Structured vs. Operational Management – Part 2

This is Part 2 in a three-part article. Click Here for Part 1. Be sure to check back next week for Part 3.
III. Friction Points
Economics is defined as the study of how people choose among alternative uses of their scarce resources. Economics also provides us with the opportunity to identify and manage those resources.
Visualize a service department as its own separate economy, a huge funnel where dollars flow in and a small amount flows out. The outflow is the net profit. What friction points along the way grab at those dollars before they exit?
Economic measurement studies the relationship of a specific input (for example, capital) versus the output (net profit). Revenue in the service department cannot make it to net profit until it passes through the friction points. Each dollar that passes through is touched in some way.
More than 100 different areas in the typical service department can be examined to find friction points. Just look to your financial statement. The financial statement is nothing more than a series of expense accounts that make up a category or line item of that statement. Here are just four areas that are used every day in a typical service department:
1.    Shop supplies
2.    Asset management techniques
3.    Spiffs and incentives
4.    Service advisor compensation
Using the example of the pendulum, removing one of the balls lessens the friction points. Subsequently, eliminating a friction point results in a better transfer of energy and a higher net return.
IV. Impact of Structured versus Operational Changes
Again, consider the definition of economics (the study of how people choose among alternative uses of their scarce resources) and that economics provide us with the opportunity to identify and manage those resources. Re-examine the choices service managers have, and the implications of structured versus operational changes:
Question 1: Should I raise my labor rate?
Answer: Yes, by $2
Question 2: Should I add a technician?
Answer: Yes, add two technicians
Question 3: Can I raise shop production?
Answer: Yes, by 10%
Question 4: Should I raise my parts prices?
Answer: No, increase will come from added shop sales
Question 5: How should I impact expenses?
Answer: I don’t know
Let’s look at how to answer Question 5. Using an expense item common to all service departments-service advisor compensation.
A structured approach is to pay the service advisors 5-7% of parts and labor sales. As we make decisions, as we have above, we alter the outcome and impact expenses. Service advisors will earn more money per year based on the outcome of Questions 1 – 4. Management has no choice but to pass along the increase as a result of the decisions made.
A possible structured economic change in response to Question 5 is to design a service advisor compensation plan that employs the use of a base salary and production pay (such as a 40 – 60 based pay plan). For example, the service advisor’s base salary is $1,000 per month, representing 40% of his pay. The other 60% of his pay results from 97 cents per flat rate hour produced. This structured economic change provides some of the following:
•    There is no active management intervention.
•    The expense is not inflation related.
•    Management lessens the financial liability.
•    The service advisor is provided with a linear cause and effect relationship between income and performance.
•    The expense as a percentage of sales actually decreases as sales increase.
•    Management regains control of the revenue source.
Let’s look at how these two different structural approaches relate to the results of Questions 1 – 4. Manager A structures his pay plan at 6% of parts and labor sales. Manager B structures his service advisor pay plan as 40% salary and 60% based on the hours produced.
Question 1: Should I raise my labor rate?
Answer: Yes, by $2.
Manager A will relinquish 6% of the increase.
Manager B will relinquish none of the increase.
Question 2: Should I add a technician?
Answer: Yes, we will add two technicians.
Manager A will relinquish 6% of the related parts and labor sales generated by the two technicians.
Manager B will relinquish an equivalent of 3% of the increased labor sales only.
Question 3: Can I raise shop production?
Answer: Yes, by 10%.
Managers A and B will have the same results as in Question 2.
Question 4: Should I raise my parts prices?
Answer: No, any increase will come from added shop sales.
Manager A will again relinquish 6% of the sales.
Manager B will yield none of the sales.
Question 5: How should I impact expenses?
Answer: I don’t know.
Manager A has structured it to relinquish 6% of the increase. Manager A has designed it in such a way that, as sales increase, he incurs a 6% liability. Manager A has designed a structure that, as sales increase, incurred liability will increase proportionately.
Manager B has designed his structure where, as sales increase, incurred liability will increase disproportionately, if at all. This is a clear example of one structure’s superiority over another.
Continued next week in Part 3!

Written by David Dietrich

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