How to calculate your rates and understand the cost and value of your business.
The automotive service and repair industry has relied on outdated business practices for much too long. Using labour rates and labour guides the way we currently do has caused us to compete in such a way that it is a race to the bottom. And along the way we have trained the driving public and consumer groups to use labour rates and labour guides as weapon against us. Labour guides were never intended to be unconditional. They were designed to help shops create estimates and billing, not only to give a customer an estimate before we started the work, but to maintain our profitability. I would like to get the industry back on track with the original intention of labour rates and labour guides.
The first step on the journey of this transformation is going to be a name change. We are no longer going to call it labour or labour rate. The word labour has garnered a lot of negative press with the driving public because it is something they must pay for. From now on, we are going to call it service and service rate. Service is something we offer, something we give to the customer. In turn, they pay us our service rate for the services rendered. It is a much better value proposition as well, and a much more professional term. I have always said that we need to behave more like accounting, legal, and engineering professionals.
The second step is a much larger one. Car owners all need and want to manage their money and not overspend on car repairs and maintenance. This has led some of them to shop around and get multiple estimates. The challenge for them has been comparing apples to apples. There are so many variables that come in to play. Each shop has its own value proposition. It is not only about the cost of the service and the parts, but all the ancillary value that comes with them. There is a huge range in the quality of parts, and maybe not as large, but there is a range in the quality of the workmanship as well. Then there is the warranty offered with the service and parts. In addition, there are many other value-added features to the automotive service experience such as shuttle rides, courtesy vehicles, digital inspections, and highly trained service advisors to assist in decision making. Just like accountants, lawyers, and engineers, we pay them to advise us.
It has also been a challenge for shop owners and service advisors to communicate their value proposition clearly, as well as understanding what they are competing against. There are automotive shops that use bait and switch techniques to get customers in the door, and there are service advisors who give estimates over the phone without having looked at the vehicle. Customers are phoning around or doing their research online using price as the only comparison. In some cases they are finding the lowest price for the parts at one shop, and the lowest price on service at another, and then asking the rest of the shops to match that price. So, what are we going to do?
We are going to start at the other end of this proposition. We are going to discuss how to calculate our service rate based on our fixed and variable costs, net profit required, and on our value proposition. I think when shop owners and service advisors understand this clearly, it will be easier to compete in the marketplace, and not by being the lowest, but by understanding the cost and the value, and finding the right kind of customers who are willing to pay that rate for that kind of experience.
Too many shops are started by technicians who think there is a large gap between their hourly rate and the hourly rate that the shop charges. They think their bosses are greedy, so they swear that if they ever open their own shop, they are going to have a lot lower rates and will not rip off their customers. In fact, they think that they are going to steal all their boss’s customers. This scenario rarely works out. If they do not go out of business first, they very quickly realize that they need to raise their rates to meet their expenses and have some money left over to take home. The other common occurrence with shops that have survived and stayed in business is the annual phone-a-thon on January 2 to find out what all the neighbouring shops are going to do with their rates.
This next step involves another name change and a concept that will be new to many of you. We are now going to have a facility service rate. This rate is going to be calculated very specifically based on several known factors. These factors are 1) occupancy costs 2) owner’s/manager’s salary, 3) service advisor salaries, 4) total of other operating expenses, 5) the dollar value of parts purchased in the last calendar year, 6) the number of technician hours worked in the last calendar year, 7) the average technician hourly wage, 8) the number of hours billed, and 9) the net profit required/desired. Together these numbers will tell us what our facility service rate should be.
Looking at Figure 1.0, we see the annual numbers of a stable profitable shop. Based on all the factors mentioned above, we can see that they are achieving their net profit goal of $150,000 with a facility service rate of $120.00 an hour. A key factor to note is that they are billing out 70% of their time. Could they be doing better? Of course, but they are already above average.
Looking at Figure 2.0, we see a shop with the same factors as the above shop except for one. This shop is only billing out for 54% of their time. This is the industry average. You will note that to achieve the net profit of $150,000 they would have to be at $155.56 an hour facility service rate, which is unrealistic in their marketplace. They would be punishing their customers for not using their time effectively. In reality, at $100.00 an hour they are 20% below where they should be, and so they only broke even this year.
In Figure 3.0, all the factors are the same except for the other operating expenses. The other operating expenses have gone from $118,000.00 to $150,000.00. They have added a $32,000 a year salary for a valet to drive the shuttle and to wash and vacuum all of the clients’ vehicles after service. This shop has added value to the client and is therefore able to have a higher facility service rate. The rate they need to charge to pay for this extra value is $129.14. You will see that they remain at $120.00 an hour, and therefore their net profit is less by the $32,000.
There are many permutations that we could discuss. For example, if the shop was at a 45% gross profit on parts rather than 50%, their service rate would need to be $137.71. And if in fact they allowed their customers to supply their own parts they would need to be at $179.29 an hour in order to achieve their net profit goals. The reality is that most shops have no idea what their service rate should be, and then do not understand the effects of poor billing practices, poor parts margins and the worst culprit of all, discounting. A 5% discount means that we would need to increase our service rate from $120.00 an hour to $130.71 an hour. That is a 9% increase in service to cover a 5% discount on the whole invoice. I trust this information will assist shop owners achieve their net profit goals.
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