Last month’s column addressed the calculation of gross margin — dollars and percent — and explored some of the reasons why a dealership would have low margins; namely the retention of order takers and the inability to properly price the product by “adding-on” rather than “marking-up” the unit. This month’s column will continue to explore other causes of low gross margins in an equipment dealership.
Low margins on used equipment are primarily the result of improper booking of the used unit, excessive reconditioning costs, and an atavistic, or primitive, sales compensation system that rewards sales personnel for poor performance.
Too many dealers over value the trade-in, resulting in higher gross margins on the new equipment and ultimately lower gross margins on the used unit. Additionally, such a practice also may result in a higher sales tax, a sooner rather than later income tax obligation, a lack of salesman motivation to sell the used that results in a low used equipment turnover and negative cash flow for the dealership.
Used equipment should be purchased based on when it is going to be sold. The longer the expected time in inventory, the greater the required gross margin. The greater the required gross margin, the smaller the required trade-in allowance. The smaller the required trade-in allowance, the lower the gross margin on new equipment. The lower the gross margin on new equipment, the faster the used equipment must turnover provided that salespersonnel are compensated on the basis of the machinery gross margin. Thus, low gross margins on new equipment should yield little compensation for the sales force while high gross margins on the used equipment would translate into large paychecks for the salespersonnel.
Many dealers and sales managers, in their zeal to keep their order takers “happy,” post a higher gross margin on the front transaction so that the personnel can receive their paycheck quicker. Nevermind that the dealership doesn’t generally receive the cash on a wholegoods transaction until the last unit is sold or the process is “washed out.”
Dealers using an annual auction to unload their overvalued used equipment would be wiser to assess why the problem persists and to correct the errors of their ways. Auctions are not a solution, but instead, a short term remedy. The solution is to start buying the used equipment correctly in the first place, which may necessitate walking away from unprofitable transactions.
Another major cause for low equipment gross margins is unnecessary or excessive reconditioning. The most prevalent problems associated with reconditioning costs are that salespersonnel lack the technical wherewithal to adequately perform a reconditioning estimate; used equipment is traded sight unseen or the order taker simply takes the word of the end user that “everything is fine;” and/or the service department inflates the time on the internal work order because the service manager has not properly filled his work schedule with customer labor.
Two other causes of unnecessary or excessive reconditioning costs are that the dealership philosophy is to make all used equipment “better” than it came out of the manufacturing plant and that the dealership does not stratify their used equipment for purposes of reconditioning. Not all trade-ins should be reconditioned. In fact, some should be sold “as is” after making them cosmetically appealing and ensuring that they start. These units should be sold to the impulse price shoppers who generally have the mechanical aptitude to repair the unit themselves and who generally lack the financial resources to purchase a “field ready” machine. All too often a dealer will end up selling a reconditioned machine to this buyer at a lower gross margin to purge the unit from the inventory. Customer wins, dealership loses.
To ameliorate the aforementioned reconditioning problems, it would behoove the dealer to undertake any or all of the following recommendations. First, as part of the appraisal process, use a trained service technician that specializes on that particular product to conduct the job estimate. Second, require the service department to inform the sales department before any work is undertaken that is over and above the original job estimate. Third, reward the service department for completing the reconditioning at levels below the job estimate. Fourth, if the estimate is undertaken by the salesperson, then any amount over the estimate should be charged back against the salesperson commission. Finally, salespersonnel should be continuously monitored as to the accuracy of their reconditioning estimates.
In reality, margins are not a state of mind, but rather a function of management. And sales management requires correctly buying the used equipment, controlling the reconditioning, and then properly compensating the salespersonnel, which will be the subject of my next column.