By Dick Glass, CET
Table 1 Direct labor, overhead expenses, return on investment, business profit, and the productivity factor together determine the rate per chargeable hour of labor. (These figures are only for illustration.)
Table 2 If you use flat-rate pricing, your list might be similar to these imaginary service charges.
Table 3 Use your own figures, and this kind of reasoning, to determine how much your income was deficient last year.
Table 4 To obtain your new labor rates, multiply your present repair rate by your deficiency ratio plus 1.
These four simple steps of the Sterling formula allow you to calculate accurate labor rates.
Setting Service Rates Scientifically
This is the second half of the subject "Establishing Service Rates," that was started last month.
The Sterling system of pricing will be described. From it, you can predict your future profits, with reasonable accuracy.
A basic problem
You deal with technical subjects (such as Ohm's Law and other formulas) that are accurate and well defined, so it's logical for you to expect equal precision in cost accounting. Not so! There are few absolute standards or formulas with cost accounting.
For example, these are some of the factors relating to business costs:
direct costs;
indirect costs;
overhead costs;
engineered costs;
allocated costs;
variable costs;
fixed costs;
controlled costs;
non-controlled costs;
breakeven costs; and
marginal costs.
Because of all these terms, and more, that are commonly used for determining cost figures for huge, well-staffed corporations, it's not surprising to find most TV-electronic servicers "guessing" about costs, and about the prices they charge for various repairs.
In fact, most servicers have no pricing formula at all, but rather set their rates according to: a competitor's prices; some manufacturer's warranty list; or their customers' ideas of what is too high.
In other words, they have no real system, but depend on others.
Factors affecting service charges Last month, we dissected the service charge of a typical one-man shop, and showed the five components that determine the actual rate per hour. Table 1 shows a similar listing.
Unless you include all five of these factors in your charges, you are cheating yourself.
Understanding the five factors
Before we show you a quicker and more simple method of adjusting your rates (either up or down), we want to stress the importance of understanding thoroughly (and approving) the five ingredients that determine your rates.
Almost everyone else would like for you to charge less. Some will try for a discount, or ask for free service. Others expect you to charge for only the actual time spent in repairs (neglecting the necessary non-productive hours). Some advocate the discount store philosophy; that if you charge less you can obtain more work. However, you MUST understand that each technician can produce only a limited amount of labor. Then, by knowing the other shop costs, you can deal with any pressure to reduce your rates.
Therefore, make sure you agree with all the reasons for your prices, and that you have calculated your rates as shown last month. It's essential to your success plan that you have confidence in the decisions you must make.
Your Present Service Rates
The "Sterling" system of service pricing (to be described next) does not begin at zero base and build up to your final per-hour charge.
Instead, it starts with your PRESENT service rates and adjusts them as needed.
Right now, you're charging some rates that were previously established. For example, Table 2 shows some imaginary rates for flat-rate pricing. Or, you might be using a Sperry or Tech-Spray system of increment pricing at a per-hour charge of $28.00.
Step One:
Determine the income deficiency of your shop last year. This is the hardest part of the method! Now, it's not difficult because the facts are questionable; it's hard because we human beings would rather avoid the issue.
We're all ready to complain that we didn't make enough money last year. But few technicians or shop owners will say EXACTLY how much more income should have been made! Did you make $100 less than you felt was fair? Was your income $2,000 less than others made in comparable jobs? Or, was your business income $10,000 short of your goal last year? Only you can answer these questions.
The key to effective use of this system is to be honest with yourself and with your business. You must establish a reasonable amount which you can justify as the deficiency suffered by your shop last year.
If you are a one-man shop, per haps you could use the reasoning shown in Table 3 (for your figures, use those from your tax report).
We determined that the income shortage was $6,640 by using this reasoning:
The owner is recognized as a journeyman technician.
If the owner were to become in capacitated by accident or illness, the business would be forced to hire another person of his general capabilities.
The wages and benefits paid to such a qualified person in this area are about $8.00 per hour.
Table 5 Correction for both deficiency and anticipated inflation should be done in this way.
$8.00 per hour times 2080 hours (40 hours for 52 weeks) equals $16,640.
$16,640 deserved salary less $10,000 actual salary equals a deficiency of $6,640.
Step Two:
Find out how much labor you produced last year. You can obtain the figure from your tax report, or your annual P&L statement. Don't include any income from parts or product sales; only your own labor.
For our example, we'll select a rate of $28.00 per hour (for hours actually worked) and a productivity of 50% (1040 hours worked in the year) which figures the total labor income at $29,120. (Of course, that's high for a one-man shop. But it's only an example.)
Step Three:
Change your deficiency to a percentage of total labor. In the previous example, the owner was
$6,640 short last year. To find what percentage of the total labor this is, we divide the deficiency ($6,640) by the total labor ($29,120) and obtain 0.23 or 23%.
So, last year your service charges brought in 23% too little money.
Or, to say it another way, your last year's service charges should have brought in 23% more, to erase the $6,640 deficiency.
Step Four:
Adjust your rates by the deficiency percentage. Multiply your present hourly rate by the deficiency percentage plus 100%, to obtain the new rate of $34.44 per hour. (Your present rate is 100%, so 23% more will total 123%. This also can be expressed as the decimal 1.23.) Assuming that your shop does the same volume of business this year, and that inflation does not increase your costs, you should receive the extra $6,640 you need.
Adjusting Flat Rates
It's just as easy to readjust your present flat-rate charges. Merely multiply each separate flat-rate price by the same deficiency percentage, as shown in Table 4.
Any other flat-rates used by your business should be adjusted in the same way. Notice that you must multiply by 123% to increase the rate by 23%.
Adjust for inflation
Even after you have adjusted your hourly or flat-rate prices, you might find inflation ruining your needed profit. For 1978, it's predicted that inflation will be between 8% and 10%.
Therefore, you should take inflation into account BEFORE you establish your rates. Not after inflation has taken its toll.
Table 5 shows how your original flat-rate prices could be adjusted for both deficiency and inflation.
A More-Realistic Deficiency
Table 6 shows other deficiency items of this 5-man shop. Notice that his wife had been working part time without salary.
Before you adopt the total deficiency figure as being unchangeable, you should find all possible ways of reducing costs. Otherwise, the false belief that your prices can be raised to any figure can cause complacency, which leads to reduced efficiency and poor productivity. Although most prices are far below that point now, it is possible to price yourself out of the business. Therefore, adjust the deficiency for all needed improvements.
For example, one owner saved $3,000 by proper pricing of parts, made productivity improvements of $2,000, and reduced overhead costs by $1,000. This is a total of $6,000, which is subtracted from the original $20,000 to leave a net deficiency of $14,000.
Next, we need to know the total labor produced by the shop during 1977. From the year-end P&L, we find it was $75,000.
The $75,000 is divided into the deficiency of $14,000 to give the deficiency percentage of 18.6% (rounded off to 19%).
To obtain the new rate per hour, we multiply the present labor rate of $28.00 by the deficiency 1.19 (119%) to give $33.32. In turn, the $33.32 is multiplied by the inflation rate of 1.08 (108%, or 8% increase), giving a final new labor rate of $35.98, which is rounded off to $36.
Of course, you should use your own figures and the estimated rate of inflation, when you calculate your labor rate.
Questions?
Probably the first question asked by a dealer (after he has figured the labor rate he should have) is, "Gosh, my customers won't pay such a high rate, will they?" Well, if they really won't pay your fair rate, you should consider one of these alternatives:
Perhaps you should change to a job where you will be paid what you are worth.
Find all possible ways of reducing your costs (overhead, transportation, parts bills, phone, utilities, etc.).
Any other action, action, or lack of, means you, are playing Santa Claus to your customers.
However, this month we are discussing how to determine proper rates.
Next month, we'll take up the "Philosophy Of Pricing." Perhaps your question is, "How can I raise my service rates arbitrarily without knowing whether low efficiency or low productivity are my problems?" Of course, you must find out how your rate com pared to similar businesses. If your productivity is only 20%, but your competitor averages 80%, it's obvious that productivity is a serious problem with you. My experience shows that one-to-five-man shops seldom can be as much as 50% productive. So, pricing is the problem, in most cases.
Table 6
For larger shops, deficiencies other than the owner's salary should be included in the calculation.
Examine three areas
Before you decide on an exact deficiency figure, you should examine these three problem areas: Determine if your parts profits are sufficient. Don't attempt to compensate for inadequate parts profits by raising the labor rates.
Place any blame where it belongs.
Carefully check your overhead, to see if any money is being wasted.
Every business should keep such costs at a minimum.
Make sure the productivity is as high as possible. Don't set high rates to permit you or your techs to goof off. Improve the shop layout, update the test equipment, increase technical training, reduce or refuse unprofitable work, and reduce paperwork.
One flat-rate out of line?
Many servicers worry about whether their bench repair price is correct compared to that of service calls, as one example. If they are not in balance (according to time studies over a month's figures), then adjust them. However, the Sterling system is NOT affected by that fault, and it should give the profit you need even with such a discrepancy. Usually, these relative prices are only minor problems. Of course, shops that price by an increment system have the most exact pricing.
New Rates Too High?
What if your calculations show rates that you believe are too high, and will not be competitive? Well, if that is your concern, then remember it's YOUR decision. No one else can tell you what to do.
Most shop managers make only a partial increase, and check the customer's reactions. But, whether you increase immediately to the calculated prices, whether you make a partial increase, or even if you make no change at all, the important advantage is that you have made the calculation. Now you know accurately what you should be charging to make the amount of money that's proper for you, your employees, and your business.
After you are armed by the facts, you can make intelligent decisions, as a manager should.
Summary
The Sterling formula is an excellent method of determining your labor pricing. These are the four basic steps:
(1) Determine your deficiency for last year.
(2) Figure the total labor income your business produced.
(3) Find out what percentage of your total labor is represented by this deficiency.
(4) Adjust your hourly (or flat-rate) prices by the deficiency percentage, and by the inflation percentage.
Correction: In May Issue In the text on page 57 under the heading "Is Smith's TV Healthy," the ratio referred to should have been between CURRENT assets versus CURRENT liabilities. Therefore, the figures should be changed to $14,000 and $7,000, for a ratio of 2:1.
(adapted from: Electronic Servicing magazine, Jun. 1978)
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