What to bear in mind when determining the price? Markup or margin - which is better and how the difference affects your profits?
Today’s article is about the labor rate that you have to charge at auto repair shop. This is a very interesting topic which I like to discuss and I believe that I’m pretty knowledgable.
I will share the basic principles of calculating the labor rate according to your costs so that you can determine it adequately and get the opportunity for better profits. There are two things I want to mention at the beginning:
- You need to understand that labor is the most important thing because it is the product that you actually sell and that is completely under your control. Yes, auto parts are also involved in profits, but they are a by-product. You don’t have complete control over the parts, and if you don’t sell labor, you don’t sell parts. That is why work is such a critical factor and that is why I will focus on it. I will return to the parts at the end of this article to explain the difference in profit formation and the difference between markup and margin but for now, I start with the profit from the labor based on the cost of running a repair shop… It is a well-established practice that shop owners ask each other on social media about what labor prices to announce, and from there, everyone gets involved with some advice. But this is not the right way to determine the price of your labor, because each auto repair shop is different – different quality and range of services, a different customer base is covered with different demographic factors, different cars are serviced, different costs by regions, etc.
- Most garages choose a price range that is common in their area – the garage opposite on the road keeps price of EUR 50, the other below is EUR 55, so I will set my price on the middle – EUR 52.50. This is also a wrong way to determine the price of labor. Yes, it is important to be aware of the prices around you, but you need to emphasize other much more important factors such as the services you offer, the level of skills, the level of quality, the condition of the facilities and buildings you manage, the investments you have made, the training costs… From this you can conclude that the prices of others help in your decision to determine your rate, but are by no means a leading factor. I am sure that many owners who read this article undercharge their labor and from there, their final profit is insignificant.
The first step is to determine the associated costs that allow you to keep your repair shop open and working. Whether it’s just you or you have staff, you have one or more lifts, these are fixed costs that may vary slightly over time. You will easily check these costs from a report that you can get from your accountant. And they do not include the cost of buying parts, but only those that allow you to turn on the lights and open the doors in the morning. Because if you do not have customers you do not buy parts, but you still have the other costs – salaries, rent, insurance, maintenance, electricity, etc.
How to determine the costs: from the Profit & Loss statement you establish the amount of expense during the year (the last whole year) and from it you remove the amount related to the purchase of auto parts. Below this line, you will get a whole list of other costs, which are the costs of maintaining the business. We will break this amount into working days of the year to get what your business costs you each day and what you need to sell as services (not parts) per day to cover costs.
Here is the formula with a simple example: EUR 300k (costs for 1 year), 8 (working hours), 5 (working days), 52 (weeks per year)…
300.000 / (8 x 5 x 52) = EUR 1152.85 per day = EUR 144.23 per hour.
Everyone can calculate for themselves what is the actual amount for them based on the above formula. Here I want to make a caveat that this is the calculation under perfect circumstances without taking into account non-working days such as public holidays, sick leave, vacations, etc. A more realistic assessment can be made over 46-48 working weeks per year. In this situation we will make the following calculation:
300.000 / (8 x 5 x 46) = EUR 1304.35 per day = EUR 163.04 per hour,
which shows that the cost per day and hour is rising. We now know that we have to sell labor within a day for that amount, just to cover the costs. The next step is to calculate labor individually because that’s how we sell it.
If we assume that a technician works 8 hours a day, 5 days a week for 46 weeks, a number of 1840 working hours is obtained annually. Theoretically, 1840 working hours can be sold. If the number of technicians is 4 the corresponding total number is 7360 hours per year. I emphasize that we work with sample values, and the actual values for each repair shop are different. You already know what your annual costs are and if you divide to the amount of time that could be sold the cost for you obtained for 1 hour of work = EUR 40.76. This is accurate if you manage to sell 100% labor time, but the reality is different and in some repair shops efficiency varies between 45% and 65% compared to the theoretical 100%. In well-organized shops with skilled technicians, good management, advertising, and a large customer base, levels of 80-95% efficiency can be achieved. For the purposes of our accounts, we are going to work with 70% efficiency.
Now we can make a more realistic calculation that if you theoretically invoice 7360 hours x 70% efficiency = 5152 effective hours of labor per year. And if you divide the annual costs by the new number obtained, you will find that the cost per hour increases to EUR 58.23. If you assume that you have set a labor rate of EUR 70, you can probably clearly get EUR 60- 61. Because here comes in play another factor that changes our arithmetic – you can’t always sell 1 hour of work at this price of EUR 70 because sometimes you run promotions or you have a car returned to the workshop… But to keep it simple we’ll adhere to round numbers, so 5152 hours x EUR 70 = EUR 360640 annual turnover in labor. Imagine a case in which the car repair shop has sold only 45% of the hours – it is quite daunting to find yourself in a situation like this because your cost per hour will increase dramatically. You can recalculate how much 1 hour of labor will cost you in this case – EUR 90.58.
There are certain cases when garages sell mixed services like operations that involve labor and materials (ex. a complex air conditioning service or brake fluid change where there are labor and materials involved). They affect the cost figures as well, but in general, the statistics show about 50% / 50% proportion. I would recommend that you strive to obtain 60% labor and 40% materials proportion, ie. to sell more labor.
Because of the low efficiency, in fact, there are garages that merely cover their own labor costs and rely on parts upsell to bring in overall profit in their budget.
Labor rate calculation
In this article, we will determine the rate of your labour…
There are two ways to determine the rate and they are (to ease our calculations, we’re going to accept an approximate round value of EUR 50 as a cost for 1 hour per technician):
- Markup – the case when the profit is formed as a percentage of your cost per 1 hour. For example, if you want to put a 40% markup on your cost of EUR 50 for 1 hour, this determines EUR 20 profit and in this case, the labour rate you charge customers will be equal to EUR 70. In reality, EUR 20 is just under 30% profit from EUR 70 rate.
- Margin – the case when the profit is a percentage of your labour selling rate. If we assume that you are charging at a 40% margin and considering that your cost is EUR 50, this means that your expense is 60% of the total labour price, and 40% is the profit, i.e. your rate is EUR 83.33 (50 / 0.6 = EUR 83.33, EUR 33.33 is your profit for 1 hour of work based on 40% margin. Respectively if the margin is 50 % then 50 / 0.5 = EUR 100 rate; margin 60% makes 50 / 0.4 = EUR 125 rate…)
Of course, after reassessing the situation and recalculating costs and profits, no garage could double or triple prices overnight to adjust its budget. And this is quite understandable. That is why your personal preferences for the types of repairs, the types of cars, the value of the customers, and what you strive for in the business, in general, intervene here… There are two ways to compensate for the difference:
- You start selling more hours;
- You increase the price of labour.
My recommendation is to combine the two of them to start gradually raising the profits and to balance the labour rate. And remember, very few customers would call to ask how much you charge per hour. You are usually asked about the approximate cost of the entire repair, and this is where your communication skills and ability to present things in the best and most convincing way come into play, and this will determine whether you are assigned the job or not.
After all, why is it so important and I pay so much attention to labour?… Because labour is the main resource that gives you control and can bring you guaranteed profits if you sell it skillfully. You will probably argue that the parts also bring profits and this is true.
When we are talking about parts, now is the time to return to the topic of parts and describe a widespread practice – it is almost common for car repair shops to provide services with customers’ parts because along with the Internet and e-commerce boom, it is way easier to find and order cheaper parts online. If you make a repair offer that includes parts with a 30-40% markup, there is a big chance that the customer will search for parts from their phone and show you the same parts at a lower price in seconds, and then want to supply their parts. What to do at this point – agree to perform the service or reject the client?
Let’s look at things from another angle – customers go to a restaurant and order a bottle of wine for EUR 30, knowing that this bottle costs EUR 10 in the store. However, they consume it and pay for it without grumbling. What happens when the same customers go to a garage and find out that the parts are not 3x but only 1/3 more expensive? They open Google and find them cheap, put their phone in the manager’s face, and ask whether the repair shop will install these parts if they supply themselves. “No, my friend, thank you for your interest in us. Find another repair shop”. If you are honoured and in business to build a reputation and class, the answer is very clear – you will show this customer where the door is because you have invested in this business a lot from a moral and material point of view, you have built something, you have established a class and that’s your price. That’s why it is imperative to properly regulate labour rates because parts profits are decreasing daily due to this tendency. That’s why the garages, which charge low labour to attract more customers and rely on the parts to make a profit, will sink deeper until they vanish.
Both methods are applicable to determine the profit on labour and parts. Lastly, which is better when calculating the profit on labour and parts – markup or margin? 100% margin.
For example, a markup of 40% x EUR 100 (labour or parts) = EUR 40 and gives you a total price of EUR 140.
But this means that you got only about 28.5% profit from the total when 40% profit from EUR 140 equals EUR 56. This is a difference of EUR 16 profit for 1 hour or one part. So, calculate prices on a hard margin and do not give in to pressure from customers. This will prevent the vicious practice of guessing what prices to offer to different customers.
Here is a small chart to help you with the calculation:
25% margin = X (cost for labour or parts) / 0.75
30% margin = X (cost for labour or parts) / 0.7
35% margin = X cost for labour or parts) / 0.65
Again, look at the big picture of your business, and think about the type of customers you want to attract. Also, being a specialist in a certain type of complex repairs allows you to keep a high level of prices and be more efficient. If you try to repair everything for everyone your work will get diluted. And because you’ll be unable to maintain the necessary skillset, quality, special tools, and diagnostic equipment you gonna perform complex operations for which you are not prepared. And it will take you a longer time, and you will end up undercharging because you will be afraid to charge as much as it costs you plus the profit. And you will waste your time and effort and will never cross the level of 50-60% efficiency.
You should be proud of the services you offer. The independent car repair industry consists of a large number of honest and hard-working people and it is time to start the practice of earning a well-deserved profit to compensate for the efforts, skills, and risks that this particular trade takes. Even at the moment, with the situation created due to Coronavirus, it is even more challenging to provide service and therefore it is even more critical to earning the money you deserve… By offering services at a fixed price that can’t be undercut. This is due to the investment in the training of technicians, equipment, tools, maintenance, and repairs to improve the environment in the garage. These are assets that should not be wasted by undercutting or being given as a gift or included in packages of cheap services.