Debunking the Gross Profit Myth
I’ve heard this story a lot of times: A shop owner (we’ll call him Guy) gets back from a networking group meeting—or a conference or a training session or a webinar or whatever it may be—and for the first time in his run as an owner, Guy has a number in mind.
I need to hit 60 percent gross profit to be successful.
I mean, that’s what Guy heard, right? That’s what a lot of us have heard.
So, Guy heads into his shop, a rural facility in an area with a low median income, and he starts tweaking things. Ups his labor rate. Changes his parts matrix. Alters his staff’s pay scale.
Guy still can’t hit 60 percent—not even close.
He calls his buddy (we’ll call him Buddy). Buddy’s shop is in a larger urban area. Buddy runs a tight ship, an impressive operation. His market’s median income is double that of Guy’s. And what does Buddy tell Guy?
I can’t get to 60 percent gross, either.
If Buddy can’t get there with his market and his customers, how can I?
It’s a great question, Guy. And here’s his answer: He likely can’t.
Stay with me as I explain this, but the fact is that many shops will not, cannot, and should not hit 60 percent gross profit. Yet, they can still be just as, if not more, profitable than shops that do.
I’ll take a second to let the gasps leave your mouth as those last two sentences likely just went against everything you’ve been taught.
OK, ready for me to explain?
The hard-and-fast 60 percent gross profit benchmark is a myth. A complete myth. For many, many shops out there, it’s not a realistic number, nor a good one to set as a benchmark. This 60 percent gross profit myth is built on a couple other false concepts.
The first is that labor rates should be based on your costs. That’s not true; it’s 100 percent false. Labor rates should be set at the maximum of what your market can bear. Every market is different. If you work on domestic vehicles in a small town with a low median income in your clientele, you can’t charge the same as an import shop in a fancy suburb. These are two different business models, and we can’t compare them apples to apples. Regardless of what your market is, your task is to find the highest labor rate and the highest price point for a parts matrix that you can charge to your customer base that allows for profitability and you to provide for your team and family.
But, Guy and Buddy might ask, how do you ensure profitability if you’re not focused on GP percentage? Truly making money comes down to your net profit, not your gross profit. And a whole lot more goes into that then just labor and parts.
If you’re in a lower demographic, you likely have lower overhead costs that, despite not hitting that mythical 60 percent GP, mean you can still achieve your profitability goals. If you have only a 50 percent GP on work, but have, say, 20 percent overhead, compared to 30 percent in a more upscale demographic, you just made up that 10 percent right there.
Overhead costs vary drastically from market to market. Let’s go back to Guy and Buddy. They have the same-sized facility and produce the same revenue per month—say, $100,000. But Guy pays just $1,000 per month in rent, where as Buddy pays $8,000. You don’t have to be a mathematician to see where I’m going with this. Guy’s rent is just 1 percent of his total sales; Buddy’s is 8 percent. Right there, before any operational factors are looked at, Guy has gained 7 percent in profit off Buddy, every single month.
Don’t buy into the myth. Some of you out there, based on your market, need to run at 50, 52, or 55 percent—somewhere in there. Some of you in more expensive parts of the country need to hit 62 or 65 percent GP. All of us need to apply what works for our business in our area of the country and allows us to meet the needed profit for that size of the business.
I can get into determining your proper GP in another column. (The simplified version: it’s based on analyzing your tickets and the amount you need to discount in effective labor rate to land each sale. If you hardly ever discount, you need hire rates. If you discount too much, you need to lower your prices.)
The bottom line here, everyone, is that you need a bottom line. And you need to find the right way to get there. A standard is often set at 20 percent net profit. But, I’m willing to give up 20 percent in net if 15 percent net gives me the larger dollar amount. You want to find your sweet spot in your business.
In the end, it’s about dollars, not percentage points. Dollars are what pay your bills. Repeat this over and over: Dollars beat percentage points, every single time.