With few exceptions, every dealer in our 20 Groups is surprised when they review their effective labor rate for customer pay and find how low their profit margin is. It is quickly sobering to see how much money they are costing themselves by under-pricing jobs, discounting labor, or over-flagging technicians for work performed in the shop compared to their cost to produce an hour of labor. Growing the profitability of your service center is paramount to a dealerships overall success, so it is typically an issue we discuss at length with our clients at NCM. Let's discuss how your dealership can gain more profitability today!
How to calculate effective labor rates
Four metrics determine your effective labor rate in the shop:
- Pricing of the job
- Discounts given off the price
- Flag time to technician
- Overall job mix
Now that we have those metrics established, let's dive into each aspect of the effective labor rate and how we can use it to our advantage.
When was the last time you compared your jobs in the shop to your competition's? Do your service consultants know these prices and consistently quote the correct price to customers to avoid "adjustments" at the cash register? Establishing an aggressive and reasonable pricing structure is key to sustainable profit gains.
Remember, your target/door labor rate may be reasonable in your market, but if the flag time is excessive it can potentially put you into a vulnerable price position pushing your customers to shop around. In the case of a "set price," we address this in section 3 below.
Once you have established competitive pricing on your service jobs, how much discounting is taking place on the service drive? Who is authorizing the discounts? Discounting structure is an important process to implement in your dealership. It is amazing to see how much the effective labor rate at a dealership increases when discounting is only authorized by the service manager and that permission is taken away from the service advisors. My 20 Groups have reported that when service advisors discount service labor, it costs the department $6.00 to $10.00 PER HOUR on average. Make sure you know who is controlling ticket discounts at your dealership, and identify how much these discounts are costing you.
#3: Flag Time
Let's look at an example: You charge Bob $100 for a labor job and flag the technician for 1 hour. Your effective labor rate is $100 (simple enough). Now, if you charge Sam $100 for the same labor job, and flag the technician 1.5 hours, your new effective labor rate is $66.67. This is easily calculated by taking the sale price and dividing it by the flag time. This example shows how even a half-hour difference can have a big impact on your numbers. In numerous surveys of franchise dealers that I’ve worked with, the flag time on the same model of vehicle/same mechanical job varies over 100% almost every time! There is very little consistency in the same flag time for the same job, and even inconsistencies in how our flag times are being calculated for each job.
One solution to this problem is to take the top 20 operational codes performed in the shop and do an effective labor rate review of the pricing and flag time for each job. Make sure you take note of what guide you use to determine flag times. Are you using the actual times, or inflating them? How does this affect your competitive pricing?
#4: Overall Job Mix
The right mixture of job types is key to improving your effective labor rate. The number of oil changes and express service jobs will affect your effective labor rate due to the lower labor sales of these jobs in relation to the flag time/cost. How you record these (under customer or internal labor) will drastically affect your rates as well.
When was the last time you reviewed 100 customer-pay repair orders for the jobs performed, and, most importantly, which jobs were NOT sold on the aging vehicles coming through service? If this was quite a while ago, I would suggest performing an audit today.
Our studies show about 50% of vehicles in the service bay are 4+ years old, with 60,000+ miles each. Are you only performing oil changes on these older vehicles? What about brakes, tires, alignments, or tire rotations? To compare, do you track how many of these are performed each month? There is a cost to produce an hour of labor in the shop that you need to cover with your effective customer and internal labor rate. To ensure you know how to do this, simply follow the guide below.
How to Calculate Your Effective Customer and Internal Labor Rate and Profit per Labor Hour:
- Divide your customer and internal sales by the hours flagged to produce those hours, respectively. This is your profit per labor hour flagged.
- Take your total year-to-date service department expenses and divide by the total number of hours flagged in the shop for all labor categories. This will equal the overhead cost to open the shop for each hour flagged.
- Add this figure to the average technician cost per hour to get your total cost of flagging one hour in the shop.
- When you add the overhead cost to flag one hour of labor to your cost per technician, per hour, you will likely find that your profit per labor hour is minimal, or even negative.
Here is a worksheet to help calculate the above.
In comparing the above cost to your internal effective labor rate, the result may show an opportunity of over $100,000 year–to-date of lost gross. This is simply due to discounting your internal rate below your cost to produce an hour of labor in the shop. Many dealers have moved their internal labor rate to the customer-pay effective labor rate to improve fixed profitability. Do the math. It is usually not a very large increase on a per unit basis to the used vehicle department. It's your fixed gross and profit. Go get it!
If you are looking for help identifying and resolving these issues in your dealership, real dealership situations are reviewed and analyzed in our 20 Groups. We discuss software tools that can analyze the above opportunities and improve your bottom line. If you are interested in learning more, give us a call at 800-756-2620 to see our upcoming openings for 20 Groups.