If you’re like most Parts Managers, at some point you’ve found yourself in a pickle with a mandate from upper management to cut physical parts inventory, or hit 1.5 Months Supply.
If upper management is focused on only one of these two numbers, it creates unintended consequences that cost the dealer substantially in the end. But there is a way to reduce the total parts inventory value or hit 1.5 Months Supply of parts inventory without creating a bigger problem.
In this video, our resident parts expect talks about what actually happens when Parts Managers get this mandate, and also how to reduce the total parts inventory value without creating more problems than intended.
TRANSCRIPT
Crystal :
Dealers are trying to get their inventory to 1.5-months supply. But, in implementing that, there is a spin-off. Can you talk a little bit about that with us?
Shawn:
There’s unintended consequences that come with any time you’re trying to reduce your total parts inventory or implement a 1.5-months supply on inventory. There isn’t a problem with implementing these numbers, a ceiling or implementing a 1.5-months supply or even trying to achieve them. It’s how you go about implementing them or trying to achieve them. So, I’ll tell you this. What happens is parts managers only have a few different ways to slim their inventory. And the parts that they sell all the time, they have to order and keep in stock. So generally speaking, the problem doesn’t come from their active inventory, and of course, we all know this. But, having a day’s supply, how much inventory you have on hand, generally is not out of whack. 30 days is a rule of thumb. You have 30 days supply of total inventory. That’s for another conversation, on how we calculate that.
Shawn:
So, we have 30 days supply, and generally speaking, dealerships have a handle on the program orders that they stock up on so that they get a big discount if they order a big order. So, when we go to achieve, put a ceiling on inventory, or even get our inventory down, generally that’s the first thing that they’ll cut is these program orders. You have to look at that and see how much you’re actually stocking, and for how long. But, virtually, that’s the thing that gets cut first.
Shawn:
So it’s not that we have 1.5-months supply on inventory or that we have a ceiling, but it’s how we get there. So, let’s first talk about what 1.5-months supply is. And I need to use some simplistic numbers. If we sold $600,000 of parts inventory last month, we can get that total parts sale last month off of our financial statement, and our gross profit was $100,000. If we go $600,000 minus the $100,000 it’s $500,000. That’s called the cost of sales. So that’s how much we’ve actually sold of parts inventory. Now, that represents 30 days. The cost of sales is 30 days. So that represents 30 days of sales activity, but that also represents, in dollars, 30-days supply which would mean $500,000. Now, if you’re trying to get to a 1.5-months supply, you would go with that $500,000 times 1.5 would give you $750,000.
Shawn:
So when you’re trying to figure out how much is 1.5, that’s how you do it. Last month’s total sales minus the gross profit equals cost of sales. And then just times that by 1.5, and in this example, that’s $750,000. Now for a dealership that has $1 million in inventory, for example, trying to get to $750,000, you tell a parts manager he needs to cut his inventory to $750,000 or we’re reducing, or we’re implementing a ceiling, a total inventory cap, whatever the case is. And we’re going to say that $750,000 in this case, you might have so many ways to do it. So, in almost every case, and I would hope in every case, the parts manager is utilizing his parts return allowance. In fact, I’ve seen it where they’re not because they’re just so short-staffed.
Crystal :
Right.
Shawn:
That’s a different story. The special orders that customers need, he has to order anyway. So, when a customer needs it, he has to order it. So, where does he get to cut his inventory? If he can’t return any more parts, and he’s actually already… So if a parts manager is trying to reduce his total inventory, and he has to order the special orders, he has his days’ supply in check and he’s not ordering any more program orders, that’s in line, where does he actually get the opportunity to cut his inventory? I’ll tell you where he’s cutting in. He’s cutting his active inventory, and it’s because he has to. Generally, he’s not really thought about that, “I’m cutting my active inventory.”
Shawn:
Generally, what they have to do, and they do in this case because they’re using all the return allowance, and getting rid of all the parts, they can’t, they have no other choice. So, you’ll start to see parts managers use some exotic or even some alternate phase-in criteria than what they normally would. And what they’re really doing is putting a chokehold on active inventory. So, you don’t really see it as that.
Crystal :
But that’s not going to help them either, right? If that’s active inventory that you’re selling lots of, you don’t really want to choke that off, do you?
Shawn:
You absolutely don’t. But what happens is there’s no other way to reduce inventory. But what he needs, the dealership is profit, and it’s active parts that feed a shop, feeds a wholesale customer. But when we’re dealing with this problem, we need to cut inventory. So, instead of using traditional phase-in and phase-out criteria, what they’ll do is they’ll start using some other criteria to try to choke the amount of parts that come up on a stock order, and that’s how it gets reduced.
Crystal :
Okay.
Shawn:
And the quicker it happens, the more of a chokehold they’re putting on and restriction on active parts inventory. And that’s where we start to see some of phase-in criteria. So what can we, or what should we order for active stock? And, we start to see some alternate ones up here that have no statistics, they may be semi-common in the industry, but it’s only because they’ve been made up through the industry and they have no statistical probabilities behind them to know what it does to their inventory or chances of selling it.
Crystal :
Right. It doesn’t really make sense.
Shawn:
So that’s a huge spin-off. So I’ll tell you what typically happens is, we think about, “Okay, well if we’re going to cut active inventory, that’s good because we have too much active inventory.” Generally speaking, dealerships, the active inventory in the parts that age out, there’s only… If you’re following traditional phase-in/phase-out criteria, traditionally only 7% of your total active part numbers or SKUs will fall off and not still be active the following year. Only 7%. So the amount of parts that become seven months old, eight months old, nine months old, and then ultimately fall off altogether, of the active inventory, is so micro, it’s not even funny.
Shawn:
I’m telling you that’s not where your problem is, and of course, you would say, “Yes, we know active inventory isn’t where my problem is,” but that’s what they have to go in and put a chokehold on. But really, I’ll tell you where the problem starts.
Crystal :
Where they should be putting a chokehold is actually in another area.
Shawn:
Yes. It’s in special-order parts.
Crystal :
Right.
Shawn:
The thing is, when a customer asks for something, you have to order it. Now we talk about a whole segment on how to get a handle on special order parts. Today, when you order the part, you expect you’re going to sell it. But what happens, these unsold and returned special order parts, you may not think you have a lot, but I’ll tell you, you can actually watch these parts kind of go through the aging of the parts inventory until they become the oldest. So, let me put it this way. Parts managers always apply the return allowance to the oldest parts in inventory.
Crystal :
Okay, that makes sense.
Shawn:
Everybody does. I mean, it’s a no-brainer. That’s what you need to do.
Crystal :
Yeah.
Shawn:
So what happens is, if your oldest part in inventory is say 13 months or 12 months, even we’ll use 12 months. Say you’re in really good shape. There’s many dealers that are in worse shape than that. They have takers and the list goes on. Well, let’s just say it’s your oldest part in inventory is 13 months or even 12 months. They’re applying all their return allowance to that. What happens is that if a customer returns a part, doesn’t pick it up, a tech misdiagnoses it, for whatever reason, now you own this unsold or this return special order part, it stays in parts inventory until it becomes the oldest.
Crystal :
Right, because you had to order that part in that you regularly wouldn’t stock.
Shawn:
Exactly. But now, you end up holding that part until it becomes now the oldest in parts inventory.
Crystal :
Right.
Shawn:
You can bank on whatever part is oldest in your inventory, the group of parts that are oldest in your inventory. Any part every single day that doesn’t get sold or returned, that are not active, are going to sit in inventory until they hit that age. Now, parts managers don’t have enough return lots.
Crystal :
That’s pretty much common knowledge.
Shawn:
It’s across the board. There’s nobody who’s getting around that. So, the unintentional consequences is, you’re really getting customers to come back twice or losing sales because you don’t have active parts. I’ll tell you, and I’ve seen this, they call it level of service, fill rate, whatever you call it or whatever which report you look at that deems how many parts you fill during the request, and not have to special order it, that’s a measurement of fill rate.
Shawn:
I’ve seen dealerships that are in the 40 some percent, because of that exact reason. They’re trying to scale back inventory and all that they ended up doing is they don’t actually fix a special order problem from the front side, not the backside. The backside is just the end result a year later. From the front side, what happens then is customers will call looking for a part, come in looking for a part, or tech, and you don’t have it, and you have to order it. Some of them will go elsewhere. Or a technician will fix it, or you’re ordering it from another Dealer.
Crystal :
It happens.
Shawn:
Or you’re doing a rush order.
Crystal :
Yep.
Shawn:
But, nonetheless, I’ll tell you where you lose even more beyond that, and it actually costs money, and there’s not a way to measure it. When you don’t have a part in stock, you order it for tomorrow. What happens now is you have to bring the customer back a second time. Now, that’s a whole other topic on when they come back. Do you keep the car overnight, service loaners, the whole bit. But, really what happens is you’ve handled the customer twice. If you think about the process of bringing in a customer into the shop, and it goes from the customer calls, you’ve talked to a BDC person, they book it in for service, the customer comes through, an advisor writes it up, touches it, then it gets moved out maybe by a porter and brought in by tech and then pushed back by a tech. Now at this point, you don’t have the part, the customer then takes it, and it’s handled by a service advisor again. That’s a huge process. And it’s a pain for customers.
Crystal :
Yeah.
Shawn:
But, now you don’t have it, we’re doing the whole process over again. We handle the customer twice. But guess how many times the customer pays? Once.
Crystal :
Once.
Shawn:
The customer is making money again.
Crystal :
We’re making twice as much work.
Shawn:
Yes. So, not having active inventory is just killing you. So, how do we go about actually implementing this properly, so that using 1.5-months supply, I believe is a good idea. Now, I don’t really agree with putting in a ceiling because it’s arbitrary. There’s no number or theory, methodology, maybe is a better word to use on why we’re implementing it. But how we’re getting to it, rather than just picking a number.
Crystal :
So your safest bet is to locate your 1.5-months supply and base it off of that, implement it that way, not so much a dollar for a ceiling. Correct?
Shawn:
Yeah. I mean a ceiling has no math behind it, or like a methodology on how you came up with that number and it’s just a number. I mean, that seems worse, because it could be too high or it could be too low. I mean, you have no way of knowing. But I gave the way on how to figure out what and how to calculate 1.5-months supply. But I’ll tell you, the first thing to go in an active parts inventory when it gets slimmed down, is the active parts that sell every two months, every three months, to a maximum of every four months. Those are the slowest movers. They sell three times a year. At least three times a year, every quarter or so. But, believe me, that those parts represent a 25% to 1/3rd of the average parts active inventory.
Shawn:
So, just because they’re slow-moving, doesn’t mean that you shouldn’t have them, but they’re easiest to take off and not think about. But that’s how they’re actually able to reduce our inventory so significantly, and really overnight. Almost overnight. Because they just stop ordering them. They cut them off, but your fill rate just plummets so bad.
Shawn:
So, we’ve actually created a make-work project, and it’s costing you so much money because you’re bringing back customers twice in shop. So you’re bringing them back twice, getting paid once. You’re losing wholesale customers. You’re doing all these emergency runs, you’re not getting stock order discounts. Your parts man becomes a firefighter.
Crystal :
Yeah.
Shawn:
A volunteer firefighter.
Crystal :
Yeah, voluntarily.
Shawn:
That’s what he becomes. And, I don’t know anybody who pays volunteer firefighters. Right?
Crystal :
No. No.
Shawn:
That’s not a job. Firefighter is not a job in a dealership.
Crystal :
No. No, and it shouldn’t be. But I mean, like you said, if we can implement a procedure so then everybody knows what they should be doing and how everyone can help each other in that process, then I think that the root of the cause will be solved. So, it’s just recognizing it before it gets to that point where you feel like you don’t know what you should be doing. Because, like you said in the beginning when you’re just kind of guessing your way or just implementing something that maybe someone else has done, or just kind of trying to figure it out as he goes, there’s no science behind that. So it’s obviously not going to be effective in your dealership.
Shawn:
Exactly. So, I’m going to tell you now how to fix and implement the problem, and it’s a slow process.
Crystal :
This isn’t going to happen overnight.
Shawn:
If you want it to happen overnight, then just stay on track, and you’ll reduce it relatively quick. And the reason that some parts managers are actually not able to reduce it that quick, generally speaking, is because they do all they can not to reduce the active inventory. So they don’t actually move the needle, but upper management’s still on their case to get it done. He knows that he’s going to shoot himself in the foot if he does. He’s going to create all kinds of other problems. So, for the guys generally speaking, who don’t or just move it just a little bit, generally, that’s why is because he won’t cut the active inventory.
Crystal :
Yeah. Probably feels a bit like he’s stuck between a rock and a hard place like, “If I do this, then there’s consequences, and if I do that then there’s consequences.”
Shawn:
Exactly. By default, the parts managers in a rock and a hard place to begin with. So let me talk about a hard place. And some of this, I’m going to refer you to material we’ve already produced, and we’ll just put the hyperlink in the bottom of the video to show you where to get them. There are much bigger topics on how to fix it. So the problem we know is unsold special order, unsold and returned special order parts. And, we need to fix it and not look at it from the backside of where it’s aged. Although it needs to be addressed, you need to deal with it from the front side. So, we’ve produced material on how to get a handle on your IO parts inventory and your special order parts inventory.
Shawn:
So, we talk about implementing special order policies, and all the different ones that apply to that. So then, of course, when you do order special order parts, you have the highest probability to get this thing sold and out the door. So we talk about a service process in order to book the customer before he leaves for his next visit. We talk about all customer pay, absolutely everything that the dealership does in parts department in terms of getting the money upfront, like prepaid, all special order parts, except for warranty. Arguably, there are guys doing it in wholesale with charge accounts, although that’s a touchy subject with some guys. They won’t do it.
Crystal :
Understandably though, because when you’re dealing with wholesale, you’re dealing with more bulk orders or larger amounts, I should say.
Shawn:
That’s true. But, I mean especially body shops, those are the guys doing the biggest returns, at least as a percentage of total dollars returned, from a customer base. So the shop is a customer, wholesale, mechanical shop is a customer, and then body shops are a customer. Out of all of them, the highest dollar values returned is the shop in almost every case, because the shop is the biggest customer. So, the highest dollar return, but as a percentage of the total business, it’s a low…one of the lowest. The lowest return or I should say the smallest dollar returns is actually counter retail. As a percentage, I’d be guessing, it’s probably 10% to 20% range, but it’s super tiny for almost all dealerships at their retail counter. But it’s insignificant, and a fair portion of it you already stock.
Shawn:
But, the wholesale customers, they’re big dollars. The return dollars are fairly high, or as a percentage are the highest. But it’s also the stuff that you only have one customer base who buys those parts. So, somebody who’s buying fenders, and quarter panels, and bumper brackets, and condensers, you only have one target audience for that. And that’s the body shops. And if they’re returning it, you can only resell it back to them. So, here’s the thing. For example, Chrysler, some of these guys get a 2% return. Some of these guys get a 3% return. Depends. So, in order to return, if he’s on a 3% return allowance, in order to return $3000 worth of parts, they have to buy $100,000 of parts. Now I’ll tell you, what we just buy $100,000, we buy so many parts, we get all kinds of return allowance. And that’s absolutely the case. The thing is, is you have enough parts you shouldn’t have. The next foreseeable future, for years forward, that’s already pre-allocated. You already have that spent before you even earned it.
Crystal :
Yeah.
Shawn:
For sure that’s already spent. You already have parts that you need to get rid of that are just waiting for you, for that date to come, and it’s already spent, right?
Crystal :
Right.
Shawn:
So, when a body shop returns, for example, a $1,000 part, and you get let’s say a $1,500 part, so I can do the math while I talk here. You got to buy $50,000 worth of parts in the case of you get a 3% return allowance. $1,500 of parts, or a part, and that’s huge dollars.
Crystal :
Oh, yeah.
Shawn:
And think about how much business you got to do to get rid of $50,000 of parts at $75 each. It’s crazy.
Crystal :
Yeah.
Shawn:
Okay. So, the other things that, a dealership needs to address if they want to do this and implement it correctly, is make sure that your active parts inventory, you have no more than 30-days supply. I wouldn’t recommend less because you’re going to start to run out of stuff. And that’s guide anyways, 30-days supply. So 30-days supply on a part number. This is handled through your DMS. They call it best stocking level, BSL.
Crystal :
Yep.
Shawn:
But, what it is, is it means you have 30 days. Now if you sell one every two months, for example, and it’s an active part, really a 30-day supply is 0.5. But you can’t have half an alternator in stock. In fact, you can’t purchase half an alternator.
Crystal :
I hope not.
Shawn:
But it’s not your active parts inventory that hurts. Now there are some guys who have 45-days supply as active, 42, 40. I’ve kind of heard the whole range, but 30 is guide. And that’s where you should be. The next thing is to have a look at your program orders. So, some guys, I wouldn’t say this is a majority, but there are dealerships and guys who go really heavy to hit the discounts, and most of it’s driven by, well first they want the huge discount money. But also it’s driven by wholesale or a plan to get rid of all this stuff. But, generally speaking, you never carry more, and this is provided that the discount that you get above and beyond what you normally would get, is worthy of even carrying it, but you would never hold more than six-months supply, provided the discount is even worth it.
Shawn:
In my mind, if your discount above and beyond what you would normally get on a stock order, maybe it’s a bulk order buying pallets of filters, of various filters, part numbers. If it’s anything less than 12% above and beyond what you would normally get, if it’s anything less than that, 10% maybe, it’s not worth holding on a six-months supply. Holding onto a year, I’ve seen guys who have a year and a half, two-years supply. It’s absolutely crazy. But that doesn’t really happen.
Crystal :
Not recommended.
Shawn:
Well, it’s not… Not only it’s not recommended, it’s not that common that that happens.
Crystal :
Yeah.
Shawn:
So it’s just making sure that I wouldn’t say don’t order these program orders, but if your back’s against the wall and you have no choice, and you need to, and you’re told to, that’s exactly one of the things you would look at. Although you cost yourself discounts. So, kind of think about if you’re going to sell the parts anyway, and you’re going to get a huge discount for buying these parts that you know for sure you’re going to get rid of anyway, cutting that off is no different, and you lose all this money that you would get anyway, is no different than cutting your active inventory, and then have our customer show up twice. You’ve just lost money for no reason. But it’s because you implemented it wrong.
Shawn:
And, I would say that is, I mean, if you’re looking for overnight results, it’s easy. Just go about it and cut active inventory, and you’re good to go. I mean, because you have no way to get rid of your idle parts anyway. And the few thousand, 10,000, less, depending on your dealership size, you’re returning a month to the manufacturer, you already have arguably a year’s worth of parts you need to return already, for certain, the next 12 months.
Shawn:
So, the $10,000 you’re going to earn next month and the following month, you already have that spent. You’re just waiting to cash in on it so you can send it. But, $10,000 doesn’t make a dent big enough.
Crystal :
No.
Shawn:
… For a dealer that would get $10,000 a month in return allowance. So, how you got to fix it, you got to fix the problem from the front side. And I’m telling you, that active parts in almost every case is not the problem, but it’s the only thing they have to touch.
Crystal :
Right? That they can actually get some control on.
Shawn:
Yeah. We’ll list all these links. So all these other ways to get a handle on it, because we’ve already talked about, we would be involved with this video for the next three hours, if I had to go into every bit and how to get it done. But, that’s it.
Crystal :
Yeah. Well, I think that covers what we wanted to talk about today, so I appreciate your time.
Shawn:
Very good, thanks.
Crystal :
Thanks.