As a child, a parent or guardian may have warned you about blindly following your friends, emphasizing that they could lead you down the wrong path. The same philosophy applies to your business. Charging the same amount your competitors charge for their services isn’t helpful to your business. Most PHC contractors don’t know their actual cost of operation, yet prices can only be set at, below or above that true operational cost.
There’s a good chance your competitors’ prices are wrong for them — and they are absolutely wrong for you.
Similarly, business forms providing specific factors to use in calculating your prices can lead you to charge selling prices that do not address your real operational costs. They hinder your ability to recover those costs and earn the profit you deserve for delivering excellence to consumers.
When I was an apprentice and capable of diagnosing problems, the PHC contractor for whom I worked would send me out to take care of the punch lists that were keeping him from receiving his final payments, as they were being held in retainage by the client.
He gave me forms to record the materials I used and the time I spent. The forms were marked as “Extra Work Orders.” By using these forms, he would know whether the time and material expended was an expense he would have to absorb or extra work for which his customer would have to pay.
If he had to absorb the cost, he would have the factors needed to know how much of an expense to include in his operational budget so he could recover the intangible business expense related to callbacks. The only way to recover legitimate operational costs is to cover those costs in your budget.
It doesn’t mean you could have callbacks galore. It means to solve a problem, you must identify the problem. Then you can control the problem. But all PHC contractors have callbacks; a controlled and limited number of callbacks are a legitimate operational cost.
If the work done was extra work for which the customer was responsible, the form would give my boss the information he needed to charge the customer so he could recover his cost and earn a profit.
The form was simple enough. It had specific areas to list the customer’s information, job location, time spent on the job with an hourly labor cost, a description of material and material costs, a summation of labor and material costs, a 10 percent upcharge to cover overhead costs as well as 10 percent for profit above costs, and total costs.
As soon as I saw the form, I wondered how my boss could know 10 percent would cover his actual overhead expenses. The truth was that 10 percent would never cover his overhead expenses. But that is how the form supplier laid out the form.
Since that 10 percent could not possibly cover his overhead expenses, his 10 percent profit would have to go to cover overhead costs. Therefore, there could not be any actual profit.
Following forms that make no sense, guessing at your prices or setting your prices based on what others charge is the wrong way to establish your prices. You must calculate your rates based on your actual costs. Guesstimating is foolish. And since your competitors may not, and probably don’t, know their true costs, using their prices as a basis for your prices is extremely foolish.
How labor costs affect price
Calculating properly profitable prices starts with knowing your real costs. To find your true cost, you must realize there are two types of true costs — tangible and intangible. Tangible expenses are those that allow you to see your actual cost. Salaries and salary-related expenses, rent, utilities, fuel, etc. are tangible expenses. Callbacks, customer relations, bad debt, etc., are intangible expenses.
Regardless of which type, you must add up all expenses to arrive at your total, real annual operational cost.
Since labor costs for tasks are calculated on man/woman hours, you will need to know how many tech hours you have available to sell. Fifty-two weeks a year multiplied by 40 hours/week gives you 2,080 hours per tech that you will have to pay annually. However, daily responsibilities for nonrevenue-producing time, holidays and vacation time will lower the number of hours you have to bring money into your business.
One daily nonrevenue-producing hour, six annual holidays and two weeks of vacation will only give each tech 1,708 potential revenue-producing hours/year.
By dividing your total real annual operational cost by your maximum available revenue-producing hours, you will arrive at the hourly labor/overhead cost per tech hour if you sell all tech hours all the time. I know what you are thinking. No PHC contractor sells all available tech hours all the time. That’s true. But the fact that you don’t sell as many of your open tech hours as possible may be due to protocols you implement.
This realization doesn’t negate the fact that you won’t sell all available tech hours all the time. But it gives you the ability to include a legitimate factor in calculating your real operational cost.
For example, when your average tech hourly salary and overhead expense is $100/tech, you are paying $208,000/tech annually ($100 x 2,080 annual hours). But since you only have 1,708 maximum hours to recover your cost, the cost you incur for one tech hour serving the consumer is $121.78 — if you sell all your tech hours all the time. That amount increases when you sell less than your maximum available revenue-producing hours.
To address this unapplied labor factor, you should apply a profit margin to your actual operational costs that considers the fact that you won’t sell all your available tech hours all the time.
If your operational costs are properly calculated, divide the number of hours you usually sell by your maximum available revenue-producing hours to arrive at the average percentage of revenue-producing hours you sell. Subtract that percentage from 100 percent to arrive at the profit margin you should apply to your true cost of a task to just break even.
For example, if you sell 70 percent of your available tech hours on average, the profit margin should be at least 30 percent to break even. However, it should be higher if you want to make a profit. If your labor/overhead cost of a task is $200, dividing $200 by 70 percent gives you a minimum break-even selling price of $285.72 when 70 percent of all tech hours are sold. Proof: $85.72 ÷ $285.72 = 30 percent. To make a profit above your break-even cost, your profit margin must be higher.
If you need help in calculating your numbers to make your price right, give me a call. Keep in mind that following your competition off a cliff is not the path to success. It will only lead to a big fall. And using pre-printed forms with factors that do not pertain to your business is detrimental to your business.