Benchmarks - Part One
Is a benchmark a thermostat or thermometer? Used properly, performance benchmarks help you keep track of your business. But where do these benchmarks come from? You could look to other contractors for guidance but will their benchmarks work for your business? Shooting for the same percentages as another contractor is very much like calling around to determine the going rate. Someone else's going rate won't work for you unless you have the same costs, vision and market conditions that they do.
Operational benchmarks may be stated as percentages, sales or other performance goals. Simply stated, benchmarks are thermometers. They can tell you what's going on and help you figure out what needs tweaking, but they do not control how your company operates. For example, you cannot decree that labor will be 20 percent of sales and make it so. However, you can calculate what you believe to be a good benchmark. If actual performance varies, you'll have a starting point for finding and solving performance problems.
Benchmark MythsBefore going further, let's clear the air about some benchmarks you may have heard. I'm often asked about benchmark percentages for labor or materials. Some contractors think that labor shouldn't be more than 20 percent of sales. Labor as a percentage of sales is simply a fact, not a target. If you pay bonuses based upon production, it's very likely that wages as a percentage of sales will be higher for your top performers than it will be for those who merely meet the production benchmark. With a good bonus plan, your professionals earn more as your company pockets more profits due to increased production. If you try to keep labor as a percentage of sales under control, you'll end up driving away your best producers.
Some say that materials expense should be no more than 15 percent of sales. I have to ask, why in the world would anyone turn down free money? Some plumbers/techs like to offer options and upgrades to their customers. The plumber who replaces more toilets is going to see materials as a higher percentage of sales than the plumber who always settles for flapper replacements. Presumably, these materials are sold at a profit, so selling more of them is a good thing, right? Even if it means that materials costs as a percentage of sales are higher? Yes. That's why it doesn't make sense to try to keep materials expense at a specific percentage.
I've picked on labor and materials benchmarks because I hear so many questions about them. These two benchmarks work against each other when viewed individually. More sold materials means a lower labor percentage yet better customer service, which may result in fewer materials sold and more service delivered. This would drive the labor percentage up and the material percentage down. Interestingly, both scenarios can be profitable for your company - on the ledger and your reputation.
Production Is The BenchmarkProduction should be the No. 1 benchmark you track. Whether you're a T&M or flat rate contractor, it's fairly simple to create a production budget. First, slice a production year into whatever unit of measurement you think makes sense. (To learn more about this, see “The Value Point System,” August 2003.)
If you're a T&M contractor, you may decide that it's reasonably easy to charge for six hours of every day, so maybe you'll want to set that as a production goal. Six units a day, five days a week, 50 weeks per year (taking time out for holidays, etc.) and you have an annual production goal of 1,500 production units per service professional.
If using a flat rate system, you'll want to base production upon the same system you built your price book on. Personally, I prefer 1,000 production units per service professional. (I call them “value points” because more production equals more value delivered to the customer.) Besides being an easy number for doing math, it translates well to a 50-percent-billed hour efficiency that many contractors already understand.
Now that you've settled on a unit for measuring your productivity, make sure that the cost of running your business is divided by your production capacity. Note: By cost of doing business, I mean you need to include everything and everybody, except materials. Just to make sure you understand: Your cost of operation includes all overhead, all base wages (even for your service professionals), owner's salary, retirement - everything but materials. Materials and bonuses will be taken care of in the “direct costs” category.
Once you know your cost per production unit, use this cost to calculate your profitable selling price. Every production unit sold will be at this price. You now have a benchmark that reflects company profits, sales performance and customer service.
If everyone meets the production benchmark, your company is profitable and your customers are being taken care of. Total sales, even though the more the better, doesn't matter nearly as much as meeting the production goal. When the production goal is exceeded, you can be very liberal with bonuses, regardless of total sales, and still be more profitable.
Why Production Matters MostBy far, overhead is the most expensive part of your business. When you make sure that each production unit carries its slice of overhead, you're making sure that all overhead is covered before anything else. When you produce (sell) more production units than originally budgeted, the costs associated with these units practically go straight to the bottom line as additional profits. Imagine netting $150 on a $175 faucet repair job. That's what happens once you've exceeded your production goals.
On the flip side, if you're falling short on production, you're faced with a steep climb. For example, if your cost per production unit is $200 and you fall short by one unit, you'll have to make up for it either in sales or in lost profits - and you know which is more likely. There is no guessing, hoping or conjecture. If you miss the production goal, you are stung. The sooner you know about the problem, the sooner you can start doing something about it. With a production benchmark, you can know how you're performing almost by the hour.
Next month, we'll delve into some other performance benchmarks designed to help you deliver better customer service while earning better profits.
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