Labor costs get out of control the quickest and are the most difficult to get back in line.



In prior columns I have written about managing key expense items. I used the term Big Five expenses, which are:

1. Direct Labor (the wages and benefits paid to technicians and helpers);

2. Material;

3. Office Wages and Benefits (all wages other than direct labor);

4. Vehicle Expenses (lease or depreciation and operating expenses); and

5. Advertising.

These five expense categories represent 80 percent or better of total expenses in the average service company and must be managed properly if a company is going to make money.

A good business operator always keeps a close eye on these expenses to make sure that their percentages are not increasing. It’s OK if the total expenses in each category are going up as long as they are growing slower as a percentage than sales. If sales are up 25 percent, the goal is that these expense items have increased less than 25 percent, which will mean profits are increasing. 

Of the Big Five, the most important expense to manage is direct labor. This is the expense that can get out of control the quickest and is the most difficult to get back in line.

What Should Your Direct Labor Percentage Be?

The answer depends on whether your company is highly profitable:

  • Equal to or lower than last year if your company is already comfortably profitable;

  • 24 percent or less if you aren’t profitable.

    Let me explain.

    If you already are highly profitable and your direct labor percentage is north of 24 percent - great. You are probably getting by with fewer people in the office, which means lower overhead. You’re spending more in the field and less in the office. 

    If you are not highly profitable, I bet your direct labor percentage is well north of 24 percent, and you are spending more than 18 percent of sales in office wages, meaning that you are paying more in the field and more in the office - a double whammy.

    So what do you do about it? Let’s walk through some common reasons for high direct labor percentages and see if any of these sound familiar.

    1. Low overall selling prices. Here is the biggee. If, as an example, you are paying your technicians $25 per hour and charging $110 per hour and billing 40 percent of your technicians’ payroll hours (a common billable percentage, by the way), there is no way to get your labor percentage in line. The math just doesn’t work. You would have to bill out virtually every hour you pay your technicians.

    Don’t rationalize getting more calls as a solution, or training your people up, or dispatching from home as a way to get your percentages in line. Get prices up to make your company profitable - period.

    2. Unmanaged discounting. Some companies have a good price built into their flat-rate book but they aren’t getting it in the field. There is widespread discounting or they give a lower price to a large percentage of their customer base, which typically is a property management company, home warranty company or general contractor. Ironically, this same company that is getting the discount also is a topic of discussion when looking at accounts receivable over 60 days. That doesn’t make a lot of sense.

    I heard Frank Blau say it a hundred times, “The price is the price.”  If you want your company to be profitable, you have to figure out how to build value in the selling price you need to make money. And you have to get that price and work with people who understand that value. It is possible that some customers at your company need to be fired.

    3. Abundance of unbilled helpers. Many companies have a culture in place where almost as many helpers are in place as technicians. The company can’t get by without a second pair of hands if you ask anyone inside the company. If that’s the case, see No. 1 above. You better be charging enough to keep your total direct labor at 24 percent. 

    I don’t see an overabundance of helpers in highly profitable companies. For those jobs that require two people, these firms may have the warehouse manager or service manager pitch in or swing a second technician by to help for short time, but they don’t have a bunch of helpers on the clock full time. If this is your company, removing this expense could be your key to a profitable 2010. 

    4. Lost morning payroll hours. This is very common for loosely run operations. Technicians take their trucks home and then drive to the shop every day. They clock in when they arrive, sip coffee and back-slap the boys for awhile. Maybe gather up some parts, straighten up the truck, go romance the new customer service representative and then off they go - at 9 a.m., arriving on the job about 9:30.

    Highly profitable companies with low labor percentages get on the first job at 8 a.m. - many times driving from home to the first job. If you do not have tight control over the time from clock in to arrival on the first job, I challenge you to put a pencil to the amount of money you are spending annually in unproductive morning payroll. You could serve more customers and pick up a couple of margin points in this area.

    5. Multitrip jobs. What this means is jobs sold that are either not completed on the first trip or require a trip (sometimes several) back to the shop or wholesaler for parts or equipment. Your goal should be to keep the technician on the job and have someone else deliver parts or equipment as necessary. Remember, if you pay your technicians by the hour, making a supply house run is not a bad thing in many technicians’ minds. It is a good opportunity to listen to the radio, sip Red Bull and extend a job.

    Your job as a manager is to prevent this from happening. The solution could be better truck inventory, a parts runner, watching your field purchase orders closely and a strict policy against leaving the job for parts or to return the next day without dispatch approval.

    6. Straight hourly pay. The vast majority of companies pay straight hourly pay. Some additional incentives that reward top performance may be in place, but nothing is in place that limits pay in the event of poor performance. Highly profitable companies have incentives in place that handsomely reward high performing technicians. Six-figure incomes are not out of the question.

    On the flip side, poor performers - those who do not bill a high percentage of their time either due to poor salesmanship or poor technical abilities - have a hard time making a living. Performance pay plans require all technicians to produce, or they quit and go to work for someone else.

    Sold hour incentives (paying a different rate for sold hours and unsold hours) and commission plans work. If you are a service company operating with an hourly pay plan, look hard at going to incentive pay and set yours where your labor percentage is again at 24 percent or lower.


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