Do you use parts-to-labor ratio as a key benchmark in your operation? This important rule of thumb maintains that for every dollar of labor sales, your dealership should generate one dollar of parts sales. Both parts and service should be your dealership’s most profitable departments and this ratio helps drive profits in both areas.
But this ratio is changing. This article examines why the changes are occurring and how you can affect it.
Why It’s Important
Your shop work orders have two revenue producing elements. The first is the hours your technicians work on each job. The dealership bills out each tech’s time spent on each job at a set labor rate, which generates labor revenue.
The second element involves parts installed by the techs for each job. They record the part numbers, which are billed out by the parts department, thus generating parts revenue.
The parts-to-labor ratio can be calculated in two ways: by work order or in total. By work order, simply take the dollars of parts billed vs. the dollars of labor billed. In total, sum the parts billed though the shop and divide by the total labor billed.
For parts, the simplest way to calculate a total is to start with your total parts revenue and deduct parts sold over the counter assuming that all other parts (repair, internal/setup, warranty) are installed by your technicians and generated through your service department.
For labor, start with your total labor revenue and deduct sublet revenue because that work is not done in your shop by your technicians.
“Growth of precision farming business has impacted parts-to-labor ratio...”
The importance of the parts-to-labor ratio is your dealership’s ability to generate more parts business without additional expenses in your parts department. By “selling parts” your technicians are, in effect, parts sales people.
The measure of parts productivity is revenue per person — the minimum for pure farm equipment dealers is $600,000 per person.
We have seen dealers who consistently exceed $800,000 per person and there are a few who exceed $1 million per person. In almost every case, higher parts productivity comes from dealers whose parts-to-labor ratio is at or exceeding the rule of thumb of $1 to $1.
This 1:1 rule of thumb may be changing. In many cases, we are seeing dealers whose ratios are lower — where the ratio may be closer to 85 cents to $1, or 0.85:1. I say, “may” because it is important to understand why the ratio is lower than 1:1.
Reason #1: Phase of the Cycle
One reason the parts-to-labor ratio is lower than 1:1 could be the phase of the business cycle. During the past few years, the farm machinery business has been very good and many dealers have sold an abnormally high volume of new equipment that has been setup, delivered and is under warranty.
This internal service work (setup, delivery, warranty) does not generate as many parts per work order, so typically when there is a higher than normal amount of internal service work, the parts-to-labor ratio will be lower.
Many dealers’ shops have been full with this internal work, but if the business cycle changes (new wholegoods sales receding), they will need to replace labor revenue with more lucrative and parts-rich repair business.
Reason #2: Change in Machine Technology
With the electronics and other advanced technology in today’s farm equipment (e.g., CVT transmissions, electro-hydraulic controls, variable rate and multi-product planting/seeding, etc.), the service work on machines has a much higher amount of trouble-shooting and diagnostics than in the past. This troubleshooting/diagnostics work generates very little, if any, parts business and thus lowers the parts-to-labor ratio.
In this case, your ability to affect the parts business is limited. Then the question becomes are you able (willing?) to charge for the time your techs spend troubleshooting/diagnosing maintenance and repair issues.
More dealers and OEMs warranty systems are adding specific job codes for troubleshooting. Of course, some situations may not allow for billing the full time, so your ability to affect this comes down to the skills and training of your techs.
Another way to do what I call “Charge for Knowledge” is to charge for the time your diagnostics tools are used. More and more dealers are adding a fee each time they hook up an electronic service tool.
Reason #3: Change in Business Model
The nature of the work in the service department is changing and that affects the parts-to-labor ratio. Dealers are doing more planned maintenance work for farmers with the intent of ensuring customer retention and providing a value added service that generates labor revenue.
In addition, inspection programs are a way to keep your shop full in the slow times and to add value by catching and fixing problems before an equipment failure occurs. The maintenance and inspection work tends to generate fewer parts dollars even if this work can (and should) lead to more repair jobs.
The growth of precision farming business is another factor that has impacted the parts-to-labor ratio because there tends to be fewer and/or lower cost repair parts and a higher amount of diagnostics and troubleshooting with this type of equipment.
The dealer’s ability to affect their revenues reflects their ability to charge for knowledge and, whenever a technician is in contact with a machine, to find other more lucrative repair work. A good technician can always find other things that can be fixed or need maintenance on a machine.
Change the Rule of Thumb?
We have been tracking the parts-to-labor ratio and have found that the average dealer is closer to 0.85:1 than 1:1 in the past few years, reflecting the strength of the business cycle, making reason #1 an important factor to consider. As the business cycle recedes, we will be tracking the affect of reason #2 (change in machine technology) and #3 (change in business model).