Machine Shop Market Profile Part II - Engine Builder Magazine
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Machine Shop Market Profile Part II

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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.

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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.

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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 [email protected]).
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).

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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.

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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.

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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.

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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.

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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.

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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%.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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%.

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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.

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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.

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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.

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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.

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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.

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