Service Department Economics – Theory is a Must

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Applying economic theory to your Service Department is a must. Ultimately, management is all about getting things done, but getting it done profitably is our goal. We’ve all heard the “talk is cheap” comments and witnessed resistance to the world of theory. Real-life experience beats a degree any day in most service managers minds, however, experience doesn’t always trump knowledge.

Theory is meant to help people understand the world in a systematic way. Even highly theoretical disciplines, like economics, can help prevent many common day to day errors.

Many confuse economics with intimidating graphs and fluffy, abstract theories. But the study of economics is about much more, and it contains many powerful truths for your business. Consider a few these basic economic principles and what they mean for your company.

Value Is Subjective. Subjective doesn’t mean “random”; it means “in the eyes of the beholder.” The market value of a product or service is always whatever the customer sees in it. Unless you know your customer, you won’t be able to figure out how he values what you have to offer — and, therefore, how to price it. The only way to properly sell your product is to offer what customers want. Your cost has nothing to do with it.

Demand Curves Slope Downward. Also known as the “law of demand,” this age-old economic truth really means that the higher the price, the fewer goods get sold, and vice versa. At different price points, you target different segments of the market and, consequently, different customers.

Price Elasticity Is Relative to Demand. You need to find your “pricing sweet spot.” Many Service Managers struggle with this concept, but it simply means that there is an ideal position on the demand curve between elasticity and inelasticity.  To put it simply: If the price is too high, you sell so few products that you’d make more money by lowering the price. If the price is too low, you’d make more money by increasing it. Entrepreneurs generally know the former; of course, you can sell more at a lower price. But they tend to forget that sometimes a higher price means more revenue. Your product’s price elasticity really depends on where you are on the demand curve.

Opportunity Costs Must Be Considered in Terms of Both Competitors and Customers. Opportunity cost is the trade-off we’re always making but forget to consider rationally. You’re not just competing with other shops but also with the customers themselves. Unless you offer greater value than all the other options available to them, your customers won’t buy your product. It’s really that simple. That’s why you need to know what sets you apart in the market and why it matters to your customers.

Comparative Advantages Must Be Maximized to Create an Overall Advantage. Renowned economist Paul Krugman calls comparative advantage a “difficult idea,” but it doesn’t need to be. It really means that if you are, relatively speaking, a little better at doing one thing over another, you should do the one you’re better at. If Team Member A is better than Team Member B at doing two things, each is better off doing the thing he is relatively better at. That makes the total outcome of their efforts are higher. If you let the least productive members of your team do what they’re relatively best at, you’ll all be better off for it.

Talk may be cheap, sure doing beats talking, but it doesn’t mean you should turn a blind eye to what’s already known. Many economic truths taught in Economics 101 courses are as true today as they were 250 years ago. These simple insights can help you make more informed decisions, avoid costly mistakes, and better plan for future growth.

Brad Porcellato