Calculated Control: How to Manage Effective Labor Rate
Some believe that effective labor rate is not an easily manageable number, or even manageable at all, which is simply untrue. Once you understand what it is and how it’s calculated, effective labor rate becomes easier to manage.
First, you must understand what your work mix is in your shop, understanding that effective labor rate will have a shift to the negative number if you don't manage your work mix in the shop, as well as managing your selling prices, and your tech costing regarding hours.
How is effective labor rate calculated?
The math for calculating effective labor rate is going to be your labor dollar sales divided by your total billed technician hours. That is going to give you what we call a blended effective labor rate. The reason it is called “blended” effective labor rate, is because there are several different effective labor rates in your department.
Now, when you start breaking it down to competitive – looking at oil changes, for example – your effective labor rate for an oil change service, to stay competitive, may be reduced to a $40/hour effective labor rate (for that type of service).
Your transmission repair, however – which is more of a precision repair, and perhaps a dealer-only item, may be at an effective rate of $145/hour. The wear mix in between could be brake services and alignments, which will typically run between $85/hour to $95/hour effective labor rate. The key thing is to know what your work mix is, and you can plan your work.
How You Can Better Manage Effective Labor Rate
You can actually calculate a targeted effective labor rate based on your work mix, then adjust your labor rates on those categories accordingly. Effective labor rate can also be impacted by discounting from service advisors, because we are taking a total labor sale divided by technician billed hours if we're discounting the sale price on that. We're not discounting the hours – we're still paying the same amount of hours and money and that will affect your gross profit, gross profit margin, and your effective labor rate.
Consider these scenarios:
- How much time do you pay a technician to do an oil change? Most would say “3/10ths of an hour,” which is pretty much industry standard on an oil change, but it can vary a little bit by brand.
- How much time do you pay a technician to do a tire rotation? Most would say “4/10ths of an hour,” which again is not unpractical and pretty much industry standard.
- How much do you pay a technician to do an oil change and tire rotation? A lot would say “7/10ths of an hour,” which is where we can often have a bit of a disconnect.
Let's think about these for a second.
If I was a technician and you handed me a repair order and you said, “Rick, I need you to go do a tire rotation on this car…” So … I walked to the keyboard, found the keys, went to the parking lot, located the car, brought it into the shop, set the lift, popped the hood, checked the fluids, pulled the cabin air filter, pulled the engine air filter, checked the lights, tested the battery, raised the car up on a lift, did an undercarriage inspection, dropped the oil, replaced the filter, checked the tire pressures, measured the brakes (if I’m able access the brakes), reinstalled the oil drain plug, put a new filter on, lowered it, topped off fluids, filled the oil, started and shut the engine off, re-checked the oil, installed a new oil change sticker, reset the oil life monitor, removed the rack from the car, parked it … and for all that, I get 3/10ths of an hour, equating to about 18 minutes of my time.
Then … I walk back up to the desk and I hand you the ticket and you hand it back to me and say, “Rick, now I need you to do a tire rotation on this car.” Of course, I'm probably grumbling under my breath knowing I'm about to duplicate a lot of the work I just did … I get the keys, go to the parking lot, pull the car in, set the lift, raise the car up, remove the wheels and tires ... At this point, if I haven't checked the brakes before, I'm going to inspect them now. I put the wheels back on the car, lower the car down, torque the wheels, set the rack out, park the car, and you pay me 4/10 of an hour – roughly 24 minutes.
So how long does it really take to do a tire rotation while the car is up on the lift while we're doing an oil change on a car? Maybe 10 minutes, right?
Basically, we have some overlap on these two laborers – we're paying the technician to 4/10ths for the tire rotation and we're paying the technician 3/10ths for an oil change, equaling a collective 7/10ths, causing us to be uncompetitive on the price that we must ask to be able to hold the effective labor rate.
So how do you manage that?
Well, let's look at the overlap between the oil change and tire rotation. I'm not saying that now you take it from 7/10ths down to 4/10ths. Maybe 5/10ths, but ideally no more than 6/10ths of an hour that I'm going to pay for that bundled service.
If I was paying 3/10ths of an hour for an oil change and I'm paying 3/10ths of an hour for tire rotation, I'm paying a technician 6/10ths of an hour to do an oil change and the tire rotation. If my standard labor fee for that oil change and tire rotation service was about $45.00, and I divide that by the 6/10th hours I paid the technician, my overall effective rate for that labor operation is going to be about $75.
If I took that 1/10th off between the 3/10ths for the rotation and the 3/10ths for the oil change, and I paid the tech 5/10th hours (still a reasonable time on most brands) at the same labor fee of $45.00, my effective labor rate just went from $75 to $90. If you take the $45.00 and divide it by the 5/10th hours, you will come up with $90.
In that particular example, 1/10th of an hour on one of the most frequent services you do in a day can have a $15 impact on your effective labor rate.
Hopefully this will encourage you to re-evaluate of some of your flat-rate times, particularly those that include labor overlap. You just need to look at the frequency of labor operation codes that you do and look at the overlap between your combination services and adjust from there.
If you need any additional help with this topic, or tips on how to implement changes like these within the dealership, learn more about our Fixed Operations courses at the NCM Institute here.