It’s a familiar story. A guy starts up a small-engine repair business out of his garage. He’s located in a rural area with a strong demand for a local repair center. He’s a service-only dealer. He’s doing a fairly modest volume. However, since nearly 100% of his income is from service labor, his gross margin is fantastic—sometimes 50% or more. He doesn’t carry any equipment lines. And, since he’s operating out of his garage, his overhead is very low. Life is good as a lower-level Tier I dealer.
Fast-forward a few years, giving this business some time to evolve. His annual revenue is now in the $600,000-$750,000 range. He’s now carrying an equipment line or two. His gross margin on equipment isn’t all that great, but parts and service margins remain strong. And because he’s still a parts- and service-dominant dealer, his overall gross margin is a healthy 30%-plus. His overhead is still low—probably 15-18% of gross, which is well below the industry average. He doesn’t do much advertising. Payroll is low since it’s him, his wife and a buddy. This dealer is likely netting $50,000-$100,000 a year. Life is great as an upper-level Tier I dealer.
Bright lights, big city
But now he’s on the radar screen. He’s showing up as a listed dealer for one or more of the engine manufacturers. He might be in the Yellow Pages. Manufacturers are starting to knock on his door. A “bright lights, big city” image is created in his mind. After all those years of hard work, sweating in his garage, he has a chance to become a legitimate business. He can add several more equipment lines and begin to rapidly grow his customer base.
This is where it starts to crumble for many a dealer. When he gets caught up in the excitement of transforming his business into a “legitimate” power equipment sales/service operation, he’s stepping away from the Tier I lifestyle that he’s grown accustomed to. He’s moving into Tier II, which has consistently proven to be difficult to manage.
The sky is falling
Typically in Tier II, which is the $750,000-$1.5 million range, the dealer has to quickly learn how to manage a growing business with a considerable increase in overhead. You need a definite strategy when you get into this middle tier. Otherwise, you can make more money staying smaller, focusing on service like you did in the beginning.
Overhead, also known as operating expenses, will typically increase 3-5%, if not more, during the Tier II phase. Taking on additional equipment lines requires more operating space. So the dealer upgrades his facility. Now there’s additional overhead in the form of rent and utilities. These are fixed expenses the dealer has to live with month after month, even during those slow stretches when revenue is down dramatically. Furthermore, since the dealer has likely relocated to a more suburban venue, operating expenses such as rent, utilities, employee wages and insurance are higher than they would be at his previous rural location.
In Tier II the employee base expands almost immediately. At this sales volume you need at least one more technician. You need a delivery driver. You probably need a salesperson to work the counter and showroom since you’re too busy managing your growing business, dealing with vendors and taking phone calls. Your wife is now busy helping you stay afloat, so you may also need to hire an office worker, at least on a part-time basis. Now that three-person staff you had during Tier I is a seven-person staff. Even at $1.5 million a year, it can be tough to carry this payroll.
Drawing the line
The Tier II dealer, so enthralled by the newfound fame of running a legitimate power equipment dealership, is typically carrying eight or more equipment lines. It’s important to carefully scrutinize the carrying costs for each of those lines: interest, insurance, property or inventory taxes, storage or floor space cost, handling costs, deterioration and theft. Obsolescence is another big carrying cost. Since the Tier II dealer is carrying so many lines, it’s probable that there’s some redundancy in inventory; carrying two trimmer lines, for example. This greatly increases the likelihood that obsolete inventory will start to mount.