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Customer surveys and focus groups have talked about your services for many years now. And we have covered some of the headlines in several of these columns over the past year. Convenience. Consistency. Quality. I would like to now focus on your price.

I remember having to take an important supplier out to dinner early in my career. It came time to order wine, and I didn’t know the ins and outs of pricing a good wine, so I did what most people do—I ordered according to the price.

I mean if it was a mid to high price, then it had to be good, right? Today, I enjoy looking over a wine list to see if I can find something at a low price by mistake.

Your customers do something similar to what I used to do. They ask you for your price. And like a good supplier, you tell them. I want to suggest that is not the right thing to do. But I say that with a reason.

Making Peanut Butter

My thinking is that your labor rate is currently the same as peanut butter. You take a highly skilled, expensive designer or inspector and put a peanut into a blender for him. Then you add another peanut for a laborer, another for a welder or fitter, another for a mechanic, and so on. Finally, you blend together all these skills and variable pay rates and you arrive at your version of peanut butter—a single labor rate.

It’s pretty simple and many would say logical. My approach, though, is that you’re overpricing simple work and undervaluing highly skilled work. I know it is much easier for everyone to do it your way, but I think you should reconsider.

Why don’t we provide a fixed labor price on all work we do? Yes, I know all the reasons why you shouldn’t, but let’s focus on why you should. Your customer wants to know how much it will cost before you start the work. They have been clear on this in the surveys and focus groups. So why don’t you give it to them?

So you get a customer talking to you about a job. They want to know your price. You need to respond that you will have to take a moment and work out the proper price to charge them. After all, you don’t want to charge them too much.

I remember working on the development of a flat rate system with a major manufacturer years ago. The coding structure on those systems is critical for it to be used, as is the development of standard times. Yet a problem we also discussed a lot related to what to tell customers when they asked for the hourly rate. We decided to respond with a question or else give the nontechnical labor rate. It worked for about 20 years. Imagine that?

Selling Your Skills

So let’s get to the establishment of the labor rate according to the asset that you truly are selling—the skills of your employees. And let’s use the tried and true methodology of a wage multiple.

So let’s review. You start with the wage of the employee—no benefits or anything else, just the wage. Then you determine the level of profitability that you need to support your service operations. That means you must identify the expense level that you can accept to maintain the facilities and your mobile fleet, the wages and benefits that you want to provide to your employees, and the training and tooling you provide. This is everything that you need to spend to maintain the cutting-edge services that you are known for in your market.

To that, you add the profit level. So let’s say for instance that your expenses supporting service run at a rate of 40% of your service department sales and that you want to obtain a 25% contribution to the profit of the business. That means your gross profit has to be equal to 65%. Got it so far? Good.

If that is the end, then you can simply multiply the wage of the technician, the laborer, the inspector, or whoever by three and have the selling price. Sell the hour of labor for $60 with a wage of $20 and you have a gross profit of $400 or 66.67%. Pretty simple, isn’t it?

But we are missing something, aren’t we? Of course we are, we’re missing labor efficiency. You don’t operate at 100% labor efficiency, so you have to charge more than $60 to compensate for the time the crew spends on the job that you can’t recover in the invoice.

When work is done in the field, the customer can see the effort and the time involved in the job. It is when work is done in your shop that the questions start to arise. We’ve all looked at service invoices and said, “I could have done it in less time than that.” But there is another truth lurking out there that says, “The older we get...the better we were.”

We will deal with labor efficiency and standard times next month. But in the meantime make sure your price represents the skills and abilities that you offer your customers—and not just simple peanut butter.