by Richard Harshaw
When I worked for Carrier Air Conditioning in the 1990’s, I was the “heir apparent” to Stu Docter and taught thousands of Carrier and Bryant dealers the financial ideas and methods of Stu. Some of you were in those meetings. Early on, I started promoting flat rate pricing for service labor as I could see that the day would come when the costs of doing business would make it prohibitive to set a labor rate that is based on an hourly cash flow, as labor rates would start to soar. (As a general rule of thumb—a rule I will flesh out in this column—a profitable service labor rate should be about 3 times your highest paid service tech’s hourly rate, counting benefits.) If you pay your tech $35 an hour, we can add about 38% for the average burden of benefits and round it up to $48. So a conservative street rate would be about 3 time that amount or $144 per hour. You can imagine how that might set with a homeowner who makes $25 an hour at her job!
Little did I know when I promoted flat rate to contractors where that beast would go. Recently, a friend had to have a 10 microfarad capacitor replaced on his unit and paid $327.00 for it, because the contractor was on flat rate. I was stunned. How did we get here? How, for that matter, did the flat rate providers talk us into jacking up our service rates “because we could” and end up with one rate that I know if in Colorado of $296 per hour?
So maybe it’s time to take another look at flat rate. I am all for the system, but I am not for the abuses that it can lead to.
Let’s see how easy it is to determine a realistic hourly rate to use with a flat rate system.
We need to first know how many hours a year we can sell (on an average per tech basis). So we start with a 52 week year, times 5 days a week, times 8 hours a day. A full year thus has 2,080 hours available. But, of course, we cannot bill all of those out. We must deduct for several things:
- Annual vacation days allowed (average, per tech)—let’s use 10 for this example.
- Annual holidays (whether paid or not)—let’s use six.
- Annual sick days averaged per tech—this must come from payroll records, but let’s use four for our example.
- Any other days off (for any reason… like hunting season, or that bass tournament). Let’s say two.
So our total days not allocated to work amount to 10 + 6 + 4 + 2 or 22 days. Multiplying by 8 hours means we must deduct 176 hours from our 2,080 starting point. We are down to 1,904 hours.
Next, we need to deduct the average travel time per day our techs spend driving from job to job. That will depend greatly on your market, traffic congestion, and other factors. To be accurate, you would need to get it from your timecard system (hopefully electronic with a code for driving time). Let’s say for simplicity sake that your techs average 2 hours a day in driving. At 1,904 hours sellable, we are looking at 1,904 / 8 or 238 days. At 2 hours a day of driving, we must deduct 476 hours from our 1,904, taking our sellable pool down to 1,428 hours.
Now, we need to know our average unbillable time per tech. That can be tricky to figure (especially as many flat rate systems don’t bother to log it because it is “covered” in the rate), but let’s say that our techs average ½ hour per day per tech unbillable. With 1,904 billable hours per year (before deducting for travel), with ½ hour per day unbillable, we have half of our 238 billable days affected, or 119 unbillable hours per year per tech. Our 1,428 hour pool shrinks down to 1,309 hours.
Now, we take 1,309 hours times the number of service techs we have. Let’s say we have six techs, so we have 1,309 x 6 or 7,854 billable hours per year.
Next, we need to know our highest paid service tech (counting his benefit cluster). Let’s use the $48 I suggested earlier.
Last, but not least, we need to know the service department’s overhead. To do that, we’ll need to do a departmentalized income statement (which is beyond the scope of this column). First off, service overheads run a lot higher as a percentage of sales than contracting overheads. If you are running a good contracting operation, your overhead may run 25% to 35% of sales. But that same company will run 50% to 70% overhead for service! Let me do some hand waving and mumbling and say that our overhead is $540,000.
We can now compute a decent hourly rate to use in our flat rate system. We take our overhead of $540,000 and divide it by the TOTAL NUMBER of billable hours we will have—in our case, 7,854 billable hours. That comes to $68.75. To that we add the highest tech’s wage with bennies and get $69 + $48 or $117.
Finally, we want to make 20% net profit on our service sales, so we would take $117 and divide it by the factor (100% – 20%) which is 80% (or 0.80). Our hourly rate would be then $117 / 0.80 or $146 per hour. (The rule of thumb said $48 x 3 or $144.) That is the figure I would use with my flat rate provider. Of course, he will try to talk me into $180 or $210 or some other higher number, but my conscience won’t permit that. I know that I need $146 per hour to make this business float, and I will hold to that and not make my customers pay for inefficiencies I can easily hide in a flat rate manual.
Which brings up another good point. As Frank Blau, pioneer in flat rate pricing once said to me, “Flat rate should only be applied AFTER a business has done everything in its power to maximize its service department efficiency and cut its waste.”
Geez, that sounds like playing a game of “Whack-A-Mole!” (Sigh)
Onward and upward, HVAC warriors! Let’s take that hill!