Internal Discounting: Culture Killer That Won’t Go Away!

As published in RVBusiness, January/February 2022

by John Spader and the Spader Business Management Team

“Why should I have to pay the same rate as the retail customers?  After all, the sales department is the biggest customer the shop has!”

Sooner or later, every dealer with department managers has to deal with this argument. First, it’s the sales department wanting a discount on labor for prep and delivery expenses.  Then they want a deal on parts and accessories.  Then they want to buy everything at cost!

There is a certain appealing logic to the argument.  After all, shouldn’t the departments be wholesale partners together?  Shouldn’t the sales department be allowed to earn some money on their hard work?  It was the sales department who sold the stuff after all!  What about the poor salesperson; don’t they deserve some commission on the things they sell?  Plus, isn’t it true that the labor rate is something like five times what the mechanics make?  Wouldn’t a simple pass through of straight costs make more sense?

Next thing you know, there is a tiered system of labor rates – at least one internal rate plus the external rate.  In most cases, the sales department is dictating the terms of this arrangement, and they often want to influence the flat rates as well.  The service manager is having a hard time with all of this, because after all they are under pressure to get the department’s profitability up.  And the accounting person, who has to keep track of it all, usually has some choice words for everyone involved!

In our opinion, all of this effort is not only wasted, it actively reinforces a set of beliefs that has a negative influence on nearly everyone in the dealership.  The existence of internal labor rates reflects a fundamental misunderstanding about who the actual customer is, displays a lack of clarity regarding the true cost of quality service, prioritizes the profitability of one department (sales) over that of another (service), and sends the message to everyone in the company that the retail labor rate is inherently unfair.  More often than not, a pay plan that ties commissions to the cost of prepping units for delivery is the root cause of internal discounting.

Fundamentally, the customer is the customer.  The sales department is not the customer!  The sales department’s main role in the dealership is to sell major units at good margins; on that we all agree.  The problem shows up when it comes time to figure out how those margins are calculated.  Most sales pay plans in effect “charge” the sales department in order to prep the unit; the cost of the prep is added to the invoice cost of the unit in order to determine the profitability (and commissions!).  The internal language of “cost” and “charge” reinforces this idea that somehow the sales department is actually buying something. This misguided but ubiquitous idea serves two negative purposes.

First, no matter what the internal rate is, in this context it is too much. Without a clear understanding of the true costs of a service operation, most salespeople are horrified to have charges of even $60 to $70 per hour levied against their sales, not to mention actual shop rates of $140 to $150.  From their perspective, in a typical pay program a salesperson is giving up something in the neighborhood of $250 to $350 in commission, or maybe more, for prep and delivery costs. The result is almost inevitably a contentious relationship in which the sales department always feels overcharged and the service department underappreciated.  The best practice is to design a pay plan that does not set up this unhealthy rivalry in the first place. 

Secondly, at the very moment the salesperson’s non-verbal communication with the customer should be screaming, “Our company is the very best place for you to buy and service your new unit!” there is a whiff of unfair treatment and high prices associated with the service department. This message is not lost on the customers, who were often thinking the labor rate seemed high too, and now they have a dealership employee reinforcing the idea. Salespeople have even been overheard giving counsel to customers to go elsewhere for hitch work or accessories!

If we unpack the idea of a discounted internal labor rate even further, it also becomes clear that many dealership employees – often the owner included – do not truly understand what goes into a properly-set labor rate, and can come to the conclusion that it is somehow unfair to both the customers and the service technicians themselves. Imagine you are a technician making $20.00 per hour, or you’re a salesperson and you are aware that your pal in the shop is getting paid $20.00 per hour. But the shop rate is $130 per hour. In the absence of additional information, why wouldn’t you think the dealer is making out like a bandit? In fact, it almost seems a little obscene – such a giant profit!

Of course that is nonsense, as anyone who has read a service department’s P & L could attest, but if no one takes the time to explain this to the employees, how would they ever know? Allowing internal discounting reinforces the idea that somehow there is lots of profit packed into the retail labor rate; after all, the dealership would not be discounting below some level of minimum profitability, would they? So if the internal rate is $40 or $50 below the retail rate, that $40 of $50 must be pure profit! Thus another unintended consequence of internal discounting is to reinforce the idea that the retail labor rate is unfairly high – to everyone.  This surely does not help the non-verbal communication of those responsible for selling work to customers!

Nothing could be further from the truth in most cases. While there are multiple factors to consider and every business is different, we have found that generally the retail labor rate needs to be 5 to 7 times the average wage of the technicians in order to generate anything close to a fair profit. Inhibiting the department from collecting this level of revenue starves it of the resources it needs to hire, train, and retain excellent technicians, invest in proper facilities, and maintain high quality management staff. And unless the dealership has a true customer-pay-based business model, it is likely true that much of the work in the service department is done in support of sales customers. In other words, in many cases the majority of the work done by the service department is done at a discounted rate, making profitability nearly impossible.

If you have discounted internal rates, consider these questions:

  • Do your employees work for less money when they are working on prep and delivery jobs?
  • Are your rent, power, or insurance expenses lower when performing internal work?
  • Even at your discounted rate, do your salespeople support the costs of prep and delivery expenses at your dealership?  Or do they still think they are getting ripped off?
  • Are you currently earning a 20% net profit in the service department?

Internal discounting adds complication to the accounting process, sows the seeds of discord between departments, reinforces the false notion that the retail labor rate is unfairly high, and reduces the ability of the service department to invest in quality people and facilities. Once started, it becomes embedded in the culture of the dealership and is difficult to eliminate without a serious retraining effort. We believe that this effort is worth it, however, as internal discounting affects the profitability of the entire dealership. Give it some thought as you lay out your plans for the new year.