How you define your parts inventory’s phase-in and phase-out criteria is one of the most important jobs that a Parts Manager has to do to control their parts inventory. Not only from a fill-rate perspective but also from a financial perspective.
How you phase-in/phase-out your parts inventory has a direct impact on how much capital you use, and how effective your use of dealer capital is. In this training video, we show you exactly how to phase-in/phase-out a parts inventory using your DMS’ data, and prior sales demand.
This video boils down a complex topic into 28 minutes and is a great tool for those of all positions within the management hierarchy; from an Assistant Manager wanting to move up the food chain, to a Dealer Principal wanting to know how a parts inventory should be controlled.
Today, we’re going to talk about how to define your parts inventory on a technical level. How to use criteria to define what is good and bad parts and how to use your DMS. Get your DMS, regardless of the DMS you’re on, to use this criterion to apply across all your parts and using sales data.
We help new car dealers, their parts departments, and parts managers get rid of their idol and obsolete parts inventory. This short segment here is geared for parts managers, assistant parts managers, and aspiring parts people who are looking to become management at some point or fixed ops managers, and GMs and DPs who want a better understanding of how a parts inventory works. A parts inventory is no different than managing, and in many cases, you could argue that running a parts inventory is not that much different than running a car inventory, used car inventory cause you got to make turns. You got to turn your inventory, you got to make a profit. Parts is no different. It’s a little more technical, but this here should really help you understand how that works and the basis of it.
So what we’re presenting today is, this is traditional inventory control. And in this criteria that I’m presenting it’s something that NADA teaches. It’s also traditional inventory control and many consulting firms teach it at least as a base strategy. There are more advanced strategies out there, but there are a kazillion different phase-in/phase-out strategies as they would call it. When good inventory comes in and went bad, where that inventory is no longer good and how you define it, but they don’t have the statistics behind them. There’s only a handful of data that exists and studied across thousands of dealerships on what the probabilities are.
And what I present to you today is the one that is traditional. It’s traditional for a reason and used across the board for a reason because we’re not playing musical chairs with parts. It’s how we actually make an inventory function turn and is profitable. Now there’s much more that goes into this beyond just qualifying inventory, stuff like how to control and implement policies and processes related to special order parts. That is a topic in itself and can get deep in itself on how to implement and execute that. So anyway, really when it comes to parts inventory, you’re really defining what is good, and what is bad parts. So what is active and what shouldn’t you have.
Now, you could argue that there’s really a couple of other buckets, but really they ultimately fit in one of these two buckets. The other two groups you could talk about are special order parts that are for customers. You don’t want them, but you have them cause you have to for a customer for the shop or a wholesale customer, whatever the case is. But those really fit in the idle parts bucket, if you will. Parts you shouldn’t have. And I hope they’re paid for, prepaid unless they are warranty. But even at that point, they should be ultimately they’re being paid for, for sure. The other group of parts is parts that the manufacturer tells you, you should take and you took them. Now, I don’t believe that you should take them unless being compliant and the benefits from being compliant more outweigh the problem and the capital tied up with holding those. That’s a conversation too, in itself.
But nonetheless, those junk parts, if you even take them, I hope you don’t. But if you take them, ’cause you had to, those are still idle parts. You shouldn’t have them in the first case. So two buckets, there’s no other, there’s no other bucket. You either want them or don’t want them on a technical level. That’s it. Okay.
Moving on. So the name of the game, when it comes to parts in any other department in any of their business, and parts department is a business of its own, is to make money, make more money, which makes even more money and more money and more money. So really what we’re doing is the DP of your store is taking the initial capital, invested in your parts inventory. That initial money is to make a profit. Then they reinvest that capital and that profit back into it. And we rinse and repeat. At some point there’s just profit, making more profit and that’s what’s actually being used to perpetually feed your inventory to make more profit. And those profits, of course, get distributed to pay wages, develop the building. The list goes on and on of what they do with that. But nonetheless, that’s job one. That’s the only thing that’s the root of what we’re doing in the parts department is everything matters that you have the parts, right parts, and that you’re making that money turn. Everything else is a spinoff of trying to accomplish that one thing.
So many may not know, but every penny of parts inventory comes from the DP’s piggy bank. Every penny, unlike cars, new cars, which are for plan every single penny in the parts department, in the inventory is out of the DP’s piggy bank. So we all know that parts that are 12 months and older are problematic. For many, especially the most progressive dealers and dealer groups. They’re writing the stuff off as soon as it hits 12 months-no-sale. It’s being tossed out, written off, but there are many others where either the dollar value is just too much or they just sit on it and they’ll sit on it for years. So there are three separate studies that I’ll talk about over here.
The first one says that parts that are 12 months, no sale better at 12 months, no sale – if you sold it, your holding costs would exceed the profit you earn from it. There are two other studies that say when your breakeven point is. One says at month nine, one says at month 10. So basically you’re effectively in trouble if you sell it come month nine. You’re not a hit. Well here’s the question: “What if you never sell it?” Especially when we get into the statistics here shortly about the probabilities of selling some of this stuff that you shouldn’t have, your non-active parts inventory, you’re going to see why that’s a problem. So 95% of your parts that are 12 months and older, never sell at your dealership ever, never sell. So those are problematic and that’s why that stuff builds up. It’s so hard to get rid of. Now it doesn’t mean that those parts are no good anywhere. In fact, we are big on data and we get aggregated data across many dealerships, across multiple countries.
And we can see that these part numbers, what moves and what doesn’t move and keep in mind the average dealership, they lose 70% of their customer base in the shop, at least, after the warranty expires. So where do these cars go? So NADA, although this may be a year, a little over a year old said the average car on the road was 11.9 years old. Now yes, they do go aftermarket. They go used, used parts of course, but nonetheless, there’s a huge gap from when the warranty expires. So the average car on the road being 11.9 years old, there’s still a market for this stuff. It’s just in the wrong store. And that’s what we see. That’s actually what we do, is try to figure out where this stuff belongs, and help you get rid of the obsolete parts. So let’s talk about how we define or what are the probabilities at least with active inventory.
So with active parts inventory seven or sorry, 93% of the active inventory skews or part numbers, talking about skews and part numbers, not dollar value, not number of pieces. We’ll go on and get another year to sell many times over many pieces over. Whereas 7% will fall off. So 7% will fall off and no longer be active. So they go from active, you bring them in on a stock order only 7% of those will not go on another year. So what happens is we actually call those and actually I think it’s on another slide. We call those phased out parts. That 7% is not the problem for any dealership at all. Especially if you’re using the technical criteria, you have so much time to see that these things are slowing down, that you’re not sitting on a huge, huge amount of these things.
So when we look at the data, it’s a very small percentage of many of these to will have seasonality in them. So whether we’re talking about seasonality from weather or consumer spending habits, many of these will start to stretch out and then they hit the season and the point in which they’re in season and they sell again. It’s interesting. We’ll talk about the thinnest of the active parts inventory. There’s a keynote that I want to talk to you about. On a technical level, defining active parts inventory, at least traditionally is called three and 12. That’s the short way we say it’s three 12, three in 12 or greater. And the long way that this is said is three periods of demand in 12 months rolling. So what does that mean or greater? I got to remember to put that or greater in there.
So periods’ means separate months. Key point, I said: “separate months”…key point. Demand means sales and/or lost sales. If you’re using lost sales, I hope you are, and 12 months rolling of course means the last 12 months. So as we move a month ahead, we’re talking we move keeps following each other. So we’re only 12 months. We’re always measuring 12 months behind. Now there are guys who are measuring less than 12 months, but my argument is, what about the seasonality? Is there seasonality? That’s the question. And I don’t think it’s actually a question, in fact, there is seasonality whether we’re talking about weather, and maybe you have weather that’s fairly consistent, or maybe you’re one that sees a high, like incredibly hot summers. But also you’ve got to think about consumer spending habits.
I know that every parts manager talks about consumer spending habits, schools in, schools out, then Christmas is here. It’s new year’s, people are on holiday. Those are seasonalities and that does affect parts. If it affects consumer spending habits definitely affects your parts inventory. No question. So how we measure active parts inventory is we get to sell at least three in three, the part has to sell at least in three separate months in the last 12 months rolling or more, like four separate months, five separate months, all the way up to it sells at least one every month, the last 12 months, we would call that 12 and 12. So let’s have a look at the first part number. So the first part number is a sensor we sold two last month, two five months ago, one eight months ago. So that would be considered three in 12.
You sold in three separate months, sales or lost sales in the last three separate months, or in three separate months within the last 12 months rolling. Now notice how I’m not counting pieces. In fact, they sold five pieces. When we’re trying to determine whether or not a part is good or bad, we’re not counting pieces. We’re counting number of separate months. And the reason we don’t count pieces is because if you think about packages, package quantities, MSQs, USBs, whatever you call them, you get a bag of bolts and there’s four and you sell all four because they’re in a package. Well, the thing is that the statistics don’t change for that. They’re still incredibly bad if you were to stock them. So what happens is we can’t count pieces. What about per job? Typically, they replaced two rotors, two shocks. So what is consistent is counting number of separate months.
Now, when we do actually count pieces, count on how many we sold or how much demand was it. The reason we call it demand is because it includes sales and lost sales. So that’s why we call it demand. But what pieces count when we figure out, yeah, it is active parts that would be considered an activist, three, 12 or greater, and well, how many should we stock? That’s when piece count matters the most. So we’ll go to the other extreme of the active parts inventory. And you’ll see that this tab, we sold the least one every single month. Let’s call it 12 and 12. So three and 12 or greater all the way to 12 and 12 is all considered active. And when is it that an active inventory would actually fall off? Well, traditionally it’s after nine consecutive months with no sales at the end of that, when it turns 10 months old, that you’ve had it or no sales, that’s when it would be considered phase out parts. We’re going to talk about that in a second, but that’s when you wouldn’t stock it anymore, it’s considered no longer active. But more progressive dealers say after six months, no sale. So on month seven, it’s no longer active.
Okay. So right now we define what is active parts inventory we’re going to talk about now, how to consider what is idle or non stocking, and there’s really two different components. Two components of what we consider idle parts.
Now, if you’re handling or looking at a manufacturer’s recommended parts for stock, and they’re not active parts inventory, they still fall in one of these two categories, which you shouldn’t stock unless you have to. Like I said, that’s an argument for later, another day on special order parts. They belong in one of these two categories too. Although if you have somebody request that you do a lost sale, I mean, we’re already starting. So it’s not that you had zero demand. In fact, you have one demand at that point, if you’ve never sold it before. Anyway, so phase out inventory is exactly what I just talked about here a minute ago, where it was active at one point, then it lost demand. Now you haven’t sold any in nine consecutive months, on month 10 it’s now considered phased out inventory.
CDK calls it auto phase out parts. Nonetheless, all these DMS’s can have the setup as it’s not that hard actually, and pull all these part numbers, and sort all these part numbers. You just look at stock where it makes it real easy, and you’re not using your gut. The other group of parts that you never brought in on a stock order to begin with. Those are called non-stocking parts. CDK calls it NS parts, these are really unsold or returned, special order parts, or just special order parts waiting to be picked up. That’s non- stocking parts. They have little to no sales demand, and they would never qualify on parts as active parts inventory, never see them on a stock order. So now here’s an interesting point. Both of these parts can be and will be a mix of them, aged parts inventory.
So those parts that are over 10 months old, over six months old, well, depends if you’re considering phased out parts at six months, if you’re more progressive after six months, even the 12-month-old parts, these parts that don’t have demand, those parts can be a combination of, but it’s hard to tell if you don’t have a system set up on what those are unless you’re scanning and looking at every single part number and reviewing it line by line. So we know you’re in trouble. After 12 months, no sale, you have a 5% chance of ever selling it. So with phased out parts inventory, as it hits month 10 and month 11, 85% of those will never sell at your dealership again. And we said that on month 12 it’s now 95% of those will never sell again.
Now with non-stock parts., special order parts is really what they’re called, they have between 35 and 95% chance they won’t sell at your store again. And that’s provided that we don’t have a compounding issue where they’re over six months old, where the odds are getting worse. Now you could say that the odds should be worse, but if you’re using lost sales, you already have a sales demand, because you recorded a lost sale. Because you didn’t have it in stock. Well, at least you shouldn’t have, but nonetheless, you would think that these odds are actually looking better than phased out parts inventory. In fact, I would rather have parts that are phased out or heading to phase out, between month six and month nine for those group of parts, than ever be stuck with an unsold or returned special order part.
First off, it’s a very small number, but non-stock parts are just brutal. They’re hard to get rid of, but looking at the statistics, you would think that that’s actually good. Well, we talked about earlier that if you were to sell one of these parts at month nine, you’re breakeven, your holding costs. But if we even slid this down the middle and say, look, we have a 50/50 chance of getting rid of these, some of you may make money and some you don’t. Why would you even want these? I mean, we’re not winning. The only way you’re winning is if you have active parts inventory, you’re turning it often. And with these parts, you’re making a profit on 93% of those part numbers and only 7% of them on an annual basis are falling off.
So that’s how we make money. We don’t make money by gambling and have what’s called even split in the middle of 50/50 chance of ever going to sell. If we look at it across a whole range, maybe the percentage is a little bit different if we plus or minus that, depending on the part and the mix of those parts that you have. But nonetheless, these numbers, these non-stocking numbers are only really any good if we were talking about playing 50/50, Bingo, or the lottery where the risk is low, the investment is tiny, the reward is high. It’s big. I mean, now we’re winning.
But with parts, average gross percentage, not cost-plus, but gross percentage in a parts department that we’ll generally see across their retail parts, is 41 to 44%. And that’s if you’re at guide. So we don’t even get much more than an on average cost plus 70 on retail, but when you’re playing 50/50 in the lottery the multipleis monstrous, compared to. So, these are junk numbers, is what I’m telling you. So we know that special order parts are a problem. And generally the guys who have not yet seen some of this, or know the statistics behind it would say that parts are a problem when they hit month 12. In fact, they are a problem, especially for many dealerships who are writing them off. In fact, it’s a problem, even if you don’t know it’s a problem, but when does it really become a problem? The day you figured out you owned it or the day you learned that you owned it.
Now, arguably, in fact, I would say the day it became a problem is the day you ordered it, not prepaid. That’s the day it became a problem. Or really, if you back up a little bit further, it’s the day you didn’t implement a prepaid special order process. That’s when it became a problem, a real problem. So if you really think about it, guys are getting return allowances. I want to put this in perspective a little bit. So guys have this OEM return allowance, and depending on the dealership size, maybe smaller dealers getting $40, $50,000, maybe a bit smaller. Some guys, large dealerships are getting hundreds of thousands of dollars, a couple hundred thousand dollars of the return allowance a year, depending on the brand too, right? Cause there’s a range in that too, on how much, or how much you get depending on brand and such.
But anyway, all those dollars are being used up every year and every month. So where does it all go? What’s it going towards? Your returned parts. It’s going to the oldest parts in parts inventory. Think about this. Your returned dollars are going to the oldest parts and parts inventory. At least I hope they are. And especially after the statistics I just showed you, I hope that they are. So you have 12, 13, 14-month-old parts, and you’re paying all your parts dollars to that. Where did those parts come from? That are that old, they were the special order parts because it’s perpetual. You never get rid of them. Where are they coming from? They’re coming from the front side. They’re coming from these unsold and return special-order parts. No question, your biggest problem is special order parts, without a question.
So if you think about it, why is it that we have all of our return dollars, that keep going to this? ?First off, it’s incredibly hard to get ahead of the manufacturer’s return allowance, where you have lots of excess or any excess even. It’s incredibly hard ’cause it’s just so tight. And just with the amount of phased-out parts that are falling off, I mean that in itself, you’re already backwards. So the best you can do is keep afloat and that’s without writing off parts or for the most part. So you got to get a handle on the parts which today, are month 11 parts or month 10 parts last month and nine months the month before in eight months, you get my point. So when you’re actually returning all these returned dollars from the manufacturer, these 12, 13, 14 month old, whatever is the oldest inventory that you have, this part that you returned today, a special order part you returned today, or you ordered, and the customer didn’t pick it up or tech misdiagnosis it.
It stays there now in your parts inventory, until it becomes the oldest part or the oldest group of parts in your parts inventory. Now we’re returning it. So what does that mean? It’s staying there for a year. And some would say that the parts that are a problem are 12 months old. Well, the real root of the problem is really your special order parts. That’s where we’re having a problem. You got to get a handle on that. So when we define what is aged parts and inventory, really would say anything over 10 months old, where you’re in trouble is 12 months old. The industry is well aware of 12 months and older parts, but that is just the end result of the problem. It’s not where the problem starts, but nonetheless, when you’re defining what is each parts inventory, it’s anything over 10 months old is a problem, for more progressive dealers, it’s anything over six months old is a problem. No matter what it is, if it’s a phased-out part, non-stock parts, or even active parts, anything over six months old.
So we finished part A defining: what is idle parts inventory. Now let’s talk about how we define non-stocking parts. And let me just say, before I go further, how you define what is aged parts inventory, what is idle inventory, or non-stocking inventory I should say, can fall into this criteria as well, or we’ll have this criterion just the same when it’s aged. And I’ll let you think about that some. If you don’t quite get what I mean, I can elaborate more. So just ping me. But nonetheless, how do we define what is non-stock, which would also include auto phased out parts. This criterion would include it.
It’s two periods of demand in 12 months of rolling two or less. So one or zero. Let’s have a look at it. So we have this pump. We sold one five months ago. We sold one 10 months ago, it’s two separate months of sales demand in the last 12 months rolling. So we wouldn’t want that. Now, even if at five months, we sold two of these, and two or three of these 10 months ago, it wouldn’t matter because we’re not counting pieces. Remember I said, we’re not counting pieces, we’re counting separate months. And here’s also a key point. It doesn’t matter that we sold two in two separate months. It doesn’t matter when we sold them. It’s how many have we sold. We could have sold this pump instead of on month five, sold it last month or two months ago, it’s still two and 12.
We’re not counting the number of months. Let me put it this way to put it in perspective. If a customer orders a wheel bearing today, you don’t have it. It’s nonstock and they want it. They buy it, they return it, or they don’t even pick it up. We have a sale and/or lost sale for this thing, but nonetheless, we’re now sitting on this thing. So we have posted, there is a demand now last month or even two months ago. So would you consider that active parts? Of course not. You would never. Why would you want to keep it? Why would you want to even order another one? Or even if you ultimately did sell that in this case, why would you want it? Why would you want to reorder? Of course, you wouldn’t. So I want to drive it home that it doesn’t matter when you sold it, it’s how many separate months of demand are attached to this part, and this data exists all in your DMS’s all of them. We collect all the data from all the DMS’s and this data does exist and it’s easily accessible even with the help of your DMS and even to get the report. So set up your system so that it actually is able to determine this without you doing all the legwork. Go to the one in 12s. You see that month four, four months ago, we sold one. This could even be two or three. We still wouldn’t make a difference. And 0 in 12, we never sold any. These are in fact the parts that are 12 months, no sale, and older, he never sold any last 12 months.
So that’s how we look at defining what is good and bad parts, really it’s three and 12 or greater is considered active, two and 12 or less is considered non-stocking or phased out parts, which includes aged parts inventory. And how you define that is traditionally, at least is 10 months and older. That’s how you look at it. So some of these statistics and some of these credits, I guess you could say, I was able to pull from these from this book. It’s an incredible book. I would get it. If you’re watching this and you found it interesting, there are very few places that you can actually get this information. So I would suggest it’s a great read, an easy read. Even for somebody who’s not into parts like a DP or GM.
That’s it for now. Questions, just ping me. Thank you.