Business & Marketing
Understanding your true labour costs
By Jim Brown
The basis of all your estimating and pricing, indeed the basis of all your measures of profitability, are tied to your understanding of your true labour costs. Without these numbers being calculated and fixed, you are just shooting in the dark and likely missing the target. In this exercise, I want to review all of the elements you need to consider in determining these costs. And then we will look at some other trades to see how your costs and rates compare.
By Jim Brown
Here are the basic elements you must consider.
- Based on your work week, what are the average hours per week over the course of the year? For purposes of this discussion, let’s work with 40. That means that your total hours per year are 40 x 52 = 2,080. This number becomes the basis for the rest of the calculations.
- Now we need to deduct the number of hours that are not billable. Based on your jurisdiction, this number will vary, but I will use 10 statutory holidays; 15 paid vacation days; five paid sick days; and 5 professional development days. This brings your billable hours down to 1,800.
- Now estimate your productivity. You know that 100% is not achievable. But is 90 per cent … 80 per cent … 75 per cent a truer number. If you lose only 1 hour per day in productivity, you have dropped under 90 per cent! But let’s go with that number. So over the year you will have another 180 hours that must be accounted for. Your billable hours are down to 1,620. This is your base line for calculating your recovery of other expenses. And remember this is best case. If your productivity is less than 90 per cent you will need to reduce the base line.
- Next you must determine other expenses such as benefits and vehicle costs. Combined these may be as much as $15,000 per year. So take this number and divide by the baseline number and your hourly rate increases by $9.30.
- If you have supervisory expenses for personnel who manage others, you must build in these costs as well. Again, take all the costs of the supervisor including all those used above and divide by the total base line number. By this I mean, take the baseline multiplied by the number of staff being supervised. Five people under supervision create a baseline of 8,100 hours and will add about $7-8 per hour to your cost structure.
- So if your direct wage expense to the employee is $20 per hour, your cost is $20 x 1.28 (2080/1620) + $9.30 = $34.90 per hour. Add another $7-8 for supervision and you are talking about a cost in the range of $42-43 per hour. And if your productivity falls below 90 per cent, you cost is higher.
Consider some other scenarios. If productivity falls to 80 per cent, your costs actually increase by 12.5 per cent to something over $47 per hour. But what if your rate of pay was increased to $25 per hour and productivity remained at 90 per cent? Your cost would increase to about $48 per hour but you would increase your revenues because more work would be done per year. And that motivated employee would require less supervision. Think about it when you determine how much to pay your technicians and the quality of people that you need to attract and retain.
With this number properly calculated, you can now make intelligent decisions on what to charge. For reference purposes, here are a couple of comparables. You will need to understand your particular market and requirements before setting your rates.
Recently our dishwasher was acting up. We called the national retailer who sold it to us and we were advised that their service rate was $110 for the first 10 minutes. In another instance I called a local handyman for a cost to do some household repairs. His rate was $75 per hour, with a two-hour minimum. Your competitors at a national level have higher overheads and they have shareholders to satisfy. You should be able to determine that their rates are not going to be as competitive as yours.
This calculation works well for determining your labour costs for installations. However, for warranty and service work, you must look closely at the aspect of productivity. Scheduled installations have a certain measure of certainty. Service is a reactive process and productivity is typically much less. What this means is that your actual costs for service are going to be much higher. More travel, more administration, more on-site issues all contribute to lost productivity. Use the same approach to the calculation, but be realistic in the productivity factor. You may be very surprised at the outcome.
As I mentioned in the beginning, knowing your true labour costs is fundamental in determining all levels of profitability in your company. Hopefully this exercise has helped you to establish a fair and reasonable rate that contributes to your sustainable results. Next time we will look at some keys in the process of accurately estimating job costs.
Jim Brown is the principal of James B Brown Consulting Inc., a management consulting firm with a focus on the electronic security industry.