Aiming At The Wrong Target
Periodically, I make the plea to service business owners to re-examine their prices, and, frankly, suggest they raise them. It's one of the toughest battles I have. Even though a thorough analysis of costs will usually convince a business owner to rethink the company's pricing, often an owner will resist. I have gone through the numbers (and I'll do it again), and many owners still are reluctant to let their pricing structure match their costs and the margin required for maintaining a profitable business.
I am aware of some of the reasons, but none are compelling enough in my mind to overlook the reality that a business must be able to generate a reasonable profit to continue to provide top quality service. I have heard about loyal customers, cutthroat competition, home warehouse stores in the neighborhood and all the other worries that service business owners face these days. However, there are successful businesses - including the most successful ones - that have maintained their margins year after year without losing business. In fact, quite the contrary, these companies have increased their business and kept their reputation for quality work.
What I typically see is a service business owner who will not break away from the mold of the "going rate." Frequently, that is the rate that the competition charges. Never mind the fact that this competition comes from a different business, with different costs, margins and, probably, a different level of service than you offer. This so-called standard has been condemned by most of the leaders and successful owners in the service and repair business for a long time, yet it is still used by the largest segment of the business. Worse yet, many companies believe they have to stick to some imaginary level of pricing to remain competitive - despite the fact that this price structure does not reflect their actual costs or margin requirements.
My assessment of this method of pricing is that we are aiming at the wrong target. What we are really doing is letting the competition run our business. How can we be so confident that the other guy knows more about setting prices than we do? The people running these other businesses don't know our costs; they are probably lucky if they know their own. If that isn't the blind leading the blind . . .
The bottom line is that you must be familiar enough with your business to be able to understand what your
costs actually are and what level of profit margin you need to meet your goals. You owe it to yourself to set
your own prices; it's your business.
New ApproachA simple set of numbers can illustrate the results of making some minor changes to your pricing structure.
The specific information you need always stems from the amount you charge for your company's labor. This is true whether you use a flat rate manual or charge your customers the old-fashioned way with time and materials. Whatever analysis you do or however you do it, that's what you have to end up with, the company's average hourly rate.
That rate will then determine your profit margin on every job you do. That amount will reflect your costs, not just for labor but for all your general overhead and administration, and it will include your desired rate of return on work your company does for customers.
As a general guideline, I estimate it will be unusual for a company to have less than a 20 percent net profit built into the selling price of its labor. Companies offering more extensive service or those with substantial overhead will, most likely, require a greater average hourly rate than similar companies with lower costs. Also included in the calculation is your desired profit margin. You determine what that should be based on what you set as your goal for operating your business. Naturally, if it is relatively high, you must be able to justify your profit margins by delivering the best service.
There is no reason with the availability of computers and software today that you should be required to manually calculate what your average hourly rate should be. By using a computer program to produce the final calculation, the decision on what this key amount will be is easy.
Computer programs can instantly tell you what rate you need to meet your profit objectives and cost obligations. The important thing is to use a program that makes it easy for you to get the number you need: the average hourly rate. Any additional, manual calculations are a waste of your time. Focus on identifying the average hourly rate and you will have the link you need to set all your job costs.
If you change your prices and see what the change in revenue is after a month, you will get a good feel for how the change affects your revenue. Similarly, if you incur costs for a new truck, new equipment or any other major expense in any month, you will soon see the net result to your profits. That's valuable information - but it's too late.
You need to be able to see the effects of changes in your costs before they occur. You need a computer
program that provides hypothetical results to any variable you adjust, and does so immediately. That way,
you can see the changes on your bottom-line profits from any change in costs. This allows you to
determine the average hourly rate you must charge with adjustments in costs or desired profit margin. No
sense waiting until the monthly financial statements say you should have made a different decision.
Examining different scenarios of pricing and cost structure is the only effective way to determine your labor
charges, and, ultimately, your net profits.
Sample NumbersFor those who need a simple, but accurate and dramatic, example of the effect of making adjustments in pricing by altering the average hourly rate, I suggest you follow the changes illustrated below. I'll go through it step by step.
Let's begin with the assumption you have three trucks. Add a technician to match each truck. Let's also assume that each of these technicians averages six hours of productive work per day. So far, we have a total of 18 billable hours available each day from the three technicians (three technicians times six hours per day).
In my simple example I want you to raise your average hourly rate by $10, no matter what it is now. If you do, then you will enjoy an increase of $180 per day. That number is computed by multiplying the total hours available per day times the increase of $10 per hour.
If we consider that this increase is applied to every hour of labor for the week, we soon see that every five days we enjoy another $900 of additional profit. That amount is profit we keep. If we calculate the amount for 50 weeks a year, we soon see that we would realize $45,000 of additional profit in a year. All that for a measly $10 per hour! What business can't raise its rates $10 per hour?
The best part is that there are no costs associated with raising your rate. Compute what $20 an hour would
do for your business.
What To Do With The MoneyHigher revenues will certainly improve profits, but I want to suggest a use for part of the additional revenue you have generated. First, use some of it to hire the best technicians and administrative people. Don't forget to train them.
People will pay for top quality service. So if you are going to charge for it, you had better deliver it. The amount you invest in maintaining the best service you can offer will keep you ahead of the competition.
You alone are responsible for your business. So it's your decision to make. When are you going to make your next pricing decision? Now it's easy, so you don't have an excuse to delay.