Ask Mike: What Should Be Considered in a Realistic Labor Rate Calculation?
This month, we “ASK MIKE” to share his thoughts on some of the critical things shops should consider when calculating their Labor Rates.
We at Hammer & Dolly hope you find the following exchange useful, and we encourage you to reach out to us if you have a question for Mike on this or any industry-related matter that he can answer in a future issue.
Hammer & Dolly: We could easily come up with a list of things that are negatively impacting shops’ profitability these days, but not all shops know how to adjust their Labor Rates to reflect these issues and charge a reasonable amount of money to stay in business. What are some of the most critical things a shop needs to keep in mind when determining a realistic Labor Rate?
Mike Anderson: First of all, employee recruitment is one of the major things our industry has been talking about recently. Obviously, part of recruiting new employees is being able to pay them a competitive wage. There are three ways to accomplish that. Number one: Shops could charge more for not-included operations, which is really the easiest path. Number two: They could increase their rates. Number three would be a combination of the first two.
When I ran my own shops, I was never a proponent of just randomly raising my Labor Rate by a dollar or two. That never made sense to me. Every business is going to be different. For example, where my shops were in Alexandria, the property tax rate was very high. Ten miles down the road, that property tax was much less. Additionally, my shops were located close to areas where there were a lot of government employees and contractors. The Federal Government paid people certain salaries and offered retirements and great benefits, so I had to compete with that.
Another consideration would be the wages you need to pay in your town. The cost of living in your shop’s area could be much different from where you actually live.
On top of an employee’s salary, you have their health insurance costs – which could have doubled over the last couple of years. Then, add in vacation time – one week could be two percent of an employee’s income – and workers’ compensation, 401(k)s and FUTA [Federal Unemployment Tax Act] and SUTA [State Unemployment Tax Act] contributions. It’s not just about what you pay an employee – it’s also about all the other things you have to pay. Those expenses, in addition to their wages, could average thousands of dollars a month. You need to figure out how many hours your employees need to produce to cover that, and then include that information in your considerations when determining your Labor Rate.
Also, if you’re going to invest $200,000 in equipment, you need to figure out what you have to do to offset that. Is that equipment going to be paid through the increased efficiency it’s bringing to your shop, or do you need to take that into consideration in your Labor Rate? You also need to think about profit. How much money do you want to make? What is it going to take to get to that? Don’t forget that when fuel prices go up, it costs us more to paint a vehicle.
When it comes to raising Labor Rates, you have to understand your cost of doing business and understand what your rates need to be based on what you’ve invested in training and equipment, the benefits you offer and the property taxes in your area. All of that needs to be considered.
Your Labor Rate should never be just a fictitious number pulled out of the air. Shops need to determine their rates through business analyses. What are their training budgets for the year? That is going to be different for a shop that’s Porsche-certified versus someone who is Honda-certified versus someone who has no certifications. Also, what do competitive industries in your area pay? If you’re located near Amazon or the Federal Government, then you need to be competitive with them.
HD: Based on your experience, how many shops are doing a thorough examination of their numbers to determine a realistic Labor Rate instead of just fabricating a number?
MA: The majority of shops still pick some number out of the sky with no rhyme or reason behind it. I don’t mean to hurt anybody’s feelings; I just don’t think a lot of shops have ever been led through an exercise on analyzing what their Labor Rate should be. The majority of shops don’t know how to determine what that effective rate needs to be.
H&D: Are there any COVID-19-specific factors that you’ve seen impact Labor Rate calculations in ways that shops didn’t need to consider two years ago?
MA: I don’t know that COVID-19 has impacted Labor Rates or people’s business decisions. But with supply chain issues, shops are having to float a lot more WIP [work in progress]. They have to make more money because they have to float more money. I talked with a shop this morning that told me they had $100,000 in WIP for one OEM sitting in their lot that couldn’t be delivered because they were waiting on parts. That shop owner has already paid for the parts for other areas of repair; he’s already paid his people to fix those cars. The paint and materials have already been paid for. He has $100,000 of his money tied up because he can’t get a couple of parts. You need to have cash flow in order to support those types of things. We’ve also seen vendors increase their prices recently. So, that means shops need to look at their paint and material rates in addition to their Labor Rates.
H&D: Let’s say a shop follows your suggestions and comes up with a revised Labor Rate, but that rate is high enough to raise a payer’s eyebrows. What are some ways that shops may be successful in communicating these necessary charges to that other party?
MA: One way is to just start raising the rate on your estimates, and then a staff appraiser finds out about it and runs it up their chain of command. The second option is to send a letter out to all the insurance companies notifying them that you’re increasing your rates as of a certain date. The third option, which I always thought was better, is to meet with the insurance company’s decision-maker in that area. When I had my shops, I’d sit down with them and say, ‘Here’s why I’m doing this.’ I didn’t just review what my Labor Rates were going to be; I reviewed what I called a ‘pricing menu.’ I’d say to them, ‘When you see me charge for feather, prime and block, this is my premise for how I’m charging for this, and this is why I’m charging for it.’ This provides the reasoning behind the charges based on factual data. We’d have discussions as to what we could agree on so that the insurer’s field staff and my estimators wouldn’t be put in a frictional position.
Want more? Check out the March 2022 issue of Hammer & Dolly!