Calculating Effective Labor Rate
Calculating Effective Labor Rate is a simple exercise that every Service Manager, Dealer, and GM should be able to do. The stronger Service departments in North America make sure advisors, technicians and any other productive personnel understand this key metric since it drives a significant portion of the Service Department’s profitability. Unfortunately, too often the numbers are just pulled from the DMS without any real analysis on how the metric is calculated and what it means. Let’s explore the basics:
The first step to make sure everyone is clear on what Effective Labor Rate is. Ask any Service Manager what their labor rate is and the vast majority will give you a posted door rate. This, of course, is a fictitious number that has absolutely nothing to do with anything. Let’s say your door rate is $90 – do you charge $90 an hour for an oil change? Are you menu priced items billed out at $90 an hour? Moreover, if you have an extremely complex repair job that requires the highest skill level in your shop (and therefore the highest wage scale), shouldn’t you be charging more than you would for a generic maintenance? So if your team equates Effective Labor Rates to Door Rate, you’ve got some work to do.
Effective Labor Rate can be defined as the actual amount of money you receive from the customer for an average hour of work. Sure, that’s generalizing a bit but it is sufficient for our purposes. This is most easily calculated by taking your total Sales dollars divided by your total flagged Hours. You can do this for different labor categories, for individual advisors or technicians, on a daily/weekly/monthly basis, or any other breakdown to assess performance. You may find when breaking down ELR to very specific areas that you can gain $5 or $10 an hour quickly and easily, which adds a ton to your bottom line. If you find that your ELR is low across the board, it is a management issue: Are you charging enough for your services, especially the highly specialized repair jobs that require a dealership’s expert technicians and equipment? Is your menu pricing accurate in the DMS and do you regularly review times paid to technicians for accuracy? Are you dispatching labor properly, with low-cost labor going to lube techs and apprentices? Are your advisors discounting unnecessarily? Do you have enough Parts Personnel to adequately service the technicians’ needs? Do you have to constantly interrupt jobs for special order parts?
Next, if you find that there are a couple individuals that are seeing lower ELR, you can take into account technician pay at a more focused level to determine if your labor costs are in line from a billing perspective; in other words, are you properly billing out labor? To investigate this, you would need to calculate Hours in a different way than simply pulling your flagged hours from the DMS:
1. Determine your total Cost of Sales over a given time period, which represents your technician pay. If your financial statement and DMS may not provide the accounting version of Cost of Sales, you would simply subtract your Gross dollars from your Sales dollars;
2. Divide your Cost of Sales by Hourly Tech Pay, which gives you Hours as calculated by total tech pay ($$) divide by tech pay per hour ($$/Hour). If you are calculating Hours for an entire department or labor category, this can be tricky since you will have to compile numerous technicians’ hourly wages into one average. As a result, this is a much better exercise to do with individual technicians;
3. Proceed as before, dividing total Sales dollars by Hours.
As noted, this is an exercise best done with individual technicians since the hourly tech wage is difficult to calculate when you are looking at multiple techs with different pay scales. Moreover, one of the biggest advantages of doing this exercise is in comparing the Effective Labor Rate calculated with flagged hours versus the ELR calculated with COS ÷ Hourly Pay. If the technician is paid flat rate, based on their productivity, these two metrics should be very, very close. If they are more than one dollar off, there is probably an issue worth investigating.
Effective Labor Rates are a key performance metric in your Service department and should be tracked on a regular basis to uncover opportunities, compare productive employees, and ensure levels of accountability. But first you have to make sure you are calculating them correctly and understand how they can be affected, for better or worse!