Absorption in 2024 and Beyond: The Lifeblood of Dealership Profitability
Absorption in 2024 and Beyond: The Lifeblood of Dealership Profitability
Guest writer Troy Ottmer returns this week with a timely blog post for our industry: Absorption in 2024 and Beyond: The Lifeblood of Dealership Profitability.
What is Absorption?
In the modern dealership landscape, absorption remains a critical measure of success. Defined as the percentage of a dealership’s total operating expenses covered by the gross profits from parts and service, it underscores the importance of back-end operations. Whether managing an automotive, truck, agricultural, or construction equipment dealership, a strong absorption rate is essential for weathering economic fluctuations.
This metric reflects the back-end’s ability to sustain the dealership’s overall financial health, independent of variable income from new or used vehicle sales. High absorption rates ensure stability and profitability, especially during periods of economic uncertainty or reduced sales activity.
Why Absorption Still Matters
The economic and technological changes of the past decade have only amplified the importance of absorption. Challenges such as supply chain disruptions, inflationary pressures, and shifting consumer behaviors demand that dealerships maximize profitability from service and parts operations.
The rise of electric vehicles (EVs) or Alternative Fuel Vehicles, Connected Technologies, and
AI-driven Diagnostics has reshaped the service landscape. While EVs require less frequent servicing than internal combustion engine (ICE) vehicles, the complexity of repairs and the specialized tooling required have made dealership service departments indispensable. These industry changes underscore the need for a sharper focus on absorption.
A Historical Perspective
Historically, dealerships relied on gross profits from new vehicle sales as their primary revenue source. Higher margins and steady demand allowed parts and service operations to function to some degree as secondary gross profit generating departments.
By the 2000s, however, the industry began shifting:
- Intense competition and slimmer new vehicle margins reduced gross profit opportunities.
- Rising operating costs increased the need for more efficient business models.
- Evolving vehicle technology demanded significant investment in technician training and specialized equipment.
- An increase in technician wages to hire the best and most technically qualified.
By the early 2020s, parts and service departments had become critical profit centers. Absorption transformed from a success metric to a survival strategy, helping dealerships navigate challenges like economic downturns, supply chain issues, and changing consumer preferences.
Today, absorption remains a cornerstone for dealerships, enabling them to adapt to an evolving landscape marked by electrification, connected technologies, and changing ownership models.
Adapting Absorption Strategies for the Modern Dealership
Modern dealership challenges demand innovative strategies to maximize absorption. Below are the key trends reshaping the industry:
- Electrification, Alternative Fuels, and other Advanced Technologies
EVs, Alternative Fuels and other Advanced Technologies have shifted service demands. Although EVs require less frequent maintenance, their repairs involve complex software updates and high-voltage systems. Similarly, Alternative Fuel vehicles add another level of complexity, as does the extensive list of other Advanced Technologies.
AI-driven diagnostic tools and over-the-air updates also transform service models. Investments in these technologies improve efficiency, reduce costs, and enhance customer satisfaction.
- Supply Chain Resilience
As with the Covid-19 inspired supply chain disruption during calendar years 2020 to 2023, dealerships continue to face continued supply chain disruptions and along with other inflation related side effects. Dealerships must adopt data-driven inventory management, leveraging AI and predictive analytics to optimize stock levels, reduce carrying costs, and maintain parts availability.
- Subscription Services and Value-Added Offerings
Subscription-based services, such as extended warranties, telematics monitoring, and software upgrades, are growing. These services boost gross profits and strengthen customer retention, creating a virtuous cycle for parts and service departments.
- Workforce Development and Retention
The evolution from “mechanics” to “technicians” highlights the growing need for IT expertise. Today’s technicians must navigate complex software and advanced systems. To thrive, dealerships must:
- Offer competitive pay.
- Invest in ongoing education and advanced training.
- Create clear career development paths to attract and retain skilled workers.
Calculating and Leveraging Absorption
The formula for absorption remains simple:
Parts & Service Gross Profit ÷ Total Dealership Expense* = Absorption Percentage
*Note: there are various methods/philosophies as to what all goes into the “total dealership expense” calculation. Consult with your controller or CFO for your specific calculation.
Example Scenarios:
- Scenario 1: Gross Profit = $1,200,000; Total Expenses = $1,000,000
Absorption = 120% → The dealership generates an additional $200,000 in gross profit, boosting profitability. - Scenario 2: Gross Profit = $800,000; Total Expenses = $1,000,000
Absorption = 80% → A $200,000 shortfall puts pressure on sales to close the gap.
High absorption rates protect dealerships from reliance on volatile vehicle sales, creating a financial safety net during economic downturns.
The Symbiotic Relationship Between Sales, Parts, and Service
The ongoing synergy between sales, parts, and service drives dealership success. New vehicle sales bring in future service opportunities, while exceptional service experiences build customer loyalty, ensuring repeat sales.
By fostering collaboration between these departments, dealerships can create a sustainable profit model that thrives even in challenging times.
The Bottom Line: Absorption is the Sum of a Unified Focus on Maintaining Profitability
In 2024, absorption is no longer just a measure of back-end performance. It represents a holistic strategy for managing dealership profitability across all departments.
To succeed, dealerships must:
- Embrace emerging technologies to enhance efficiency.
- Invest in workforce development to manage evolving repair complexities.
- Maintain competitive wages for technicians and critical dealer staff.
- Foster customer-centric strategies that align sales, service, and parts operations.
By focusing on absorption, dealerships can not only survive but thrive in today’s competitive environment, ensuring long-term profitability and resilience.
In conclusion, absorption is more than a financial metric—it is the heartbeat of a dealership’s sustainability. By adapting to industry shifts and investing in technology, workforce development, and customer-centric strategies, dealerships can ensure steady profitability amidst change. A unified focus across departments empowers dealerships to weather economic fluctuations and emerge stronger in an evolving marketplace.