The Impact of Zero-Margin Warranty Parts

In the June issue of ASN, a position paper was published titled “The State of Warranty Service”.  This paper clearly outlines the health of warranty service, as it exists in our industry today, as viewed by the IRC.  (You can view a copy of this report on the USA web site www.unitedservicers.com) This report also includes a list of the ten most important issues regarding warranty service.  This list is not prioritized, or in any particular order, but it is no coincidence that “Zero-Margin” on warranty parts is at the top of the list.  If you do warranty service, the impact of this Zero-Margin issue on your bottom line is huge.  Some have called it the “Silent Killer” of warranty service. 

This report will discuss the Zero-Margin issue in depth.  It will offer a way to evaluate the impact of Zero-Margin on your bottom line.  The OEMs will argue that the cost of handling warranty parts should be built into you labor rates. This simply doesn’t work.  Not only is it very difficult to arrive at a reasonable amount to include on top of your negotiated labor rate, and even if this amount can be determined properly, no OEM would consider that high of a warranty rate.  Also, including these costs within the labor rate unfairly shifts some of this burden away from those responsible, that being the OEMs.  We are then placed in the position of subsidizing a particular OEM’s warranty parts with other sources of revenue. It is the position of the IRC that the parts department within your business should be looked upon as a stand-alone profit center and it is unreasonable to expect labor revenues to pay for that overhead. 

Traditionally, the various methods of evaluating “Cost of Doing Business” (CODB), have considered total overhead expense, “Operating Expense” (OE) plus the direct cost of technician labor when determining your CODB.  These methods basically will determine the number of completes per day your company averages, divided by the total labor revenue required per day to breakeven.  This will then give you the average labor revenue per completed service call that is required to breakeven.  Knowing that, you can then determine the profit you require and therefore arrive at the average labor amount per completed call that will pay for all of your cost and provide a reasonable profit.  With this information, you can now establish your service call rate and your hourly rate. 

This method sounds more complicated than it is.  It is simple, but the drawback is that it only considers complete jobs and does not consider the various repair times required for the different products and brands being serviced.  This method will treat all completed jobs the same.  If you are not doing any cost analysis, it is a very good starting point.  Having said all of that, why then do we want to complicate things by separating the parts operation from service labor? 

If you have a separate parts department with employees, inventory, and you sell over-the-counter, then you should not expect your labor revenue to pay the entire overhead of your service company, including the overhead for your parts operation.  This would place an unreasonable burden on you labor customers and the price they pay for service.  Your parts revenues should pay the responsibility of this overhead expense.  The IRC takes the position that there should be sufficient margin on warranty parts to meet all warranty parts costs, including the operating expenses.  This operating expense is real.  Those are real dollars paying to order, receive, process and eventually bill back (at cost) for this warranty part.  The IRC maintains that the OEMs are responsible for the expense and should not try to dismiss this obligation or try to bury it in your warranty labor. 

To shift the burden of this expense to the OEM will be a drastic change for our industry.  The OEMs will argue that they cannot bear this additional cost.  The service provider should no longer bear this burden as well.  Currently, our warranty labor rates are at or near cost.  It is simply unreasonable to argue that costs of handling warranty parts are included.  A simple way to evaluate the burden of this expense on your bottom line is to use an income statement format. 

 This gives you some idea of the impact on your bottom line.  Study the 6 different scenarios.  Find the one that is closest to your warranty parts ratio, and this will be close to your situation.  This assumes that your OE is 30% of sales.  Actually this is conservative.  Most service companies operate at 35% to as high as 50%.  But, the message is clear.  As in scenario “F”, if half of your parts sales are warranty, then for every $200 of sales, you will lose $22.  This loss will have to be subsidized by labor revenues, because your COD parts revenues are already depleted. 

The only solution here is for the OEMs to meet this obligation and offer at lease a 25% to 30% margin on warranty parts, and that will not fully meet the costs of those companies operating in the 40% to 50% range. 

In conclusion, the IRC’s position is that OEMs pay a margin on warranty parts.  This number may be negotiated with the service provider or offered at a nationwide rate that will fully meet the costs of handling warranty parts.  Your IRC is working with various OEM’s to transmit this message and help find ways to bring about this essential change.  Warranty service must be profitable to the service provider.  This change cannot happen overnight, but for a healthy service industry, it must happen soon.