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Machine Shop Performance: This Month We Complete Our Extensive Market Profile

Last month's data provided details on cylinder head and crankshaft production levels, average production time per specific shop machining jobs, equipment purchases and more.

This month we complete our extensive market profile with details on size and annual sales of shops, gross profit margins, customer base analysis, warranty trends, expansion plans, shop-labor-to-part-sales comparisons, employee benefits, etc.

Our market data were compiled through a survey of the membership of the Automotive Engine Rebuilders Association (AERA). During the first quarter of this year, survey questionnaires were mailed to 3,260 machine shops in the U.S. The effective return rate was 15.3%. Survey results were compiled by MarketScope, a division of Babcox Publications.

Industry-wide, average gross sales per shop increased marginally from $599,067 in 1994 to $603,650 in 1995. Sixty-five percent of all machine shops responding to our survey recorded annual sales of less than $500,000, a little less than the 67% of total survey respondents that fell into this sales range in production year 1994.

The largest percentage shift was from respondents reporting annual sales of $1 million to $1.5 million. Nearly 8.5% of machine shop owners fell into this sales range last year, compared to 6.5% of all shops in 1994. However, in general, both average annual sales as well as the percentage of shops falling within specific sales ranges, have remained fairly constant over the past several years.

Overall, fewer shops reported an increase in gross annual sales (43.4%) compared to 50.3% that reported an increase in 1994. The number of shops that said sales remained the same was identical (34.7%) while the number of shops that reported sales levels declines rose from nearly 15% to nearly 22%. The average increase was nearly 13% for those reporting an increase, and the average decrease was 12.3% for those shops reporting a decrease. Based on figures reported in 1994, as an industry, machine shops totaled a modest average increase in annual sales ranging from 1.6% to 4.0%.

Gross profit margins on annual sales declined in 1995. In 1994, shops averaged gross margins (sales minus cost of goods sold) of 33.2%. In 1995 gross margins were reported at 31.6%, a decline of about 4.8%. Additionally, fewer survey respondents reported gross profit margin increases than in previous years. In 1994, nearly 36% of machine shop owners said that gross margins had increased. Last year just 19% of shops reported an increase.

For the majority of machine shops, profit margins remained steady. Last year 63.5% of all shops reported that profit margins were equivalent to the prior year, compared to just 47.3% who said so in 1994. The number of shops reporting that profit margins declined was almost identical to the prior year - about 17%.

In focus group meetings conducted by Automotive Rebuilder, and in personal and telephone interviews, many shop owners stated that competitive pricing from larger production engine rebuilders, as well as from competing machine shops, made it very difficult for them to maintain margins on typical passenger car and light truck engine rebuilds. Many shops continue to look for opportunities in more profitable markets, e.g., industrial, performance, marine, restoration, in an effort to increase profit margins on complete engine rebuilds.

The cost to operate machine shops today in terms of equipment, local, state and federal regulations, labor and overhead continues to increase. In order to meet these expenses, shops must price their products with an eye towards continued investment to meet both product technology requirements and customer expectations.

Is that happening? Well, in terms of labor rates, the trend since 1990 has been up. The average hourly shop labor rate in 1990 was $33.99. In 1995 that same rate was $39.42, an increase of 16%. Shop owners reported that in 1995 their average markup on shop labor was 42.6%. This is a decline from the average markup of 51.9% reported in last year's survey, although it is in line with markups reported in 1991 through 1994.

The greatest percentage of machine shop owners (nearly 50%) mark shop labor up between 21 to 40%. Only 11% of all survey respondents reported shop labor rates that were marked up more than 50%.

The national average hourly shop labor rate is $39.42. The largest percentage of shops (56.9%) charge an hourly labor rate between $21 and $40. Twenty-seven percent of shops charge $41 to $50 hourly, while just over 10% of shops reported hourly labor rates at $51 or higher. On the other hand, just over 21% of all shop owners reported charging hourly shop labor rates of $21 or less.

Total sales volume attributed to machine shop labor, and parts sales related to shop work, declined by a little more than 3%. In 1994 machine shop generated business represented a little more than 61% of total company sales. In 1995, 59.3% of total sales volume was attributed to machine shop parts and labor sales.

About one-third of all those responding to our survey derive the vast majority of their sales from the machine shop. A little more than 31% of all survey respondents reported that labor and parts sales related to the shop accounted for 91% or more of total sales.

More than 53% of all machine shop owners reported that labor and parts sales related to the shop accounted for 50% or more of total company sales. On the other hand, one-third of all respondents reported that shop labor and parts sales represented 33% or less of total sales.

The average parts dollars generated for every dollar in shop labor billed has continued to decline over the past several years. Machine shop owners reported that in 1995, for every dollar in shop labor billed they generated $1.52 in parts sales. This is a decline of about 2.6% from the $1.56 in parts sales generated per labor dollar billed in 1994.

However, in 1992 shop owners reported generating $1.76 in parts for every labor dollar billed, which fell to $1.71 in part sales in 1993. With the increasing complexity of engine designs, the variety and number of components in those designs, i.e., late model cylinder heads, we would expect part sales associated with labor dollars billed to be increasing. However, the reduced parts sales dollars may indicate that more shops are focusing on machine work rather than complete engine rebuilds.

Interestingly, the total dollars expended on internal engine parts rose significantly in 1995. Last year, the average machine shop spent $153,992 for internal engine components compared to $141,484 spent in production year 1994. That represents an increase of nearly 9%.

A number of factors may account for the rising dollars spent on engine parts. As previously mentioned with late model cylinder heads, many shop owners and their suppliers feel that more component parts are being replaced. This may be due to engine designs that more easily produce catastrophic failures, or because of the particular failure characteristics of late model units. For example, on Mitsubishi 2.0L engines, when the timing belt breaks it has the propensity to destroy all, or a good percentage, of the valves.

On a number of aluminum cylinder heads, cracking between the valve seats requires replacement of many of the seats following crack repair. In general, newer head designs, when they fail, have a tendency to require more component replacement due to the required repairs. In some instances the design of component parts also does not lend itself to rebuilding, e.g., reduced margins on valves which makes it difficult to reface them.

Later model cylinder heads also tend to be of the OHC, multi-valve, multi-cam design. So there are more parts to replace and the cost for many of these parts is higher. In addition, older engines originally designed to operate on leaded fuels, will often require more valves, seats and guides to be replaced to accommodate unleaded fuels.

At an average annual expenditure of $153,992, based on a universe of 6,000 to 8,000 full-service machine shops, the internal engine parts market at the machine shop level is worth $924 million to $1.23 billion. Of the total dollars spent on engine parts by machine shops, nearly 52% are for internal shop consumption. The remainder is for retail or wholesale sales.

Machine shop owner preferences for their sources of engine parts have not changed much over the past several years. Nearly 70% of survey respondents reported preferring to purchase parts from multiple suppliers versus a single source. The average machine shop utilizes 6.5 suppliers for their hard parts requirements. About 16% of shop owners use two or less suppliers, while 20.6% of shop owners reported using nine or more supplier sources.

Beginning with last year's survey, we began tracking the average age of machine shops. There are many who feel that the total number of machine shops is consolidating and that it is becoming increasingly difficult for smaller shops to survive or for new shops to open. The reasons for this span the spectrum from the high cost of equipment to the shortage of skilled machinists. Conversations with equipment suppliers tend to confirm the reduced number of new shop start-ups from an historical perspective.

Over the long term, we hope to be able to document where these trends lie through tracking the age of shops. This year the average age of the machine shop climbed modestly from 19.8 years to 20.3 years. If such a trend continues it would document the "maturing" of the machine shop market.

Although essentially statistically insignificant, there were fewer shops in the less-than-five-years old, six-to-10-years old, and 11-to-15 years old categories. On the other hand, there were modest increases in all shop age categories from 16 years old through 45 years old. We'll have to wait a few years to see if this trend continues.

Customer base

Historically, machine shop sales have been primarily to the do-it-yourself and service garage/installer. Since 1991, sales to DIYers have accounted for an average 38 to 40% of total sales, while the service garage/installer has averaged 28 to 30% of sales.

In 1995, machine shops reported a significant increase to the service garage/installer. In 1994 shops reported 28% of sales to this customer base, however, last year that percentage climbed to a little more than 34%. Sales to the DIY customer was virtually unchanged.

Sales to the professional service garage have been on a steady upward climb since 1993. The increasing complexity of vehicle systems will likely continue to keep this trend intact. However, it is interesting that sales to the DIYer continue to remain strong, despite the fact that many have predicted this customer base will be less involved with vehicle repairs in the future.

Our educated guess is that much of the continued strength of sales to the DIY customer is related to increasing work done on performance, restoration, marine and other specialty areas rather than the typical passenger car or light truck engine or cylinder head rebuild.

Just as increasingly sophisticated technology may be contributing to strong sales to the service garage/installer market, it also may be contributing to a rise in service work or engine installations being done by jobber machine shops and custom engine rebuilders. Since 1992 the percentage of shops reporting that they operate service bays for vehicle repairs or engine installations has risen from a little more than 25% to nearly 34%. The average number of service bays operated by those performing this service has risen from 3.2 to 4.4 over the same time period.

Those involved with engine installation and/or vehicle service work do so for a variety of reasons ranging from profit potential to an effort to reduce warranty returns.

As far as warranty returns are concerned, machine shops have reported little change over the past few years. Since 1992, engine work returned on warranty has averaged about 2.5% of total sales. However, the percentage of those returns that are attributed to customer installation or misdiagnosis is at its highest level ever. Last year, machine shop owners reported that nearly 68% of all warranty claims are due to customer-caused problems.

There is no question that warranty charges today are more costly than they have ever been. The problems related to the overall shortage of skilled service technicians, and the availability and access to equipment and information required to service today's vehicle systems, will likely continue to impact the warranty policies, marketing and service provided by the machine shop/custom engine rebuilder.

Facilities/employees/productivity

Despite the challenges in operating a machine shop today, more than 50% of survey respondents reported that they planned to expand their engine rebuilding capabilities over the next two years. The single largest percentage (72.1%) said that this would be done through the purchase of rebuilding equipment. Expanding the engine production area, adding shop services and adding employees were cited by 50% or less of survey respondents.

Presently, the typical company operating a machine shop employs an average 7.6 people, 4.5 of whom are shop employees. Shop employees have been with their current employer an average 8.67 years. Experienced machinist are paid an average $12.07 hourly, while inexperienced machinists receive $7.68 per hour. This represents and increase of 5% and 9.2% respectively.

Wages for shop counter sales and core disassembly personnel also rose modestly. Counter sales employee wages increased from $8.45 hourly to $9.51, while core disassembly personnel wages rose from $6.62 hourly to $6.78.

Judging from time studies to rebuild engines, over the past three years, shop productivity and efficiency levels have improved. The average amount of time required to disassemble a typical four, six or eight cylinder engine core has been increasing. However, the total time required to rebuild the same engine from core teardown through cleaning, machining and final assembly has been decreasing.

On average, shops reported spending 95.7 minutes to disassemble an eight cylinder engine, 83.6 minutes to disassemble a six cylinder engine and 69.7 minutes to disassemble a four cylinder engine. This represents an increase of 3.1% and 1.2%, and a decrease of 9% respectively over times reported in last year's survey.

On the other hand, the time to rebuild an eight cylinder engine last year decreased from 13.5 to 12.5 hours. Six cylinder engine production time declined from 12.2 to 11.3 hours, and four cylinder production time declined from 10.9 to 10.1 hours.

Overall, shop owners reported that 80.6% of their business is on domestic engines while the remainder is for imports. Specifically, shops reported that an average of 13.6% of total engine and cylinder head rebuilding is related to performance/racing engines.

In conclusion, the machine shop industry showed its third consecutive strong year since recovering from the recession which ended in 1992. Shop owners continue to focus on keeping costs down while striving for productivity and efficiency enhancements.

Competitive pricing from PERs and mail order parts houses, governmental regulations, and finding, training and keeping qualified shop employees were continually cited by survey respondents when asked to define the biggest problem facing their business in the coming years.

It seems clear that management expertise in terms of knowing actual job costs and then matching products, services and pricing to a specific customer base is a necessity for today's shop. Otherwise shops will be unable to finance the equipment, training and information resources required to build today's engines in today's markets.