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Machine Shop Market Profile Part II

1998 Market Update - Engines

In Part I of our annual review of the machine shop market, which appeared in our July 1998 issue, we provided average production numbers in 1997 for cylinder heads, engine blocks and crankshafts reported by machine shops. According to our survey respondents, custom engine rebuilders/machine shops averaged 18.29 gas and diesel engines rebuilt monthly during production year 1997, virtually unchanged from the 18.2 units rebuilt monthly in 1996.

Based on a universe of 6,000 to 8,000 full service machine shops, the custom engine rebuilder/machine shop market produced between 1.32 million and 1.76 million rebuilt engines last year. At an average sale value of $1,000, the machine shop market generated between $1.32 billion and $1.76 billion in rebuilt engine sales during 1997.

Last month's report also contained a variety of other important industry data including: gross sales volume, gross and pretax profit margins, sales dollars generated in machine shop parts and labor, average hourly shop wages paid to machine shop employees, time spent on various machine shop jobs from disassembly to final machining and assembly, specific employee benefits offered, and much more.

Data provided in our survey was generated from surveys sent to 3200 machine shop members of the Engine Rebuilders Association (AERA), primarily in the U.S. A total of 462 questionnaires were completed and returned for an effective return rate of 14.5%.

Questions pertaining to survey data should be directed to Bob Roberts, marketing research director for Babcox Publications Market Research Division, 330-670-1234, ext. 252, (email broberts@babcox.com), or to Dave Wooldridge, editor of Automotive Rebuilder magazine, 330-670-1234, ext. 214, (email dwooldridge@babcox.com).

Annual sales increased
Actual annual unit production of rebuilt gas and diesel engines increased 1%, and annual production of gas and diesel cylinder heads increased by about 0.5% over the previous year's production figures. However, machine shops reported that annual gross sales volume rose at a significantly higher 11.4% compared to year earlier figures.

Industry-wide, machine shops reported generating an average of $626,065 in gross sales volume during 1997. This compares to $561,997 in gross sales generated during production year 1996. In general, there were fewer numbers of survey respondents in the lower sales volumes categories and larger numbers of respondents in the larger sales volumes categories.

The increase in sales volume average is likely the result of higher charges for parts and labor as well as the larger percentage of survey respondents falling into the higher sales volume categories. Looking closely at the number of respondents in the various annual sales volume ranges seems to indicate that the big are getting bigger and the small are getting smaller.

Still, 65% of all machine shops reported annual sales of less than $500,000. This compares to nearly 70% of machine shops that reported annual sales of less than $500,000 during 1996. On the other hand, the percentage of shops generating more than $1 million in annual gross sales increased significantly. Last year, 18% of our survey respondents reported generating $1 million or more in gross sales. In 1996, just 14% of shop owners reported annual gross sales above $1 million.

Survey data also indicates that fewer shops reported an increase in annual gross sales while more shops reported a decease. In 1996 a little more than 48% of shop owners said that annual sales increased from the prior year. Last year just 40.2% of shop owners reported gross sales increased.

On the other hand, nearly 19% of shop owners reported a decline in gross sales in 1996 while last year 23% of shop owners said annual gross sales had declined. For those reporting a decline, the average drop in sales was 11.3%. For those reporting an increase, the average increase was 13.2%. Both average gross sales increases and decreases were very similar to those reported in the prior year.

The percentage of sales volume attributed to machine shop parts and labor sales declined from 67.8% in 1996 to 63.4% in 1997. However, the largest percentage of survey respondents, 39.8%, reported that 91% or more of their total parts and labor sales are directly attributable to their machine shop business. This is a slight increase from the 38.9% who said that machine shop parts and labor sales accounted for 91% or more of total company sales in 1996.

In general, both machine shop owners and parts and equipment suppliers that we interviewed reported that it was becoming increasingly challenging for smaller shops to generate the sales and profit margins required to invest in the growth of their businesses. OBD II and emissions requirements have lead to the development of increasingly sophisticated engines constructed from lighter materials and built to increasingly tighter tolerances, clearances and smoother surface finishes.

To build these modern engines cost effectively requires an ongoing investment in training and equipment. It's an investment which cannot be made unless profit margins improve for many smaller shops. On the other hand, for those shops willing and capable of making such an investment, the proliferation of part numbers, the increasing difficulty in finding replacement cores and/or parts, and the technical expertise and training required, provides some very good opportunities.

Unfortunately, average gross profit margins on machine shop parts and labor declined in 1997. Shop owners reported a 33.3% gross profit margin in 1997 compared to a reported 35.1% gross margin in 1996. The largest percentage of shop owners, 31.9%, reported earning gross margins of 21-30%. A little more than 24% of respondents reported gross margins of 31-40%. At the two extremes, 12.4% of shop owners said they earned 51% or more in gross profit margin, while 7.7% of respondents reported earning at least 10% gross margin.

As with gross annual sales volume, a higher percentage of shop owners reported a decrease in gross margins while a smaller number of survey respondents reported an increase in gross profit margin. In 1996, a little more than 26% of shop owners said gross margins increased, while in 1997 just 19.7% reported an increase. In 1996 about 15% of survey respondents said gross margins had declined, while in 1997, nearly 19% of shop owners reported a decline.

The average increase in margins for those reporting an increase was smaller than it has been since 1993. Last year the average increase in gross profit margin was 6.6% compared to a reported 7.8% in 1996. On the other hand, for those reporting a decrease, the average amount of the decrease in gross margin was 8.2% compared to an average decrease of 6.2% reported in 1996.

Despite higher average annual sales, shop owners reported lower pretax profit dollars. In fact, pretax profits are the lowest that they have been since at least 1993. Last year, shop owners, industry-wide, averaged just $39,493 in pretax profits. This is a 14% reduction compared to pretax profits of $45,977 generated in 1996. Pretax profits for machine shops have been on a steady decline for at least the past five years. However, the two largest declines in pretax profits have come in 1996 (11%) and in 1997 (14%).

Parts costs are up
Machine shops reported that their annual average expenditures for internal engine parts rose in 1997. Last year shops averaged $136,227 in engine parts purchases compared to just $106,830 in 1996, a 27.5% increase. Based on a universe of 6,000 to 8,000 full service machine shops, machine shops accounted for between $817.4 million and $1.09 billion in engine parts purchases. However, 1997 engine parts purchases are still significantly lower than production years 1993 through 1995 when shops averaged $143,000, $141,484 and $153,992 in annual engine parts purchases, respectively.

This year's survey respondents reported that engine parts purchases used for redistribution or retail sales (not for shop consumption) also rose. Of total parts purchases in 1997, those not used in shop consumption accounted for 44.9% Ð a 23.6% increase compared to 1996. However, 1997 non-shop consumption parts are not that far off from the percentages reported in 1994, 45.9%, and 1995, 47.7%.

Although many shop owners have reported that it is more difficult to sell engine parts today due to mail order houses' and retailers' pricing pressure, machine shop owners reported selling more parts for every dollar billed in shop labor. Last year, shop owners said they averaged about $1.96 in parts sales for every dollar billed in shop labor. This represents a 26.5% increase from the $1.55 in parts sales generated in production year 1996.

Parts sales directly related to labor dollars billed are the highest they have been since 1993 when shop owners reported generating $1.71 in parts sales for every dollar in labor billed. As those we have interviewed surmise, the rise in dollar amount is likely the result of more expensive parts, rather than more total parts actually being sold.

Machine shop owners also reported purchasing more engine components in kit form compared to bulk parts purchases. Custom assembled engine parts kits accounted for 64.1% of all parts purchased in 1997, a significant increase compared to 1996 when machine shops reported that just a little more than 58% of their engine parts purchases were in kit form.

The percentage of purchased custom assembled kits is at an all time high. Machine shops are most likely using custom assembled kits to reduce their overall inventory expense as they are able to take advantage of just-in-time or overnight delivery services provided by engine parts suppliers. Custom assembled kits also provide an answer to the problem of engine part number proliferation.

Looking more closely at the frequency of buying patterns reveals that in 1997 a little more than 62% of all shop owners reported that custom assembled engine parts kits accounted for 71% or more of their total parts purchases. In 1996, just 50% of shop owners said that custom assembled engine parts kits represented 71% or more of their total engine parts purchases.

In light of the ongoing news of continuing consolidations taking place among engine parts suppliers, it is interesting to note that more machine shop owners cited a preference for using multiple suppliers than ever before. This year a little more than 74% of survey respondents indicated that they preferred to use multiple suppliers when purchasing engine parts. Last year just 66% of machine shop owners said they would prefer to use multiple suppliers compared to a single source for their engine hard parts purchases.

Length of years in business
Little change was noted in the frequency range for average length of years a typical machine shop has been in business. In fact, industry-wide, the typical machine shop has been in operation for 20.8 years, the exact same number reported in last year's survey. The largest percentage of survey respondents, 32.6%, reported that their businesses have been open for between 11 and 20 years.

About 24% of shop owners reported that they have been in business for between 16 and 25 years, nearly 16% reported being in business between 26 and 35 years, and 14.7% reported being in business for more than 35 years.

As was reported in last year's survey results, equipment and parts suppliers report that fewer new shops are opening. Additionally, the costs to shops in terms of equipment, training, overhead and customer service are higher than at any other time in history. To stay in business over even the short term, shops must be continually investing in their companies. To do this many shops are researching and exploring new niche markets, markets that offer a better return and profit margin than competing with the local retailer for cheap rebuilt engines and parts.

Shop owners, overall, also reported a small increase in the average hourly shop rate charged for machine work. In 1997, the typical machine shop charged $42.99 per hour for machine shop work performed. This represents a 1.8% increase from the hourly rate of $42.25 charged in 1996.

The largest percentage of survey respondents, 71.2%, reported charging an hourly rate between $31 and $50. A little more than 11% of shop owners charge $51-$60 per hour while 5.2% reported charging $61 or more per hour.

On the other end of the spectrum, just .5% of shop owners reported an hourly shop rate of less than $10, while 2.6% reported charging $11-$20 and 9.4% reported charging $21-$30 per hour. Shop labor rates are very geographically sensitive, with the highest rates found in the New England and West Coast areas. The lowest rates are generally found in the Southeastern states of Georgia, Alabama and Arkansas.

In next year's machine shop market profile we plan to provide the hourly shop rates charged in seven geographic areas across the country. We'll also provide the shop charges for various jobs typically performed by the typical machine shop.

Although the average shop hourly rate rose only marginally, industry-wide, machine shop owners reported that markup on the hourly rate paid to machine shop employees rose nearly 40%. In 1997, survey respondents reported that markup on hourly shop labor rates was 68.3% compared to a markup of 48.9% in 1996. However, nearly 38% of all machine shop owners said that they marked up their hourly rate paid to machine shop employees by 91% or more.

The next largest percentage of survey respondents, 17.1%, reported a 41-50% markup on the hourly rate paid to shop employees, followed by nearly 12% with a 20% or less markup, 18.1% with a 21-40% markup, and about 15% of shop owners with a markup between 51 and 90%.

Hourly wages declined
Except for the hourly rate paid to core disassembly personnel, average wages declined slightly for machine shop employees across the industry. In 1997, experienced machinists were paid an average of $12.89 hourly, a decline of about 1% from the $13.04 they earned in 1996. Newly hired machinists earned $7.66 per hour, a decline of about 6.5% from the $8.20 they earned in 1996. Countermen/sales personnel were paid an average $9.55 hourly, a decline of about 2.3% from the $9.78 per hour they were paid in 1996.

Fourteen different employee benefit categories were tabulated for this year's survey. Of these benefits, paid vacations ranked as the most frequently provided by shop owners. Nearly 80% of shops provide their employees with a paid vacation. About 58% provide training, 56.2% offer hand tools, and 52.4% provide major medical insurance.

The benefit notching the highest percentage increase was year-end bonuses. In 1997, a little more than 51% of shop owners reported paying a year end bonus, an increase of about 25% from the 41% that offered an annual bonus in 1996. Almost 22% of shop owners also reported offering bonus programs that were paid throughout the year.

Disability insurance was provided by 31.4% of shops, life insurance by 30.5%, dental care and a pension plan by 21%, and eye care by 15.2%. A profit sharing plan was the benefit offered lest often. Just over 13% of all shops reported making a profit sharing program available to their employees.

Although the total number of employees rose from an average of 7.4 to 7.6 last year, the average number of employees that are machine shop employees declined slightly. In 1997 shop owners reported that they employed an industry average of 3.5 machine shop employees, a decrease of nearly 7% from the 3.76 machine shop employees per shop location in 1996.

Hiring and keeping qualified shop employees is ranked by many shop owners that we have interviewed as their single biggest challenge in operating their business. Most shop owners report that there is a declining number of candidates coming out of high schools that are interested in working in a machine shop.

In today's tight labor market, many shop owners report that they cannot compete with the higher wages and increasing use of hiring bonuses being paid by other industries to attract qualified help. Competitive pricing by other machine shops, retailers and production engine rebuilders continues to put pressure on the ability of the typical machine shop to meet employee wage expectations.

Customer base
Traditionally, the do-it-yourself customer and the professional service garage have been the two primary sales outlets for the typical machine shop. Although percentages of sales to each of those two customer bases have changed somewhat in 1997, combined the two represented just a little more than 70% of all rebuilt engines sold by machine shops.

Despite all the talk of the declining DIY market due to increasingly sophisticated technology and computerized vehicle controls, last year, sales of rebuilt engines to the DIYer actually rose from 41.6% to 44.3% of all engines sold. Sales of engines to the service garage/installer, on the other hand, actually fell slightly from 27.6% of all engines sold to 26.1% in 1997.

Jobbers accounted for 8.4% of all engines sold, followed by automotive dealers, 6.3%, heavy duty fleets, 4.6%, automotive fleets, 4.4%, and truck dealerships, 1.7%. All remaining market segments, except for ÒotherÓ represented less than 0.1% of engines sold.

We also asked machine shop owners to divide their total production into gas and diesel short blocks, long blocks, complete engines, heads and crank kits. Industry-wide, machine shops reported that cylinder heads accounted for 44.6% of their total gas engine rebuilding business. As might be expected, this represents a slight increase from the 42.9% of total gas engine rebuilding business that heads represented in 1996.

Following cylinder heads, long blocks accounted for 19.2% of all gas engine rebuilding, complete engines, almost 15%, short blocks, 13.1%, and crank kits 8.2% of total gas engine rebuilding work performed. Head, short blocks and complete engines increased 4%, 8.1% and 20% respectively from year earlier figures. Long blocks and crank kits declined 15% and 18%, respectively, as a percentage of all rebuilding work performed.

For diesel engine jobs performed, cylinder heads, again, represented the lion's share of the work. Cylinder head repair accounted for 54.7% of all diesel engine work performed in 1997, a decline of 3.2% from the 56.5% which this category represented in 1996.

Following cylinder heads, complete engines at 15.5%, crank kits at 14.3%, long blocks at 9.4% and short blocks at 6.2% rounded out the demand for diesel engine rebuilding.

We also asked shop owners to provide us with their average times required to disassemble, clean and rebuild an eight, six and four cylinder engine. Not including cleaning time, shops reported that four, six and eight cylinder engines required 1.3, 1.6 and 1.8 hours, respectively, to disassemble. These times represented increases of 27.4%, 18.8% and 15.4% respectively.

Total time required to rebuild an engine from core teardown to final assembly also increased for all engines. Four cylinder engine rebuilding time increased 27.8%, going from 10.2 hours to 13 hours. Six cylinder engine rebuilding time increased 23.5%, going from 12.1 hours to 14.9 hours. And eight cylinder engine rebuilding time jumped 30.5%, moving from 13 hours in 1996 to 17 hours in 1997.

Many shop owners told us that upgrading their equipment to be able to produce quality rebuilt engines cost effectively was one of the biggest challenges facing their businesses. Certainly, the increases in times required to disassemble, clean, machine and assemble engines speaks to the impact of new materials and new engine technology. It also speaks to the requirement of providing qualified and trained personnel to rebuild these engines. These are resources that can only be paid for through cost effective and profitable operation of the shop.

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