Establishing your company’s service rates is obviously important to the success of your service business, but knowing how to price services can be challenging.
Most company owners just getting started in business either set their service rates at or below a previous employer’s rates or they survey the rates of the companies in their hometown and set their rates slightly lower than the competition. That’s because newbies believe pricing services with lower hourly rates will generate business. It is a very common practice, although low service rates don’t magically make the phone ring and don’t guarantee success.
Surveying the competition to decide how to price service rates may be more helpful, but it is decidedly more difficult if the competitors are using flat rate pricing instead of time and materials pricing for services. That’s because companies on flat rate will likely only quote their service call fee, not their hourly rate.
Two words of caution: “Be careful.” If competitors’ service rates can be determined, charging less than the competition assumes a couple of things that may not be true. Perhaps the biggest false impression is that the guy down the street knows how to price his service work. That may be a dangerous assumption. Another potentially false assumption is that a competitor runs a profitable service business. Without knowing all of a competitor’s numbers, any assumptions about their service pricing strategies may be completely false, and could result in “the blind leading the blind” causing your company to operate in the red right from the get-go.
Some service companies use a trial-and-error method for deciding how to price services when starting in business or when converting from time and materials pricing to flat rate. That can work, but pricing services with those rates may not be as accurate as they should be.
For an established business, the best way to make a proper determination about pricing service rates is to first departmentalize the company income statement. Separating income and expense by service and installation work provides insight into the rates that should be charged to cover direct and indirect costs. It will also show if a division is making or losing money. In addition it allows the company to factor in desired net profit by company division.
When setting service rates, besides covering expense and desired net profit, consideration should be given to the amount of time that cannot be billed. Unapplied or non-billable time will have significant impact on a service division driving overhead expense as high as 50-55 percent of service sales. That’s because service technicians generally only bill 4 to 5 hours in a eight-hour workday.
Conversely, there is significantly less unapplied time during an installation. That’s because almost every hour is billed on installation work. Therefore, segmenting income and expense by type of work allows the company to determine the rates that will carry each division to turn a profit. Using only one billing rate based on man hours regardless of type of work and overall expenses may cause the company to under charge on service and over charge on installation work. It’s important to keep in mind, that a more competitive hourly rate on installation may mean significantly more new equipment sales, while a more realistic and possibly higher hourly rate on service may turn service division losses into profits. Remember, without departmentalization a company cannot recognize growth opportunities or where cash is being drained. Here's more on unapplied time.
Once service rates are set, the company needs to determine if the service rates pass the “squawk test.”
When using time and materials pricing, customers tend to hyperfocus on the hourly rate and they tend to squawk about any hourly rate regardless of the amount.
When using flat rate pricing, customers tend to complain only if the repair fee is high, but they usually overcome those concerns because they can make the decision in advance of repair.
As time goes by, labor rates should be reviewed and adjusted seasonally. When using time and materials pricing or a flat rate pricing mobile system, labor rates can be adjusted at any time. Companies using printed flat rate pricing books will need to complete an update and then await the new books to arrive. That usually only takes a couple of weeks.
There is a distinct advantage when using a flat rate pricing mobile system over time and materials pricing. That advantage relates back to the fact that hourly rates are not quoted. That is a significant advantage over quoting rates and tying those rates to the time on the job. With flat rate on a mobile device, service pricing strategies can be changed and tested repeatedly to see if they pass the squawk test. If the customers don’t squawk, the service rates can be bumped higher. Once the rates reach a threshold where a few complaints are experienced, the service company can hold the rates or back them down to a slightly lower level to eliminate complaints. Generally, customers are more accepting of the repair fees even if they are a bit higher with flat rate, because repair fees are quoted in advance allowing the customer to make a buying decision.
Remember, the labor rates you charge should be high enough to keep your company in the black. Direct and indirect costs, overhead expense, unapplied time and desired net profit all need to be determined to establish service rates that will carry your company forward and turn a profit.
Remember, just a little bit of squawking about your repair fees can ensure that your service rates are where they need to be. And, if you are making money, a little squawking from your customers can be a good thing.