Everyone who knows this industry understands that things are changing very rapidly. Everyone also understands that there is an extreme shortage of competent technicians. The problem with this is that the issues in our industry are creating increasing costs, and these costs must be dealt with. Let’s assume the shop owner goes through the processes and have examined the operation very carefully and eliminated any waste to keep costs down without affecting the service levels delivered. Management has also examined the level of productivity per person to ensure that this issue is addressed. Everything has been approached with thoroughness, but management comes to the only conclusion that increased costs are higher than expected, and they must be passed on through an increase in the shop’s labor rates.
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Now management’s mind starts to play games. Management doesn’t sleep too well at night. Management starts to think, “If I increase my labor rates, I will lose my customers and suffer financially.” Consider this: if you are competent and your clients trust you, and you never let them down, why would they leave you over a labor rate increase?
Consider that it is time to slow down and do the math in your business. How many customers could you let go (or even fire) and send them over to the competition? There is a formula; follow the example below:
- the shop labor dollars sold last year was $350,292
- the shop labor rate is $80
- the shop is averaging 1.48 labor hours billed per repair order
- the shop’s gross profit earned from labor is 94.5 percent (labor dollar sales minus sublet labor equals labor dollar gross profit. Labor dollar gross profit divided by labor dollar sales equals labor gross profit percentage)
- the shop needs a 15 percent labor rate increase taking it up to $92 ($80 X 15%= $12)
1. The first step is to take the labor dollars sold and divide it by the current labor rate: $350,292 divided by $80 = 4,378.6 hours billed for the year
2. Take the hours billed for the year and divide it by 12, which gives you the average billed hours per month: 4,378.6 divided by 12 = 364.88 average billed hours per month
3. Gross Profit Margin percent on labor divided by gross profit margin percent on labor plus 15 percent minus 1 = the percentage reduction allowed in billed hours: 94.5% divided by 94.5% + 15% = 94.5% divided by 109.5% = .8630; .8630 - 1.0 = .1369% (expressed as minus 13.69%)
4. Average labor hours billed per month times percentage reduction allowed in billed hours equals actual number of reduced labor hours allowed: 364.88 X 13.69% = 49.95 hours
5. Average labor hours per month minus actual number of reduced labor hours allowed equals new average labor hours to be billed at new labor rate: 364.88 – 49.95 = 314.93 average monthly hours
PROOF: 364.88 X $80 = $29,190.40
In other words, we can bill out less hours at the new labor rate and still retain the same labor dollars coming into the shop as we had at the old rate.