The effective labor rate is one of the most important elements in maintaining profitability in the service department. But what is an "effective labor rate," or ELR, and how does it differ from the labor rate printed on your repair orders? More importantly, how do you make sure it stays as high as possible?
Your shop's ELR is the average rate that is charged to all customers. The labor rate printed on your repair orders, or the one you quote for a job is your "posted" or "door" labor rate. There is a difference, and unfortunately sometimes it is a big difference. If your door labor rate is $75, and your shop offers LOFs at a discount, then that will reduce your average rate or ELR that the average customer pays.
ELR is important because the average rate helps establish your shop's average gross profit on labor sold.
Getting back to our $75 labor rate, if the average technician in your shop is paid $22.50 per flat rate hour, that would result in an average gross profit of $52.50. In dealership financials this is often expressed as a percentage. Since $52.50 is 70 percent of $75, we would say your shop has a gross profit percentage of 70.
That might or might not be an acceptable level for your dealer-ship's needs, but it is a reasonable enough amount for us to use as an example.
A 70 percent gross profit might sound pretty good, but in fact those profits have to cover a lot of other expenses. Everything that is needed to operate the physical shop is only part of the overhead. The management and support staff are paid out of those profits. And most important to you, your paycheck comes from those profits. With the rising costs of health care and liability insurance, utility rates and everything else that goes into just being able to open the doors in the morning, it is no wonder that just a small percentage of each hour sold will make it all the way down to the bottom line.
Now back to your role. You are in the front lines dealing with the service transaction every day. One of your roles is to maintain the integrity of the labor rate by not being too cavalier with discounts or rate reductions in order to sell a particular labor job.
Staying with our example, if a service advisor discounts a labor rate from $75 to $60, it might not seem like much to get a big job, but this seemingly small discount results in an almost 30 percent reduction of gross profit. Again, for most shops that is worse than doing the job for free. At that point the shop is probably losing money.
Another reason to keep integrity in your labor rate is that your door rate helps cover the losses on any competitive services or discounts your shop offers. If LOFs are done at a very low labor rate, it takes a lot of higher priced hours to off-set those discounts.
Since every shop sets its own pricing policy, now would be a good time to have a discussion with the service manager/director about your shop's needs and goals in labor pricing. To help with that discussion here are some situations to clarify your dealership's policy.
1. A customer needs a 60,000-mile maintenance that your shop sells at a competitive $450. The customer states they only have $400 to spend. Do you work the pricing to fit the customer's budget, or should you strip off some of the services to fit the customer's budget and reschedule those at a later time?
2. A customer needs a repair that you have estimated to be $335. The customer says that they know of another shop that can do it for $275. How do you build value in your estimate? Is a competitive discount appropriate?
3. You quoted the customer a repair for $282. Unfortunately, during the repair the technician discovered one additional part was required and it costs $35. Do you just adjust the labor amount down to cover the part? Would you violate the estimate already offered and call the customer back with a revision? Or do you just let it go and watch to see if the customer catches it at the cashier's window?
For the purpose of showing an example we may have suggested some outrageous solutions to each dilemma, but we all know that similar situations occur every day and the reality is often more outrageous than the fiction above. By clarifying your management's
position on pricing, you will have a better focus on how to maintain an acceptable ELR.