By Dick Glass, CET
How can you figure sales expenses and profits separately from your service department costs and profits? This article tells how.
Service Losses?
A retailer recently told me that he was considering closing his electronic -repair department. However, he intended to continue his present sales of furniture, appliances, and TV receivers. The reason: his sales operation was profitable, but last year he lost $10,000 in his service shop. So, he knew that drastic changes were necessary or he couldn't continue to suffer such a financial drain on his business.
As we analyze the wisdom of his decision, we need to consider several important questions, such as these:
Did his service operation actually lose $10,000?
If his service did lose that much money, was one important factor the below-cost labor rates he established in an effort to attract more customers for his sales operation?
Did the service technicians regularly make deliveries of appliances, TVs, and furniture for the sales department, but without proper credit?
Did the technicians repair the floor-stock TVs without charge, or perform warranty repairs for below-cost prices?
Business Evolution
One business owner started with a small electronic repair shop, where nothing but parts and labor were sold. With gradual growth through the years, the operation expanded by stocking small radios, toasters, and other small appliances. Later, one or more full lines of TV receivers, stereos, refrigerators, and automatic washers were added.
Finally, a business that started as "all service" developed into one that is "mostly sales." Both sales and service were handled in one building. For accounting purposes, the owner lumped all income (from sales, parts, and labor) together and subtracted the total expenses.
Therefore, this owner finds it impossible to even estimate the individual profits from sales and service.
Probably the owner justifies his lack of itemized profits and expenses by thinking that he is doing the best possible. Knowing about individual profits-he rationalizes would not increase them. After all, he's selling merchandise at competitive prices. Service labor is priced below the point where his customers might rebel. He prices parts at the manufacturer's suggested-list price. Warranty work is done for whatever each manufacturer agrees to pay. What more can he do? Most store managers, when faced with this question, try to increase the efficiency in making repairs, and to expand the volume of parts and merchandise sales.
What's Wrong? Here are some things this typical dealer is doing wrong.
Parts prices
Probably his shop is selling component parts at too little mark up. Fewer parts are being required per repair, thus increasing the overhead. A 50% (or larger) gross profit from parts is not out of line, at this time. In fact, it might be mandatory, if you expect to make any profit.
Labor rates
If you base your labor rates on those being charged by others in your area, you probably are losing money. It's likely your competitor is basing his rates on yours! Perhaps all of you are losing money.
Instead, you need to calculate your profit or loss from labor, and adjust your rates until they bring in the return you need to stay in business.
--------- PROFIT DICK'S & LOSS STATEMENT (combined operation) TV
SALES AND SERVICE
Merchandise sales costs
The most common mistake of sales/service firms is wrong allocation of some TV, stereo, and appliance sales costs.
Usually, the service technicians are required to help deliver the large merchandise after delivery, to uncrate it, and to check the performance. Also, they often answer phoned questions about performance of new sets. In some organizations, the technicians are expected to attend sales seminars, learn the features of each product, and even sell it at times.
Sometimes trade-in machines are repaired by the service crew. In the worst cases, the service department receives no credit for labor and parts used on trade-ins, while the income from trade-in sales is listed under "merchandise sold." Many sales/service stores fail to credit the service department for any of these expenses made to help the sales department. At best, only a fraction of the actual costs are charged against sales. The result is a constant showing of poor service productivity, and a large loss on paper. Of course, this is demoralizing to the technicians, and con tributes to low wages for them.
A Solution
Even if you are resigned to the poor performance of your business, you would do well to take a realistic look at the relative profitability of each segment of your business.
Product sales, parts, and service labor must be examined separately.
Parts profit
The industry average of profit from parts sales is between 40% and 60%. If your gross parts profit is found to be 34% (for example), this might influence you to change your parts -pricing formula.
Service profit
If you properly credit your service department for work done to help the sales branch, and then separate service expenses and income from that of parts sales and product sales, you just might find to your surprise that your service department is doing very well.
Service supports sales
Some sales/service firms deliberately operate their service department at a loss in the belief that this will enhance their image and allow considerably more profit from merchandise sales. Usually, this is a false premise.
If your philosophy is to offer cheap service and recover the lost profit from increased sales, you should calculate what this "sales incentive" is costing you. Perhaps it's worthwhile as a sales -promotion expense, but it is an unknown one, in most cases.
For example, assume that you figured your service rates (as explained previously), and found them to be 25% low. Therefore, they produced a service loss of $10,000 last year. But, your "gut feeling" tells you that the "cheap -service" incentive brought in an extra $50,000 in sales. These extra product sales produced a gross margin of $10,000. Therefore, the increased sales gross profit just cancelled the gross service loss.
Was this a smart decision? Probably not, when the net profit figures are in. But, knowing the true figures can help you plan for the future.
Next, we'll show you how to calculate the profits separately.
Dividing the P&L
Figure 1 shows a typical profit -and -loss statement (P&L) showing the income and expenses for a firm which sells merchandise and also operates a service department.
Column "C" gives listings in the usual way, with all income and expenses combined. Column "S" shows only the income and expense items applying directly or indirectly to the service department, while figures for the product sales are given in the "P" column. Notice that the "S" and "P" columns together total the same as the "C" column.
This P&L might be similar in dollars to that of a large firm for a month, or for a year with a small store. Of course, P&Ls for a year permit better accuracy in separating sales and service figures.
Combined figures are okay According to the combined "C" column, the business doesn't appear to have any serious problems.
Merchandise gross profit is 20%, parts are being sold at 100% markup (50% discount from list), and the 60% figure for direct-labor costs is not excessive since it includes some unlisted repairs of trade-in sets and deliveries of new merchandise.
However, by separating the two departments and allocating the costs accurately, we find this hypothetical business actually lost $22,500 in its sales department, and the service shop produced a profit of $30,500.
Of course, the example has been exaggerated to make the point, but it might not be far from reality with some stores.
Allocations
When you construct your own split P&L, you might want to follow these allocations:
We attributed $10,000 of sales to the service department, since the techs made 10% of the total sales while on service calls. So, 10% of the merchandise cost ($8,000) was charged against the service department.
10% of the total parts cost was charged to sales, because many parts were used in repairing trade in sets for resale-a large part of this store's sales business.
About 25% of total technician's time was charged to sales, because of trade-in repairs, delivery of sales merchandise, and other jobs in support of the sales effort.
Overhead expenses were allocated according to the percentage incurred by each department. For example, advertising usually is 100% for product sales, but the service department was assumed to have benefited. Therefore, 20% of advertising cost was listed against service. Insurance covers sales merchandise primarily. But, the trucks were used more for service than for sales deliveries; thus, a large proportion was charged to service. You must decide these percentages for your own firm.
Conclusions
If you were the owner of Dick's TV, and only used a combined P&L, you might be satisfied with the $8,000 profit for the period. However, if you split the P&L and recognize the real costs and profits for each department, you probably would consider strong actions to improve the results.
For one thing, the margin for product sales is too small. While improving on the 20% gross profit for new merchandise might be difficult, the sales of used machines often bring in 25% or more.
The 50% direct -labor cost versus labor -sales percentage is too high for most service businesses, even allowing for the $10,000 in labor costs listed against the sales department. Probably the service rates should be raised.
Other items are not so easy to decide. There are many trade-offs and considerations to be taken into account before you take any drastic actions, such as the elimination of either the sales or the service. However, the beginning of any intelligent decision should begin, as we have done here, by listing all of the known facts.
Next Seminar:
Instructions about pricing component parts-profitably-will be given next month.
(adapted from: Electronic Servicing magazine, Oct. 1978)
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