Increasing Shop Profitability Series (Part V): How to establish a fair market hourly labor rate

Fifth article in a series

By Jim Yount

At this juncture in “How to establish a fair market hourly labor rate,” it’s time to determine annual cost of an experienced, qualified and certified technician.

Step 10
The following chart establishes standards to measure and calculate technician efficiency.

EXAMPLE:
Suggested allowance for measuring Technician Operating Efficiency Ratio (TOER):

 Technician will work a standard 8-hour day for 5 days:
 40-hour week

 Annual payroll hours, 40-hour work week multiplied by 52 weeks: 
 2,080 hours

 Allocated Hours
 

 Subtract time off for 2-week vacation: 
 80 hours

 Subtract time off for 1-week sick leave: 
 40 hours

 Subtract time off for 6 holidays: 
 48 hours

 Subtract hours allocated to company (equipment setup): 
 112 hours 

 Subtract total allocated hours from 2,080 payroll hours: 
 280 hours

 Technician annual hours available for billing to customers:
 1,800 hours
This exercise reveals the relationship between cost of operation, shop’s hourly labor rate, technician billing efficiency, and how each impacts the service department’s ability to earn a profit. It is important to remember that no two markets and shops are identical.

Technician annual wages and benefits equate to $37,000 for this exercise only and may not represent your market. Our experience reveals technician annual earnings range from a low of $22,000 to more than $70,000.

 A. Estimate: 40-hour work week in round numbers ($37,000)
 Annual cost of tech number one: 
 $37,000

 B. Transfer from Step 8 (see Part IV in August 2012 OPE for Steps 1-9), the department’s share of applied hard cost:
 $75,655

 C. Add the two numbers from lines “A” and “B” to determine department’s cost of operation with one technician: 
 $112,655

 D. At your current hourly labor rate ($70), how many customer billing hours are required to pay the break-even cost of operation?  
 1,609 hours

 Math: Enter into your calculator the department’s applied hard cost ($112,655) and divide by the hourly labor rate ($70). Number of hours will be revealed.
 

 E. Technician operating efficiency ratio (TOER) is:
 Annual hours available for billing: 
 89.38%
1,800 hours

Math: Enter into your calculator the number of break-even hours billed to customers (1,609 hours), and then divide by 1,800, representing available hours for billing customers.

EXAMPLE:
Profit analysis and efficiency ratios

Technician minimum acceptable operating efficiency ratio (TOER) is 50 percent. With TOER at 50 percent, the profit window is the difference between 50-85 percent. In this case, it’s 35 points. (I do not know any shop billing 100 percent of tech real time.) Since there are no costs of goods associated with producing labor income, every dollar earned is considered 100-percent gross profit. Technician’s wages are accounted for in budgeted operating expenses as part of payroll.

 Step 11
 

 Let’s measure the cost impact of adding the second technician.
 

 A. Transfer the department’s cost of operation as defined in Step 10, Item C: 
 $112,655 

 B. Enter the same cost used for technician number one as defined in Step 10, Item A:
 $37,000

 C. Add lines “A” and “B” to determine department’s cost of operation with two technicians:
 $149,655

 D. At your current hourly labor rate ($70), how many customer billing hours are required to pay the break-even cost of operation? 
 2,138 hours

 Math: Enter into your calculator the increased service department applied hard cost from Step 11, Item C ($149,655), and divide by the hourly labor rate ($70). Number of hours will be revealed.
 

 E. Two technicians operating efficiency ratio (TOER) is: 
 Annual hours available for billing:
 59.38%
3,600 hours

Math: Enter into your calculator the number of break-even hours billed to customers (2,138 hours), then divide by 3,600, representing available hours for billing customers (two technicians).

EXAMPLE:
Profit analysis and efficiency ratios

Technician minimum acceptable operating efficiency ratio (TOER) is 50 percent. It’s acceptable to some dealers to operate with a TOER of 55-60 percent. When a shop is operating with a TOER of 60 percent, the profit window will shrink by 10 points. These 10 points represent a loss of 28.57 percent in the profit window. Indeed, that’s a large chunk of profit potential.

Math: Enter into your calculator 10 (points) and divide by 35 (points). Answer: 28.57 percent of profit dollars.

 Step 12
 

 Should two technicians not be able to produce positive cash flow, in excess of paying department cost of operation, it’s time to add the third technician. 
 

 A. Transfer the department’s cost of operation with two technicians as defined in Step 11, Item C:
 $149,655

 B. Enter the same cost used for technician number one as defined in Step 10, Item A: 
 $37,000

 C. Add lines “A” and “B” to determine department’s cost of operation with three technicians:
 $186,655

 D. At your current hourly labor rate ($70), how many customer billing hours are required to pay the break-even cost of operation? 
2,666 hours

 E. Three technicians operating efficiency ratio (TOER) is: 
 Annual hours available for billing:
49.37%
5,400 hours

Math: Enter into your calculator the number of break-even hours billed to customers (2,666), then divide by 5,400, representing available hours for billing customers.

Let’s take a quick study of what we have learned on the subject of cost impact as we continue with the issue of how to establish a fair market hourly labor rate from cost center to profit center.

Case History Model

These numbers reflect a case history from our consulting file. Our model is typical of a dealership with annual sales of $1,500,000.* The following are real numbers from the voice of an audience of more than 100 business owners and service managers who were attending a workshop. These business owners and service managers were from dealerships located on the Mid-Atlantic coast.

Using our case history model, we will present the numbers as previously outlined in this series.
*We assume these numbers that were brought forth at the workshop.

 Service department share of applied hard cost, using Part 1: Equipment cost only from Step 6 (Part 2: Creature comfort for technicians not applied):
 $74,035

 Payroll for three technicians costing $50,000 each: 
 $150,000

 Total department cost of operation (by adding two previous lines): 
 $224,035

EXAMPLE:
Suggested allowance for measuring Technician Operating Efficiency Ratio (TOER):

 Technician will work a standard 8-hour day for 5 days:
 40-hour week

 Annual payroll hours, 40-hour work week multiplied by 52 weeks:
 2,080 hours

 Allocated Hours
 

 Subtract time off for 2-week vacation: 
 80 hours

 Subtract time off for 1-week sick leave:
 40 hours

 Subtract time off for 6 holidays: 
 48 hours

 Subtract hours allocated to company (equipment setup):  
 112 hours

 Subtract total allocated hours from 2,080 payroll hours:
 280 hours

 Technician annual hours available for billing to customers:
 1,800 hours

 What can these numbers tell us?
 

 Case history model’s current hourly labor rate: 
 $70

 How many customer billing hours are required to pay service department’s break-even operating expenses? 
 3,200 hours

 Using information from the preceding table, how many hours are available for billing to customers (3 x 1,800):
 5,400 hours

 Required technicians’ operating efficiency ratio (TER) to pay break-even operating expenses:  
 59.25% 

 Billing 3,200 hours to customers at $70 per hour earns: 
 $224,000

 How many labor dollars will be earned with the department working at 70-percent technician operating efficiency ratio (TOER)? Seventy percent of 5,400 hours is 3,780 hours billed at $70 per hour:
 $264,600

 Raising shop hourly labor by $10 generates an additional: 
 $37,800

 That’s equal to billing 3,780 hours at $80 per hour:
 $302,400

 Difference between cost and earnings going to the bottom line: 
 $78,400

 Billing at 85-percent efficiency of 5,400 hours is to bill customers 4,590 hours at $70 per hour earns: 
 $321,300

 *By changing shop hourly labor rate to $80 per hour, billing efficiency remaining at 4,590 hours, shop earnings increase to: 
 $367,200

 Difference between cost and earnings going to the bottom line:
 $143,200

 Service departments operating at 85-percent efficiency and billing at $80 per hour will earn in gross profit dollars: 
 $367,200
*THE GOOD NEWS: There is no cost of goods associated with these earnings. It’s all gross profit dollars. That’s right: 100 percent can be used to pay suppliers. Here’s a very good question: How much of this could be added to your pretax net profit dollars?

Take a look at these real (rounded) numbers from our consulting files. This customer’s annual sales were $3,800,000. The service department was responsible for generating 10.52 percent of total sales, or $399,760. That dollar figure ($399,760) is 29.17 percent of $1,370,000 total gross profit dollars earned.

These numbers represent a technical service department’s earning power when service managers and technicians are held accountable for overall operations and billing efficiencies.

Remember, technicians’ wages and benefits are accounted for in payroll. Total employment is a critical number used to measure company overall operating efficiency.

My closing thought on establishing a fair market hourly labor rate: The objective is to work the numbers until the following happens:
* Department efficiency forecast is realistic.
* You can establish an hourly labor rate that’s fair for the customer and equitable for your business.

If you have more than three technicians, simply do the math using your number of technicians. Most shops we know need to increase hourly labor to a more equitable cost of doing business ratio. In the past 12 months, every product or service we have purchased has risen sharply. And it is evident all pricing policies will continue to be challenged. Shed your fears and doubts and begin working at a higher efficiency rate. I promise, when your service department is managed for overall operating efficiency, profits will increase.

You might say or think, “Because I own a service business, I speak with a voice of experience. Sometimes, it takes all the courage I can gather to overcome internal struggles with raising fees.”

Walk past fear and doubt, and raise your hourly rate. A few customers may not return, but additional earnings will soon cause you to prosper. Memories of a cheaper hourly rate and a lost customer or two, will soon fade, if you stick to the policy of zero defects and no returns. Become the proud owner of the best shop in your market.

Remember the following profit policies and rules:
* Target technician operating efficiency (TOER) should be 50%.
* Never spend more than 50 percent of tech time to pay department operating cost.
* Don’t pay overtime, unless there is an equitable return in gross profit dollars.
* Stop interrupting technicians. They could be earning up to $85 per hour in department revenue.
* Assign your best technicians to work on customer equipment only.  
* Hire an assistant to set up equipment for the sales department.
* Typically, a service manager is not affordable until the shop has five technicians.
* Assign a lead tech to be a working shop supervisor, and adjust that tech’s wages accordingly.
* Take time to do the mathematics. Earnings and efficiency are revealed by numbers.
* Take time to sell your service department with every sale you complete.
* Invest time making outside sales calls to grow and expand.
* Never stop training technicians.
* Increase customer care by putting customers first.

 Jim Yount is the founder and chief executive officer of Jim Yount Success Dynamics LLC. For more than 30 years, he has hired, trained, managed, sold, marketed, and motivated. Extensive real-world experience in retailing, distribution and working with manufacturers, both domestic and international, has earned Jim the reputation as a trustworthy and knowledgeable professional in his field. As a results-oriented speaker, he is dedicated to inspiring groups of 30 to 3,000 to develop their talents and realize their full potential. As a business consultant, teacher and coach, Jim is experienced at challenging leaders to explore their operational procedures and change unacceptable practices that are producing poor results. For more information, contact Jim at jimyount@hughes.net or (903) 796-3094 or visit his website at www.jimyountsuccessdynamics.com.