In addition to monitoring the department sales mix, the equipment sales mix, and the new and used equipment turnover, dealers and sales managers should also vigorously monitor their new and used equipment gross margin.
As hopefully everyone knows, gross margin dollars are calculated by subtracting the cost of sales from the actual sales dollars. Similarly, the gross margin percent is calculated by dividing the gross margin dollars by the sales dollars.
For example, if a salesperson sells a tractor for $150,000 whose cost was $140,000, then the gross margin would equal $10,000, and the gross margin percent would equal 6.67%.
While the sales price is fairly straight forward, the cost of sales will require some simple calculations. The cost of sales for a new piece of equipment will include the invoice price of the machine, the freight in, any set-up costs (hopefully at the prevailing customer labor rate and hopefully at pre-determined flat-rate hours previously negotiated between the sales and service department) and any delivery charge to the customer.
Similarly, the cost of sales for the used piece of equipment will include the value at which the machine is booked, plus any reconditioning costs (again, hopefully at the prevailing customer labor rate), and any delivery charges to the end-user.
Interestingly, since 1982, the total wholegoods gross margin has averaged 7.30% with a low of 6.11% in 1991 and a high of 8.54% in 2008. Between 2009 and 2011, however, the margin steadily declined to 6.58% with a slight uptick in 2012 to 6.86%. Why, in a market with high demand, would prices decline?
Even more interesting is the fact that since 1982, the margin on new equipment has been higher than the margin on used equipment. Except in markets where there is no used equipment, or else in a consumer-oriented market, the margin should always be substantially higher on the used equipment than on the new equipment. Yet, just the opposite has occurred in the agricultural equipment market since 1982.
For the past 30 years, the new equipment gross margin has averaged 7.45% while the used equipment gross margin has averaged 5.94%.
In fact, during this period only twice did the used margin exceed the new margin and that was in 1989 and 2006. Even worse, during 2012, the margin on new equipment (8.17%) exceeded the gross margin on used equipment (4.20%) by nearly four percentage points. Could this be a harbinger of the “Gathering Storm Clouds” that was the subject of my September 2013 column?
Margins are a state of mind. Dealers and salespersonnel who think “low margins” will inevitably get “low margins.” This, together with the fact that order takers, rather than retail sales consultants or field marketers, populate the equipment industry, and contribute to the overall low margins. Order takers sell price, while retail sales consultants and field marketers sell value.
Also contributing to the low margins on new equipment is the fact that there are far too many in-line dealers who find it easier to drop their price rather than sell their product support, if in fact they have the requisite product support. Contrary to popular belief, end users purchasing capital goods are more interested in the dealership’s product support than in the dealership’s low prices. Guaranteed up time trumps low prices 80% of the time.
Another reason for a low gross margin on new equipment is the confusion that exists between add-on and mark-up. For 35 years, I have encountered sales personnel who believe that if they want to achieve a 10% gross margin, then they simply have to multiply the cost of sale by one plus the designated add-on.
For example, let’s say that a dealership, which has a new unit that cost $75,000 and who wants to generate a 10% margin, would sell the unit for $82,500 ($75,000 x 1.10). Rather than yielding a 10% gross margin, this add-on approach results in a gross margin percent of 9.09%:
$82,500 – $75,000=$7,500
$7,500 ÷ $82,500=9.09%.
Thus, even before negotiations begin, the dealership has “left money on the table.”
The correct way of establishing a selling price is by “marking up” the cost by dividing the actual cost of sales by the desired cost of sales percent.
Thus, if a dealership desires a 10% gross margin, then the desired cost of sales percent will be 90% since the gross margin and the cost of sales percent always have to equal 100%, or 1. Therefore, in the above example, the desired selling price would be $83,333, or $833 greater than the incorrect add-on approach:
$75,000 ÷ 0.9=$83,333
$83,333 – $75,000=$8,333
$8,333 ÷ $83,333=10.0%.
Next month’s column will continue to explore why some dealerships continue to experience low gross margins. In the meantime, buy low and sell high!