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Machine Shop Market Profile Part II

Based on information provided in part one of our annual Machine Shop Market Profile which appeared in last monthís issue, the machine shop market produced between 1.31 million and 1.7 million rebuilt engines in 1996. These figures represent a decline of about 7% from the previous production year.
Part one of our annual Machine Shop Market Review featured details on engine, cylinder head and crankshaft production numbers, labor hours spent on specific shop jobs, equipment purchases, market trends and more. This month we complete our market analysis with information on annual sales, gross and net profit margins, customer base sales percentages, parts purchases, employee benefits, shop expansion plans, etc.
Data provided in this survey was compiled through a survey sent to the membership of the Automotive Engine Rebuilders Association (AERA). Our survey was sent to 3,279 AERA machine shops throughout the U.S. The initial mailing was done on Feb. 18. Completed questionnaires were accepted for inclusion in our study through April 10. The effective return rate was 12%.
Our survey consisted of four, four-page questionnaires which contained about 20 questions each. Each of the questionnaires was mailed to 820 potential respondents. The first 10 questions - primarily directed at assessing engine production numbers - were identical on each questionnaire.
Specific questions regarding statistical averages presented in this study should be directed to Dave Wooldridge, editor of Automotive Rebuilder (330-670-1234, ext. 214, or e-mail to dwooldridge@babcox.com). Space limitations prevent us from being able to publish all charts generated from this study. For a copy of all charts which were generated from this market analysis, call or e-mail Wooldridge at the number provided above.

Sales were down

Gross sales (parts and labor) for the typical machine shop declined an average of nearly 7%. Shops generated an average $561,997 in gross sales volume in 1996 compared to $603,650 in 1995. Interestingly, total engine production in units also declined about 7% compared to year earlier figures (see June 1997 issue, page 36).
The largest percentage of shop owners - 42.4% - generated less than $250,000 annually in gross sales. The percentage of shops falling into this annual sales category has changed little over the past five years. The second highest percentage of shop owners - 27.3% - generated between $250,000 and $499,000 in gross sales last year. In 1995, 23.4% of shop owners reported annual gross sales within this range.
In total, nearly 70% of all machine shops generate less than $500,000 in gross annual sales. The biggest change in gross sales volume categories in 1996 was in the $250,000-$499,000 range. A little more than 27% of machine shops fell into this sales category in 1996 compared to just 23.4% in 1995. All other sales category ranges showed statistically insignificant change from the previous yearís number of shops falling into those categories.
More shops reported an increase in gross sales volume - 48.3% - than in 1995 when just 43.4% of shop owners reported an increase in sales. The average increase in gross sales was also higher - 13.5% compared to 12.9% - in 1996 compared to 1995. For those shops reporting a decrease in annual sales, the average decline was 12.3%.
Parts sales directly related to machine shop labor increased marginally compared to the prior year. Machine shops reported selling $1.55 in parts for every dollar billed in shop labor in 1996. This is a 2% increase from the $1.52 in parts from every labor dollar billed in 1995.
Many machine shop owners have told us that it is increasingly difficult to earn the type of margins on parts that they saw several years ago. Many shop owners have also told us that retail discount and mail order parts houses have lead to an increasing number of customers coming into the shop with their own parts. Rather than turn away machine shop work, more shops today seem to be performing machine work for customers that provide their own parts. However, for those that do, reduced or no warranty is usually provided on the machine work or assembly work performed.
There are those who feel that a number of economic, marketing and product technology factors should lead to a decline in the number of small shops and an increase in the number of larger operations. Although there may be fewer total shops than in years past, there are no trends that seem to show any significant change in the percentage of shops falling within specific sales volume ranges or the percentage of shops reporting increases or decreases in gross annual sales from year-to-year.
The percent of total sales volume that was attributed to machine shop parts and labor was significantly higher in 1996. Shops, on a national basis, reported that shop sales of parts and labor accounted for nearly 68% of total business sales volume. This is an increase of a little more than 14% compared to the 59.3% of total sales attributed to machine shop parts and labor in 1995.
Nearly 40% of all businesses responding to our survey reported that machine shop parts and labor accounted for 91% or more of total annual sales. This percentage is up significantly from the 31.5% in 1995 and the 29.9% in 1994 that reported that more than 91% of total annual sales was derived directly from the machine shop side of the business.
Total gross profit margin (sales minus cost of goods sold) on machine shop parts and labor was the highest it has been since at least 1992. In 1996, gross profit margin averaged 35.1% on a national basis. In 1995, shops reported generating an average 31.6% in gross profit margin.
The highest percentage of shops - 26.2% - generated a gross margin between 21-30%. The next highest percentage of shops - 22.7% - produced gross margins between 21-30%.
Grouping profit margin categories reveals that about 23% of shops generated gross margins of 20% or less, 49% of shops generated margins between 21 and 40%, and nearly 28% of shops earned gross margins of 41% or more.
A higher percentage of shops reported an increase in gross margins compared to those that reported an increase in last yearís survey. A little more than 23% of shops reported an increase in gross margins in 1996 compared to just 18.9% who said margins improved in 1995. The average increase for those reporting an increase was 7.8%.
Fewer shops reported that margins declined or remained the same compared to the prior production year. For those shops reporting a decline, the average drop in gross margin was 6.2%.
Pretax profit was lower than at any time in the past. The average national pretax profit for the typical machine shop was $45,977. This represents an 11% decline from the $51,673 generated in pretax profit in 1995. It should be noted that regional factors play a significant role in determining both sales volume in parts and labor, as well as dollars generated in profit margins.
In surveys that we have conducted over the past few years, charges for specific shop jobs such as cylinder head repair, surfacing, line boring, etc., always vary significantly between shops located in different parts of the country. Prices charged in the Southeast, for example, are consistently less than those reported in the Northeast. West Coast prices for shop work often are in line with those charged in the Northeast, but also usually higher than those reported by Midwest shops.
Todayís machine shop is under considerable pricing pressures generated by competition from local machine shops as well as production engine rebuilders (PERs) or large retailers being supplied by PERs. The cost of purchasing parts and equipment does not vary by geographic location. Although the cost of utilities and labor is significantly higher in some regions compared to others, all machine shops today are being forced to run their operations more cost effectively than ever before.
Machine shops also reported the lowest percentage of total parts purchases for retail sales or redistribution (those parts not used for shop consumption) since 1992. Of the total internal engine parts purchased in 1996, just a little more than 36% were for redistribution or retail sale. This represents nearly a 24% decline compared to 1995 when nearly 48% of total engine parts purchased during the year were for redistribution or retail sale.
Fewer shops reported an increase in engine kit sales to both retail and wholesale customers in 1996. Just 20.3% of shops said engine kit sales increased last year compared to 26% who said so in production year 1995. However, for those that did report an increase, the increase was much higher. The average increase in 1996 was a little more than 19% compared to an average increase of just 13.7% in 1995. The greatest majority of shops - 68% - reported that engine kit sales remained comparable to those generated in the previous year.
The reduced amount of part sales independent of shop work again reflects the growing impact of retailers, mail order parts houses, and overall reduced market demand during 1996. More and more machine shops seem to be attempting to look for niche opportunities to perform machine work in an expanding array of markets from small engine, to performance to industrial and off-road. Judging from just the marginal reduction in annual sales and total engines rebuilt in 1996, we would say that many shops are becoming better marketers of their shop services.

A maturing market

The average length of time that a machine shop has been in business now stands at 20.8 years. This is up slightly from the 20.3 year average reported in 1995 and the 19.8 year average reported in 1994. The trend seems to point towards the continued maturing of the machine shop market.
Most equipment and parts suppliers we have spoken with tell us that there are fewer new shops being opened. This is due to a variety of factors from the cost of equipment to the difficulty in finding and keeping quality shop personnel. The increased cost of start-up operations combined with older machine shops that have not made the investment in updating equipment and personnel in order to transition into providing repair services for higher technology products and a more demanding customer base, are probably the root explanations for the rising average age of existing shops.
As was mentioned earlier, the cost to operate machine shops today in terms of equipment, overhead and personnel continues to grow. In order to finance these increasing costs, shops must be able to price products commensurable with the cost involved in doing the job. Is that happening?
The answer, again, depends on regional location, customers served, products and services provided and specific competitive market factors. However, in terms of national averages for shop labor rates, the trend is up. Nationally, the hourly shop labor rate was $42.25 in 1996. This represents a 7.2% increase over the average $39.42 hourly rate charged in 1995. This is the largest single increase since at least 1993 when the average hourly shop rate rose 6% from $35.12 to $37.22.
Survey results also show that more machine shops have computerized their businesses in order to better manage shop operations. Last year nearly 44% of survey respondents reported that they were using computers and software programs for job tracking, labor costing, warranty analysis, productivity analysis, and more (See our complete list of computer software and hardware available to machine shops in the June 1997 issue of Automotive Rebuilder, pages 64 and 65).
Use of computer technology to manage shop operations has been on a slow and steady increase since 1992 when 38.7% of shop owners reported using computers to manage their shops. If you include the 11.6% of shops that said they are in the process of implementing computer technology, we project that nearly 50% of machine shops should be utilizing computers to manage shop operations within the next few years. Better shop management is a critical issue if shops are going to be able to afford quality machinists in the future.
Part of the equation for ensuring quality and knowledgeable machinists involves paying shop personnel a wage which reflects the expertise, knowledge and experience required in todayís shop. The average hourly wage paid to shop employees rose last year for both experienced as well as non-experienced machinists.
Experienced machinists saw the largest increase in several years. The average rate jumped to $13.04 from $12.07, an increase of 8% compared to the previous yearís hourly rate. Inexperienced machinists saw their hourly wage rise nearly 7% from $7.68 in 1995 to $8.20 in 1996. Wages paid to counter sales and core disassembly employees saw marginal increases from the prior year.
The average number of machine shop employees per business location declined to its lowest level since 1993. In 1996, the typical engine rebuilder/machine shop employed 3.76 machine shop employees, a decline of nearly 16% compared to 1995 figures. This decline is likely the result of tighter labor markets as well as more productive equipment investments.
It has been reported widely that many areas of the country have less than a 4% unemployment rate. There are also many metropolitan areas with 3% or less unemployment. Although upward pressure on wages has been lower than in any other previous recovery in recent history, there still remains a shortage of qualified available employees for many shops. We have talked with at least two large engine rebuilding businesses in the Midwest, for example, that have actually moved portions of their operations to different locations in order to find a larger labor pool.
The Automotive Engine Rebuilders Association (AERA) recognizing the increasing concern in the industry for finding and keeping qualified machinists, recently created the Engine Rebuilders Educational Foundation. AERA is presently involved in fund raising activities for the foundation. More than $10,000 has already been raised. A five-member board of governors is in the process of determining how foundation money will be awarded.

Parts expenditures up

Although the typical machine shop saw lower production and gross sales than in the previous year, dollars expended for internal engine parts were at an all time high. Machine shops spent an average $157,264 on engine parts in 1996 compared to $153,992 in 1995, about a 2% increase.
The increase in parts costs is likely the result of vender increases from year-to-year, along with more expensive parts for late model engine applications. As one machine shop owner explained it, "We are spending more money on parts to rebuild engines with fewer cylinders."
Where most vendors are very competitive on pricing for parts for early model 350 and 302 engines, for example, parts costs are higher for later model applications. And as demand for early model engines declines and that for late model applications increases, expenditures for parts can be expected to continue to rise.
Based on a universe of 6,000 to 8,000 full service machine shops, the custom engine rebuilder/machine shop market accounted for between $943.6 million and $1.26 billion in engine parts sales at the wholesale level. Exactly 34% of all machine shops reported that they preferred to purchase their engine parts from a single source supplier. This is up from the nearly 32% that preferred one-stop shopping in 1995.
However, there is not a documented trend for increasing preference for single source versus multiple source buying habits on the part of the typical machine shop. In fact, 44% of shops indicated a preference for using only one supplier in 1992, 29.1% in 1993, 32.8% in 1994 and 31.9% in 1995.

Customer base analysis

Sales to the DIY and professional installer continue to account for the two largest segments of the typical machine shop customer base. Sales to these two market segments account for nearly 70% of total engine sales. However, there was a significant decline in sales to the professional installer last year.
In 1996, shops reported that 27.6% of rebuilt engine sales were to service garage/installers. In 1995, though, a little more than 34% of total engine sales were reported to be to the service garage. We are unsure whether this represents a long term trend or whether it just reflects a down year for engine sales in general compared to 1995. In 1992 through 1994, for example, the percentage of engine sales to the service garage customer averaged about 27%.
We have spoke with more than a few machine shops and parts and equipment suppliers, however, that are quite concerned about the availability of "qualified" service technicians for installing a rebuilt engine. There is no question that if a service garage owner cannot install rebuilt engines profitably, i.e., without expensive and time consuming rework, he will likely target other more profitable jobs for his business.
Much of the rebuilt engine sales of the past have been for earlier, non-computer controlled cars and trucks. However, as computerized vehicles become a larger percentage of the rebuilt engine sale target vehicle population, more knowledgeable service technicians will be required to ensure a proper installation.
Although new vehicles are becoming more and more expensive for the typical consumer, OEMs are providing more attractive financing and leasing options on both new and used cars and trucks. Repowering an expensive car, truck, van or sport utility vehicle should be a more and more attractive option for a growing number of consumers.
However, without proper marketing and promotion of the viability, performance and cost savings of a rebuilt engine alternative to the consumer, without qualified service technicians to install them, without available financing for the vehicle owner, and without an attractive warranty, our industry may miss a golden opportunity to enlarge the total market for rebuilt engines. If that happens, fewer machine shops and production engine rebuilders will be left to fight over flat or declining demand for a rebuilt replacement engine.
If machine shops, however, are concerned about the number of qualified service outlets for installing their engines, it is not reflected in the number of shops performing their own installation work. Fewer shops reported operating service bays for engine installation and/or repair work.
Just 24% of shops reported operating a service bay in 1996, a 25% decline from the 33.8% that reported doing engine installations in 1995. For those shops providing installation services, the average number of service bays in operation was 3.3. The total number of shops with service bays and the average number of service bays per location is the lowest reported since at least 1992 when 25.3% of machine shops reported offering engine installations with an average of 3.2 service bays per location.
Despite concerns about the availability of qualified service technicians, neither total warranty returns or the number of returns attributed to installation or diagnostic problems increased. In 1996, just 2.6% of all engines rebuilt were returned as a warranty claim. Warranty returns have hovered between 2.3% and 2.7% for at least the past five years.
In conclusion, the machine shop market showed its first decline in production numbers since the recession ended in early 1992. Both engine and cylinder head production were off, although marginally. Of course, regional economic sensitivities, various products and services provided, and customer base served all influence specific rebuilding operationsí business numbers. Productivity enhancements, machining efficiencies and exploration of alternative niche markets for shop services continue to be priorities for todayís machine shop.
Sourcing qualified shop employees, competitive pricing on rebuilt engines and parts from other machine shops, PERs, retailers and mail order parts houses, and maintaining acceptable profit margins while updating equipment to keep pace with product technology, were most often cited by survey respondents when asked to define the biggest problems facing their companies now and in the near future.