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The key to profitably pricing service work is knowing the true “street cost” of running your service department, which, simply put, is the cost incurred fulfilling your customers’ needs and expectations. The cost of providing service is more than the direct cost of labor and materials expended at the customer’s site during a service call. The true street cost is the total cost of running your service department, which includes indirect or overhead costs as well as the direct on-site costs of providing service. These overhead costs increase with the extent of customer service your firm provides. For example, a service department that provides only warranty work on new construction during normal business hours has a much different cost structure than a service department that provides year-round, 24-hour support to its customers. This article will address pricing service work for profit.
When determining the true cost of running your service department, it is helpful to group the various costs into three categories:
• Direct service technician cost
• “Rolling” overhead
• Base overhead
These broad categories are not only helpful in establishing the total cost of running your service department but also in monitoring and controlling costs. To illustrate how to convert service department costs into an hourly rate for customers, we will use a fictitious electrical contracting firm, Tesla Electric.
Direct service technician cost
The cost of a service technician includes hourly wage plus benefits. Like most firms, Tesla Electric wants full-time service technicians. Assume they will be paid for 2,080 hours per year and that Tesla’ averages direct cost is $35 an hour fully burdened. Further, assume that the payroll burden includes two weeks of vacation and five paid holidays per year that Tesla does not have to pay for directly. This results in the following average annual cost:
Technician Annual Cost = (1960 Hours)($35/Hour)=$68,600
The annual cost of a service technician will vary between electrical contracting firms due to differences in labor agreement provisions, employment policies, benefits provided and the nature of the service work performed.
Rolling overhead is the cost of keeping a service unit operating in the field, excluding the direct service technician cost. From the company’s standpoint, rolling overhead is a direct cost because all costs incurred by the service unit can be traced directly to that unit. However, for individual jobs, the costs that makeup rolling overhead are indirect costs and must be allocated to each job using some activity base such as service technician billable hours.
Typical “rolling” overhead costs include:
• Service technician uniforms
• Service truck depreciation
• Service truck operating expenses
• Service truck parts and material inventory
• Service truck tools and test equipment
• Service truck expendables
Let’s say Tesla Electric’s accountant has reviewed its rolling overhead costs and determined that a reasonable estimate is $700 per month or $8,400 per year per service unit.
Base overhead is the cost of office support for the service technicians. Base overhead expenses can either be traced directly to the service department, as in the case of a dedicated service dispatcher, or can be part of the of the electrical contracting firm’s general administration and office (GAO) expense, as in the case of the warehouse operation. If the cost is part of the contractor’s GAO expense, then an appropriate share must be allocated to the service department based on its operations.
Base overhead is a very real cost of providing service and must be recovered through the pricing of service work. Typical base overhead costs include the following:
• Service manager salary and benefits
• Dispatcher salary and benefits
• Communication expenses
• Technician education and training
• Warehouse materials and support
• Office space, utilities and supplies
• Estimating, procurement, and accounting support
• Interest and insurance expense
Tesla Electric’s accountant has reviewed home office overhead expenses and determined that a reasonable amount is $1,250 per month or $15,000 per year per service unit.
Service unit billable percent
Since most service work is performed on a time and material basis, the total cost of a service unit is typically allocated based on anticipated billable service technician hours. Technicians are typically not 100 percent billable so an estimate must be made. There are unbillable breaks, time spent stocking and maintaining the service truck, time spent doing paperwork, shop meetings, marketing and developing proposals for customers, among other things.
For example, if Tesla Electric’s service technicians bill on average of seven hours per day then their average percent billable is 88 percent. This average billable percent needs to be taken into account when Tesla Electric sets its service technician hourly rate because it must recover the 12 percent nonbillable service technician time. Even though this time cannot be billed directly to a particular job, it is a real cost of providing the service. Without the work that this unbillable time represents, the service technician could not perform his or her work effectively for the customer.
Service unit hourly cost
The total cost of a service unit is the sum of the direct service technician cost, rolling overhead, and allocated base overhead. Using Tesla Electric’s estimated costs, the total annual cost of a service unit would be as follows:
Total Annual Cost = Technician Annual Cost+Rolling Overhead+ Base Overhead
The estimated hourly cost of the service unit would be the total cost of the service unit per year divided by the product of the number of hours that the service unit is available for work each year times the service unit billable percent. Based on the estimated total annual technician cost, number of available hours per year, and billable percent, the estimated hourly cost of Tesla Electric’s service technicians would be as follows:
Hourly Cost = [Total Annual Cost/(Available Hours)(Percent Billable)] = $92,000/(1960 Hours)(0.88) = $53.34 Per Hour
Set your price and stick to it
Pricing is risky. Price too high and you risk losing business. Price too low and leave potential profits on the table. The right price balances these two risks.
Your estimated hourly cost should be your baseline for setting your hourly service rate. Pricing your service work at anything less than your estimated hourly cost means that you are losing real money. Recovering your actual costs but not earning a reasonable profit on service work results in economic loss to your firm. You must establish a markup on service cost that compensates your firm for its investment in the service department, the risks inherently associated with service work, the value provided customers, and alternative uses of the money tied up in the service department. Each electrical contracting firm needs to determine its markup based on its financial goals and position as well as the market it serves.
Tesla has decided that a reasonable markup on its estimated cost of providing service is 10 percent. A 10 percent markup on cost results in the following minimum hourly rate for service work:
Minimum Service Unit Hourly Rate=(1+Markup)(Hourly Cost)
Based on the calculated minimum service unit hourly rate, Tesla Electric’s management decides to charge an even $60 per hour for service work.
Installed material and equipment
The “all in” cost of installed material and equipment also needs to be recovered plus a markup for profit. Like the service technician rate, the price charged for installed material and equipment must include direct costs, indirect costs and a markup on cost for profit. The all in cost of installed equipment and material includes the actual price paid for material and equipment, any shipping and handling charges, taxes or other direct costs. Overhead or indirect costs associated with installed materials and equipment include any design and specification time, purchasing costs, inventory costs. A reasonable markup must also be added to the cost of materials to provide profit.
Make service a profit center
Service work has a different cost structure, customer base and profit potential than the electrical contracting firm’s contract construction business. Your service operation should be set up as a profit center so that it can be managed independent of contract construction. Only by making service a profit center will you know the true cost of providing service, the effectiveness of your pricing strategy, and the contribution that service makes to achieving your firm’s strategic objectives and profit goals. EC
This article is the result of an ongoing research project entitled Developing Innovative Service Contracting Strategies that is being sponsored by the Electrical Contracting Foundation, Inc. The author would like to thank the Foundation for its continuing support.
GLAVINICH is director of Architectural Engineering & Construction Programs in the Department of Civil, Environmental & Architectural Engineering at The University of Kansas. He can be reached at 785.864.3435 or [email protected].
About The Author
Thomas E. Glavinich was an associate professor in the Department of Civil, Environmental and Architectural Engineering at the University of Kansas. His tenure as one of Electrical Contractor's most trusted and reliable source of industry research ended in 2014 when he passed away. Click here for more about Tom.