Absorption rate, whatever it is, also has detractors

Just what is fixed absorption rate, and how is it calculated? Frankly, it depends on whom you ask. And those you ask may have other thoughts on the value of your calculation when it comes to making business decisions about the financial health of a dealership.

If you rely on the National Automobile Dealers Association definition of fixed absorption percentage, the formula goes something like this: gross profit (the sum of profits from the parts department, service department and body shop) divided by dealership overhead expense (not including expenses attributable to selling cars, such as commissions and delivery).

NADA's 20 Group guides suggest including used-vehicle gross in the formula above to calculate a dealership's overall absorption rate — as opposed to fixed absorption rate. Note that in all cases, the numbers to do the calculations come from a dealership's financial statement.

But Scot Eisenfelder, CEO of Affinitiv, a marketing technology company in Chicago that works with more than 5,500 franchised dealerships, argues that using fixed absorption to measure financial performance is "archaic" and "dangerous."

Eisenfelder wrote in 2017 that his "primary issue with service absorption is that it's composed of two unrelated measures and does not speak to a store's achievement relative to its potential. Service profits are not substantially driven by store fixed costs."

"Most dealership fixed costs support vehicle sales, not service, so there is no reason to expect correlation between the two metrics," he wrote.

"Therefore, the metric itself does not provide any guidance for how to optimize service profitability."

Eisenfelder counsels his clients to instead focus their resources on increasing the service percentage of their units in operation — the number of vehicles their dealerships have sold in a given period. He says most dealerships capture just 20 to 25 percent of the potential service revenue from their units in operation, meaning the vast majority is lost to other providers.

"Focusing on maximizing revenue per [units in operation] creates a fundamentally different strategic and operating mindset where the dealer does not concede any revenue to the aftermarket," Eisenfelder wrote. Shifting the measuring formula means "additional investments in marketing, service lane technology, or loaner vehicles, are not measured as an expense, but against their impact on incremental service gross profit. With only 25% service revenue capture, you could dramatically expand store profitability, no matter what happens to new vehicle profits. But only if you are willing to look beyond service absorption."