Up Your Business is an exclusive GEARS Magazine feature in which I share stories, insights, and reflections about business and life.
In last month’s article, I pointed out that many shop owners struggle when it comes to pricing policy. However, it’s the most critical aspect of your business to control.
There’s a difference between using methods and using philosophies. You can’t manage philosophies, but you can manage methods. Shops that run on a pricing philosophy are running on dumb luck.
Pricing policy should be based on a methodology. Those who have one, foolproof or not, are more likely to achieve consistent enduring results.
In part one, I explained how to build a financial business model that treats your profit goal as a line item in your budgeted expenses. This concept is foundational to building your pricing model, as well.
Just about anyone can come up with a price that yields gross profit. For instance, let’s assume your policy is to double your parts cost and charge $100 per hour for labor. You don’t need a calculator to know how much to charge for a job that takes 10 hours and $500 in parts cost. $500 X 2 = $1,000 for parts plus 10 hours X $100 = $1,000 in labor for a total of $2,000.
This simple example yields $1,500 in gross profit; right? That’s not a trick question, $2,000 – $500 = $1,500. I know there are exceptions, but for this article, I’m treating labor as an overhead expense.
The $1,500 gross profit is then applied to pay overhead expenses, and some of it is net profit; right? No, that is a trick question. Technically, all of the gross profit from all your jobs goes to pay overhead until overhead is covered, in full – then and only then do you have any net profit.
The question is, “How many jobs are needed to make the profit goal?” Using our model from last month, we need to cover $730,000 of overhead per year or about $61,000 per month plus $250,000 for profit or about $21,000 per month for a total of about $82,000.
If all of our jobs are identical to the example above, with $1,500 gross job profit ($150 of gross profit per hour), we’d need to do about 54 jobs per month or a little over 12 per week. The gross profit per hour (GPPH) reference will become clearer later in the article.
However, there’s a wide variety of job types relative to both parts and labor. For example, what if the parts only cost $100? In the above model, the selling price would be $100 X 2 = $200 for parts plus $1,000 for labor totaling just $1,200. The resulting gross profit is just $1,100, which is $400 less and only $110 GPPH. But, the job consumed the same amount of tech time, tied up the service bay just as long, and most important, consumed the same proportional amount of the shop’s overhead expenses.
On the contrary, what if the job had a parts cost of $500 and the labor was only 5 hours? The result in this case is $500 X 2 = $1,000 for parts plus $500 in labor for a total of $1,500. Now, we have $1,500 – $500 = $1,000 gross profit, but we only consumed half as much tech time, service bay time, and the shop’s overhead. Interestingly, this job has a GPPH of $200 ($1,000 / 5 hours = $200).
Also, in today’s environment, some jobs have little or no parts, but you might invest several hours into them. Especially with electronic issues, the problem is resolved by the diagnosis, itself. Let’s use an example of a job that consumes 2 hours of tech time and no parts (2 X $100 = $200). Recognizing that many shops charge extra for “labor only” jobs, let’s say $175 X 2 hours for a total of $350. Since there’s no parts cost, the gross profit in this example is $350 or $175 GPPH.
These are just four examples of an inexhaustible number of parts and labor combinations. On the surface, the problem of standardizing seems to be irreconcilable. However, I believe there is a solution that while not perfect, provides predictable results in spite of so many possible scenarios. What if you calculate prices based on a target gross profit per hour – GPPH?
THE COMMON THREAD
There’s a common thread in every job performed in your shop. While each job consumes parts, and parts vary significantly from job to job, the amount of time required is predictable and unrelated to the parts needed. Time is the only common thread.
Our industry has always charged for parts and labor. The selling price of the parts helps justify the total sales price. Customers expect to pay for both because that’s what we taught them. However, isn’t our real value in our skills and knowledge? Isn’t it more logical and honest to monetize our value by charging the target GPPH for our time and adding only the cost we incur for parts?
You probably think this is nuts and it won’t work because the competition charges for parts and labor. The real question isn’t if you can do it; it’s how can you do it?
I’m suggesting that you could calculate your estimates based on labor time billed at your target GPPH plus the cost of parts and materials. I’m also suggesting that if you did this, you’d have much more control over your net profit rather than just settling for the leftovers.
HOW TO DO IT
Step 1 – Determine your shop’s actual labor sales and production capacity.
- Using your shop’s computer system, pull up your sales history for the past year.
- Calculate the numbers of hours of labor you sold each month.
- If you didn’t track hours sold, divide the dollars of labor you sold by the shop labor rate you used at that time.
- Create a table that illustrates numbers of hours of labor for each month.
Step 2 – Calculate your shop’s historical parts profit.
- Determine the total dollars of profit you made on the parts you sold during each month.
- Your computer system should be able to tell you how many dollars of parts you sold and what you paid for them.
- Insert the total parts profit into the above table for each month.
- To determine parts profit per hour, divide the monthly parts profit by the hours sold in step 1.
Step 3 – Determine your GPPH for the last 12 months.
- Add your parts profit per hour to the shop labor rate you were charging in any given month.
Step 4 – Determine your needed/ target GPPH.
- Use your Income Statements to calculate your average monthly budgeted overhead expense. If you only have an annual statement, divide by 12 to get an average per month. You can also total your expenses from your check register if you don’t have accurate Income Statements.
- Add your monthly profit goal to the overhead to determine the total expenses. Remember, treat your profit goal as an expense; it’s money the business owes you as your return on investment (ROI).
- Divide your total expenses with profit included by the number of labor hours you sold. This result is the amount you needed per hour to cover your expenses and net profit goal – your target GPPH.
- Compare this to your result in Step 3. How did you do?
- Now plan your next 12 months using your projected expenses, profit, hours you expect to sell, and your prevailing shop labor rate. Apply the same factors as above to determine your new target GPPH.
Step 5 – Estimate a job using this method.
- Determine the number of labor hours for this job.
- Multiply the hours by your target GPPH from Step 4.
- Add the cost of the parts to calculate the estimated total job price – the price you need to charge for the job with all parts and labor.
- You’ll most likely want to present it in a traditional “Parts & Labor” format on the invoice.
- One method is to use your shop labor rate for calculating the labor total and apply the difference to parts. This method works best if there are lots of parts on the job.
- Another alternative is to use a comprehensive labor description with a total for labor and a list of parts without itemizing prices – sort of an “All Parts and Labor Included” description.
- I recommend that you check your local regulations to make sure you comply with their requirements.
REAL WORLD APPLICATION
Let’s look at some actual cases where shops have used price strategy to remediate their particular profit issues.
Recently, I worked with a shop that had an issue with too much work and not enough profit. They were afraid they’d lose a large segment of their fleet business if they increased their prices. When we applied the formula, we found that they were losing money on some of the fleet jobs and were below their profit target on nearly all of them. When they increased the fleet prices, they only lost a small number of jobs, and the ones they kept were now profitable. As an added benefit, they were able to attract additional higher-profit work because they had more time available in their schedule for retail customers.
Another shop I worked with had a problem with too much overhead. Their overhead was so high that their target GPPH would have been above market constraints. However, during the process, we discovered that their productivity was very inefficient. They had six techs working 45 hours per week (6 X 45 = 270 hours), but they were averaging only 120 billed hours of production. It turned out that the techs were doing a lot of unbilled and unprofitable tasks. Everyone felt overwhelmed with work, but it wasn’t all revenue-generating. They eliminated the dysfunctional minutia, became more selective regarding taking in jobs, and reduced staff by two techs without reducing sales or productivity. They saved over $150,000 per year in overhead expenses and brought their target GPPH to a workable level.
I’m not saying that price alone, will fix every problem, but applying a systematic process for determining your price strategy forces you to look at things differently. You’ll discover that busyness often camouflages the real issues until you peel back the layers related to how price affects your sales, productivity, and profitability.
Don’t rely on dumb luck when you can use a foolproof method to strategically manage aspects of your business that are directly and indirectly affected by price.
If you want to learn more on this topic, I highly recommend that you attend this year’s POWERTRAIN EXPO. Scott Johnson’s presentation reveals the myths and math behind successful shops versus those that fail.
About the Author Thom Tschetter has served our industry for nearly four decades as a management and sales educator. He owned a chain of award-winning transmission centers in Washington State for over 25 years.
He calls on over 30 years of experience as a speaker, writer, business consultant, and certified arbitrator for topics for this feature column.
Thom is always eager to help you improve your business and your life. You can contact him by phone at (480) 773-3131 or e-mail to email@example.com.