Tool Repair: A Labor of Love?

Brent Grover, Managing Partner, Evergreen Consulting

Brent R. Grover, Evergreen Consulting

Are your service labor hours just another product?

How does your management team track and account for service labor hours?

1. To us, service labor is a high-profit product that we manage diligently.
2. We do try to manage service labor hours but we’re not very good at it.
3. We don’t worry much about service labor hours. They are a cost of getting business.

One of our oldest clients was a radiology supplies distributor whose service technicians repaired diagnostic equipment. The supplies sales force traditionally provided free equipment service to large supplies customers. The service techs were little more than personal assistants to the sales team. The “free service culture” did not change until the service department was spun off into a separate division whose manager was paid based on service department profit. Service then became a large and lucrative business.

Professional services firms such as your accountants and attorneys regard labor hours as inventory. Each hour paid to professional staff is recorded and tracked by category, billable or non-billable, and further broken down by client, assignment and type of work. Each staff member including partners must submit a daily time record. Work in process becomes inventory that is ultimately billed to clients or written off.

I started my career at Arthur Andersen immediately after college. My starting salary of $875 per month (it was a long time ago) came to $10,500 per year, or about $5 per hour. The firm set my billing rate at the seemingly outrageous amount of $22 per hour. Young CPAs today start out at close to $50,000 per year or about $25 per hour. Their billing rates are in excess of $100 per hour. I will explain why this is necessary and why you may not be charging enough for labor.

This article will review three critical service labor functions that distributors must manage: service labor hourly rate, service labor utilization and service labor realization. These three factors determine how profitable (or unprofitable) your service department will be.

Service labor hourly rate
Distributors tend to be bashful about setting the hourly rates for their service employees. The pattern we see is that the standard rates are too low and that distributor sales reps try to discount the already low rates.

• The formula used by most professional firms is to multiply the base hourly pay rate (not including fringes or overtime) by a factor of 4.0 to 4.5. The billing rate for a technician whose base pay is $40,000 per year (about $20 per hour) would be in the range of $80 to $90.
• Following the above example, the burdened cost of the technician’s time is not less than twice the $20 hourly pay. The $40 burdened cost includes fringes benefits, supervision, equipment, training and other non-billable “down time”.
• The $40 burdened cost may be used for determining sales commission on labor. At a billing rate of $80 the gross margin is 50% of selling price based on a $40 cost.
• The billing rate must be competitive with other suppliers. The formula outlined above should be in line with competitors whose well-managed, capable technicians have a similar base pay, benefits program and overhead. Compare the $80-90 with rates charged by qualified professionals in your area for similar services.

Distributors must manage service labor hours as they do other expensive inventory. Like other products, labor most be sold both at a fair price and at a reasonable profit.

Service labor utilization
Your accounting or law firm sets budgets for and keeps careful track of “chargeable time”. Each professional is responsible for meeting goals for chargeable time. Incentive compensation is usually tied to the number of hours charged to clients versus non-chargeable time. In an extreme case one of my colleagues at Arthur Andersen worked 3300 hours of billable time in one year, about twice the average of 1500-1600 hours. The poor man worked seven days most weeks. His work was profitable for the firm but his schedule was not a healthy way to become a partner.

• Distributor service technicians should be able to generate at least 1,500 chargeable hours per year.
• The starting point for measuring utilization is 2,080 hours per year (52 weeks times 40 hours). Subtract holidays, vacations and other paid time off (generously 28 days or 224 hours), leaving 1,856 hours not counting overtime. The service technician has only about 250-350 hours left for non-chargeable time such as training.
• Service technician time reports must account for chargeable time by customer, job or invoice number and task performed. The service tech needs a time realistic time budget for each task.

The time charged to jobs by service technicians is part of the distributor’s inventory. It must be managed meticulously.

Labor hour realization
The third component of service labor profitability is the realization rate. This rate is the percentage of the technician’s time charges ultimately billed out to customers. Time charges that are written off before billing reduce the realization rate.

• Distributors should be able to maintain a 90% realization rate. The unrealized portion, representing chargeable time that is not billable, usually results from technicians exceeding the time budget for their jobs.
• The write-off may be the fault of the estimator not the technician. Distributors often have problems with staff under quoting due to underestimating the labor needed to do the job.
• Low realization for a particular technician may indicate that the billing rate is too high relative to the person’s qualifications to do the work.

In this example, the combination of $80 billing rate, 1,500-hour utilization and 90 percent realization yields $108,000 in annual billable revenue at an annual cost of  $83,200 (2,080 hours paid @ $40). The gross margin is 23 percent. CS

Brent Grover is managing partner of Cleveland-based Evergreen Consulting, a specialized consulting firm advising the wholesale distribution channel. Brent is also an adjunct professor at Case Western Reserve University’s Weatherhead School of Management. His latest book is The Little Black Book of Strategic Planning for Distributors. He can be reached at the website: www.evergreenconsultingllc.com.

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