally different strategic and operating mindset, in which the dealer does not concede any revenue to the aftermarket.

The good news for dealers in that since 2012, the combination of increased new-vehicle sales and a 13 percent reduction in the number of dealerships has created the highest ratio of units in operation to dealers in industry history. The bad news is that a continued reliance on service absorption is preventing dealers from taking advantage of this opportunity to increase market share and service department revenue.

To view this article in Automotive News, click here.