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Machine Shop Market Profile

By Dave Wooldridge

In Part I of our annual profile of the custom engine rebuilder/machine shop market (see June, 1999 issue, page 54) we provided details on the average number of engines, cylinder heads and crankshafts produced monthly by the typical machine shop during production year 1998.

Also included in Part I’s profile were summaries of the percentage of aluminum versus cast iron heads rebuilt, scrappage rates, types of engines rebuilt, core acquisition patterns, import versus domestic production, shop equipment ownership and purchases and percentage increases and decreases in various rebuilding product categories.

Babcox Publication’s Market Research division mailed 3,200 questionnaires to the membership of the Engine Rebuilders Association (AERA) in early January with a follow-up mailing in mid-February. A total of 487 completed questionnaires were received for an effective return rate of 15%.

Based on a universe of 6,000-8,000 full service machine shops, the total number of engines rebuilt in 1998 was 1.32 million to 1.76 million units. Applying an arbitrary average sale price of $1,200 per engine, machine shops collectively generated between $1.7 billion to $2.23 billion in annual rebuilt engine sales last year.

In Part II of our survey we’ll take a look at a number of other market defining characteristics including gross sales volume in parts and labor, profit margins, years in business and average number of employees, wages and benefits, expenditure on internal engine parts, customer base, most popular engines and cylinder heads rebuilt, parts purchasing preferences, and the percentage of total production time spent on various machine shop labor activities, among others.

Gross sales volume, profits
Machine shop owners reported that their average gross sales volume in parts and labor declined in 1998 from $626,065 to $581,260, a little more than a 7% drop. However, annual sales in parts and labor was still higher than the national average of $561,997 generated in production year 1997.

Of total survey respondents, 44% reported an increase, 35.2% remained the same, and 20.8% reported a decrease over year earlier gross sales volume. Of those reporting an increase, the average increase was 12.4%, and of those reporting a decrease in gross sales the average decrease was 9.6%.

Although total average gross sales volume per shop was down, the percentage of shops attributing the majority of their sales to parts and labor generated from machine shop work increased. On average, in 1998 shop owners reported that parts and labor sales generated by the shop represented nearly 70% of total business sales dollars.

More specifically, in 1998, nearly 44% of shop owners reported that gross sales generated directly from machine shop parts and labor represented 91% or more of all sales dollars generated by the business. In production year 1997, about 40% of shop owners said machine shop parts and labor sales represented 91% or more of total business sales.

On the other end of the sales spectrum, just 9.3% of shop owners reported that parts and labor sales generated by the shop accounted for 10% or less of all business sales. In 1997 a little more than 11% of shop owners reported that machine shop parts and labor sales accounted for 10% or less of total business sales. The trend over the past two years seems to point toward the machine shop becoming the primary profit center of the total business’ sales efforts.

Despite the fact that average machine shop sales were lower compared to production year 1997, profit margins, industry wide, were higher. The average gross profit margin for machine shops in 1998 was 35%. This compares with an average 33.3% and 35.1% gross profit margin generated by machine shops in 1997 and 1996, respectively.

Specifically, the largest percentage of respondents (27.5%) reported gross profit margins of 31-40%. A little more than 25% of shop owners reported gross margins of 21-30%. So, combined, a little more than one-half of all shop owners generate average gross profit margins of between 21-40% on machine shop parts and labor sales.

As might be expected, a higher percentage of shop owners reported increases in gross profit margins, while lower numbers of shop owners reported that profit margins remained the same or decreased compared to year earlier figures. Interestingly, however, 1998 percentages are very similar to those reported for production year 1996. Nearly 27% of all shop owners reported that profit margins increased in 1998 compared to 19.7% and 26.3% of shop owners in 1997 and 1996, respectively.

This year’s higher gross profit margin on machine shop parts and labor sales also translated into a significantly higher pretax profit for machine shops compared to that generated in 1997. In 1998 machine shops, nationally, averaged a pretax profit of $51,507 - a 30.4% increase compared to the $39,493 average pretax profit generated in production year 1997. This is a significant turnaround from the declining profit margins reported by machine shops over the past several years.

Industry representatives, suppliers and machine shop owners we have interviewed generally describe the market as one in which the number of both suppliers and machine shops continues to consolidate. Our gross sales and profit margins for 1998 may indicated a continuing overall flat demand for rebuilt engines and cylinder heads. But it also seems to point toward those surviving shops becoming more efficient and earning higher profit on the work that they are doing.

In line with this thinking, shop owners reported a significant increase in the hourly labor rate charged for machine shop services. In 1998 the national hourly shop labor rate was $46.16, an increase of more than 7% compared to the national hourly shop labor rate of $42.99 reported for production year 1997.

The average mark-up on shop labor charged to the customer also increased in 1998. Nationally, machine shops reported an average shop labor mark-up of 70.4%, an increase of 3.1% compared to the 68.3% mark-up on shop labor reported in production year 1997.

Machine shop owners seem to be getting the message that to stay in business, provide quality service and make the necessary investments in shop equipment to work on today’s engines, profit margins must increase. Mark-up on shop labor rates have been on a steady increase for several years. In production year 1996, for example, the mark-up on shop labor was just 48.9% compared to the 70.4% mark-up reported for 1998.

Engine parts purchasing
Annual expenditures for internal engine parts was on par with that spent by machine shops in the prior year. During production year 1998, machine shops spent an average of $134,217 on internal engine parts, a decline of 1.5% compared to the reported $136,227 spent on engine parts during 1997.

While engine and head production in 1998 was almost identical to that of 1997, we would surmise that the slight reduction in expenditures for engine parts is likely the result in variances in the respondents to this year’s survey compared to last year’s respondents.

Pricing, however, remains very competitive among engine parts suppliers. Some shop owners tell us that they are able to source, especially engine parts kits, at better prices than they have in the past, expending less money on stocking inventory and receiving same day or next day delivery when required. Since 1995, when machine shops averaged $153,992 annually in internal engine parts purchases, expenditures on these parts has, generally, been on a steady decline.

A significantly higher percentage of engine parts purchases during 1998, however, reportedly were for redistribution or separate retail sale, rather than for use on rebuilt engines and heads. Machine shop owners reported that of all their internal engine parts purchases, an average of nearly 51% or about one-half were sold independent of rebuilt engine or head work undertaken by the shop.

That represents an increase of about 13% compared to the average 45% of engine parts purchases that were sold by machine shops independent of engine or cylinder head work requiring these parts. This is the highest percentage of engine parts sales not installed on a rebuilt head or engine since 1995. During production year 1995, shop owners reported, nationally, that nearly 48% of all engine parts purchases were for redistribution sales and not parts installed on a rebuilt engine or cylinder head.

We are a little surprised that parts sales independent of machine shop work rose as much as it did. Many conversations with machine shop owners continues to indicate that pricing competition from large retailers on engine parts continues to be intense. Again, the 1998 numbers may be a reflection of differences in this year’s survey respondents, as well as consolidation in machine shops that have left larger shops being able to buy and sell parts at more competitive prices.

Parts sales generated from labor dollars billed did rise in 1998, marginally, compared to 1997. Machine shop owners reported selling $1.98 in parts sales for every dollar billed in machine shop labor during 1998. During 1997, machine shops, nationally, reported selling $1.96 in parts for every labor dollar billed by the shop.

Overall, parts sales per labor dollar billings have been on a steady increase since 1995. During production year 1995, shop owners reported selling just $1.52 in parts for every labor dollar billed.

Purchasing of engine parts by machine shops remained primarily in kit form. Many machine shops today have reduced the amount of inventory which they carry and can order next day delivery of custom assembled kits for the specific engine which they will be machining/rebuilding.

Nearly 58% of all engine parts purchased by machine shops in 1998 were in custom assembled kit form. This compares to 64% and 58% of total engine parts purchased in kit form for production years 1997 and 1996, respectively.

Looking a little closer at engine kit sales, a nearly identical number of machine shop owners in 1998 reported an increase in engine kit sales versus year earlier figures. In 1998, 21.6% of shop owners reported an increase in engine kit sales versus 21.2% who reported an increase in production year 1997.

A significantly higher percentage of shop owners said engine kit sales remained the same, 62.9% versus 56.7% in 1997, while fewer shop owners reported a decline in engine kit sales in 1998, 15.5%, compared to 22.1% that reported a decline in 1997.

For those shop owners reporting engine kit sales increased, the national average increase was 14%. For those shops that reported engine kit sales declined, the national average decline was 21.7%.

When asked if they preferred to use multiple versus single source suppliers when purchasing engine parts, 69% of shop owners said they preferred to use multiple suppliers. However, this is a drop from the 74.4% of shop owners who cited a preference for multiple suppliers during production year 1997.

Interestingly, if we averaged the percentage of respondents who cited a preference for multiple source suppliers of engine parts since 1995, the four year average is almost exactly 69%. So, over the past four years, there has really been little to no change in the purchasing preferences of machine shops when it comes to single source versus multiple source engine parts purchasing preference.

Customers, marketing
Machine shops continue to rank their shop’s reputation, i.e., word of mouth advertising, as the most important factor when it comes to the sales and promotion of their engine and machine work. In fact, shop reputation has been on a slow but steady increase in importance over the past three years. On a scale of 1-5 with one being most important, in 1998 shop owners, nationally, ranked their shop’s reputation as a 1.54. In 1997 it ranked as a 1.68 and in 1996 as a 1.93.

Price and availability have almost identical rankings of 3.0 and 3.1, respectively, while warranty policy in 1998 carried a rating of 3.5. National brand parts ranked lowest in marketing importance with a rating of 3.85.

Looking a little closer at these marketing factor rankings, more than 85% of all shop owners ranked their shop’s reputation as number 1 or 2 on a 1-5 ranking scale. A little more than 37.5% of shops ranked price as a number one or two, 31.3% of shops ranked availability as a number one or two, 27.1% ranked warranty as a one or a two, and 18.8% of shops ranked genuine brand parts as either a one or a two in importance when marketing their rebuilt engines and shop services.

The two single largest customers for machine shops and custom engine rebuilders remain the do-it-yourselfer and the professional service garage. Together these two categories represent nearly 71% of all customers for rebuilt engines and machine shop services.

Along with reports over the past several years that the DIY market is shrinking for major vehicle repairs, this year shop owners reported a decline in DIY sales and an increase in professional service garage sales. In 1997, 44.3% of all sales were to the DIY customer while in 1998 just 41% of total business sales were to the do-it-yourselfer.

On the other hand, in 1997 machine shop owners reported that 26.1% of all sales went to the professional service garage. However, in 1998, shop owners said that the professional service garage had increased to nearly 30% of total business sales. 1998 marks the first year since 1995 that DIY sales have decreased rather increased. 1998 also marks the first year since 1995 that sales to the professional service garage have increased rather than decreased.

Shifts in sales to these two customer categories may signal the long predicted arrival of the "do-it-for-me" category of customers for vehicle repairs. It may also indicate the increasing number of engines that are more representative of later model, electronic configurations that require more knowledge, equipment, tooling and diagnostic capabilities of both the rebuilder and the professional service garage.

Production time details
In our survey we provide shop owners with 14 major labor categories and ask them what percentage of total shop labor time is spent in each. The amount of time spent on specific machine shop labor jobs continues to indicate that the majority of shop labor relates to cylinder head rebuilding.

In 1998, 46.8% of all shop labor hours were expended on cylinder head repairs. These repairs include cylinder head resurfacing, valve guide and seat work, cylinder head crack repairs and valve reconditioning. Cylinder head labor hours have increased in these four head repair categories compared to production year 1997. In 1997, shop owners reported that just 42.5% of shop labor was involved in cylinder head repair work.

Machine shop owners and suppliers of parts and equipment used in making cylinder head repairs tell us that the proliferation of lighter weight aluminum heads in combination with cast iron blocks has resulted in more and more shop labor on the engine’s top end, i.e., cylinder heads.

Quality improvements in OEM powertrains have resulted in less block work and more head work for machine shops. When fluid levels are maintained, and oil and cooling system maintenance is done on a regular basis, most modern engines are reaching 100,000 mile longevity with relatively little need for machine shop repairs.

However, aluminum heads are more susceptible to cracking and warping when this type of maintenance is neglected, or when cooling and/or oil levels drop even modestly in some engine models. Many machine shops tell us that much of their engine work today is on relatively old engines - early to mid ’80s - or on relatively newer engines - mid to late ’90s - engines and heads that suffer catastrophic failures. In many of these cases, in addition to the DIYer or local independent service garage, OEM car and truck dealers will use a local machine shop to undertake cylinder head rebuilding where replacement heads are not readily available and/or quick turnaround times are critically important. This is especially the case when warranty coverage is still being provided on the vehicle.

Looking at the labor categories individually, the top five in 1998 in terms of the amount of labor time spent of total production time were valve guide and seat work (15.3%), disassembly/cleaning (13.7%), valve reconditioning (13.1%), cylinder head resurfacing (13%) and cylinder block boring (11.3%).

The same five labor categories ranked in the top five in terms of labor time requirements in production year 1997, too. However, the rankings were different. In 1997 disassembly/cleaning ranked first (15.2% of total production time), followed by cylinder head resurfacing (14.7%), valve guide and seat work (12.8%), cylinder boring (12%) and valve reconditioning (10.1%).

We also asked shop owners to provide us with the average total hours spent on disassembling an engine and on rebuilding a long block. The time (in hours) for rebuilding a long block includes everything from core teardown to cleaning, machining and reassembly.

Time spent on disassembly of four, six and eight cylinder engines changed little, if at all, from what was reported in last year’s survey. Time spent on disassembly of eight, six and four cylinder engines averaged, 1.8, 1.4 and 1.2 hours, respectively. In 1997 shop owners reported the time to disassembly eight, six and four cylinder engines to be 1.8, 1.6 and 1.3 hours, respectively.

Average hours spent on rebuilding a long block did change depending on the engine. Time spent on rebuilding an eight cylinder engine rose 9.5% from an average of 14.1 hours in 1997 to 16.1 hours in 1998. Average hours to rebuild a six cylinder engine rose marginally from 13.2 hours in 1997 to 13.5 hours last year. And time required to rebuild a four cylinder engine fell nearly 5% from 12.3 hours in 1997 to 11.7 hours in 1998.

Average hours required to disassemble engines can vary significantly from shop to shop based on the type of equipment in use, the type of engine being rebuilt, and the employee/machinist level of experience and expertise. It is interesting to note, however, that, in general, the average time required to rebuild an engine, regardless of size, as been on a slow but steady increase since 1995. This, no doubt, reflects the increasing complexity and tighter tolerances and specifications that engines since the late ’80s and early ’90s have been built to.

Unit percentages
We also provided shop owners with five different gas and diesel engine rebuilding categories and asked them to report the average percentage of total production in units in each category. The five categories were short blocks, long blocks, complete engines, cylinder heads and cranks.

In the gas engine category, by far, the largest amount of business is done in cylinder heads. In 1998, machine shop owners said that nearly 47% of all gas engine rebuilding business was in cylinder heads. This is an increase of 5.2% compared to the 44.6% which this category occupied in production year 1997.

Cylinder head rebuilding was followed by complete engines (18.9%, 14.9% in 1997), long blocks (15.4%, 19.2% in 1997), crank kits (9.5%, 8.2% in 1997) and short blocks (9.4%, 13.1% in 1997). So, for production year 1998, shop owners reported fewer short blocks and long blocks, while doing increased numbers of complete engines, cylinder heads and crank kits.

The percentage of gas engine short blocks and long blocks are at their lowest levels since 1995. On the other hand, the percentage of rebuilding business devoted to cylinder head rebuilding is at its highest level ever.

When it comes to diesel engine rebuilding, similar trends emerge. Diesel heads occupied 55.8% of total diesel production, followed by complete engines (18.4%), crank kits (12.9%), long blocks (7%) and short blocks (6%).

Although the percentage of units built in gas and diesel categories are similar, the total number of units built in gas and diesel are not. In 1998 the typical machine shop rebuilt an average of 17.5 gas engines monthly compared to just under two diesel engines. The typical machine shop also rebuilt an average of nearly 50 gas cylinder heads monthly in 1998 compared to just about seven diesel heads each month.

Shop owners were also asked to rank from 1-5 the top cylinder heads that they rebuild by manufacturer, with 1 representing the most popular cylinder head being rebuilt. Chrysler, GM and Ford ranked number one, two and three respectively in the numbers of heads rebuilt. About 42% of shop owners ranked Chrysler heads as the number one make of head which they rebuild, while 33% ranked GM heads as the number one head rebuilt in their shop. A little more than 14% of shop owners reported that Ford heads were the number one head rebuilt.

The percentage of shop owners ranking other heads as the number one repaired unit dropped off significantly after Ford. Following Ford, 6.6% of shops said the Mitsubishi (essentially a Chrysler head in many cases) was the number one head rebuilt, followed by Toyota heads (5.5% of shops), Honda heads (2.2% of shops), and Mercedes, Isuzu and Nissan reported by 1.1% of shops, respectively.

So, of the Big Three U.S. auto makers, although Chrysler has the lowest market share in vehicle population, it by far has the highest market share in cylinder head rebuilds in the aftermarket.

Warranty issues
Although the percentage of engines returned as a warranty claim remained unchanged from year earlier figures, 2.7%, the percentage of returns assessed as a customer installation problem was at its highest ever reported. Shop owners said that of all warranty claims made, nearly 71% were due to customer installation problems. In 1997 shop owners attributed 68.6% of all warranty claims as a customer installation or diagnostic problem.

Although our ’98 production year market profile points to flat demand for rebuilt engines and cylinder heads, continued consolidations, intense pricing and competitive pressures on many fronts, a higher percentage of shop owners reported plans to expand their operations over the next two years. A little more than 47% of shops said they would expand their machine shop operations over the next two years.

What’s interesting about the expansion plans is the type of expansion shop owners plan to make. By far, the largest percentage of shop owners, 65.2%, who said they would expand their operations, said they would add rebuilding equipment. The second highest percentage, 56.5%, said they would add employees.

For those shops that plan to survive over the coming years, it seems quite evident that having the proper equipment and tooling to build more sophisticated engines, along with properly trained employees are the two highest priorities for most shops. If you can’t rebuild it with quality and efficiency it appears that in the coming years, you won’t be rebuilding it at all.