Why Flat Rate Doesn’t Work

Ken Secor

After reading arguments for and against flat-rate pricing, I would like to take up on the side of those who are opposed to flat rate.

The premise of flat rate is the notion that the price of a job can be quoted before a job is started. I believe you cannot know what the problem is — nor the solution — until frequently lengthy and substantial diagnostic routines and test dynamics and data are completed and gathered.

Since the time and effort required to find the problem of most service calls can vary wildly — and frequently is more time consuming than changing the offending part(s) — the suggestion of charging diagnostic fees is, in fact, guesswork.

No two jobs are ever alike. “One size fits all” is the basis of the flat-rate price books. Each job is unique and should be billed based upon the actual labor involved.

The Arguments Against Flat Rate

In a nutshell, here are my viewpoints on flat-rate pricing:

Flat rate does not work (without knowing your costs).

Flat rate advocates suggest the time and materials (T&M) method does not work — despite the fact that T&M has worked since the industrial revolution and continues to do so.

Flat rate and written estimates are not the same thing, despite what a handful of flat raters claim.

The attorneys general and the laws of many states consider some methods of flat-rate pricing to be illegal.

Flat rate does not work because it does not have a “lock” on knowing costs of doing business, despite the fact that its most vocal advocates suggest it does.

Virtually every successful business owner knows the costs and overhead of doing business — and makes every conscious effort to control and reduce them. Flat raters, however, suggest these costs simply need to be passed on to the customer.

Flat rates are based on averages. On those occasions when the time runs way over, the company loses. On occasions when the task is easy, the customer loses. Either way, someone loses. This is hardly a practice that instills customer satisfaction — or reasonably accurate profit expectations. It is, in fact, nothing more than guessing.

A few have noticed that using flat rate adds a completely avoidable cost to both the customer and the contractor. Many states require bundled labor and materials (as in flat rate) to be taxed on the entire invoice — not just labor (or in some cases materials) expense. This unavoidable inequity of flat-rate pricing suggests that charging sales taxes when not required is in neither the client’s, nor the contractor’s, best interest.

Using flat-rate pricing manuals, the higher profit margin percentages are frequently required to create a healthy projected balance sheet. Because of this, totally inaccurate results become averaged, leading the user into false profit figures based on multiple wrong pricing strategies, which hopefully will average out.

The suggestion that all customers like knowing the price before the work is done is absurd. The price is secondary to the quality of the work — period.

Firm prices for complete removal and replacements, or entirely new work, have no linkage to typical service calls, be they flat rate or T&M.

The “Evolution” Of Flat Rate

Implementing flat-rate pricing frequently results in the following evolution:

Upon implementation, profits rise dramatically, reinforcing the notion that flat rate may actually work.

After a year or so, a few longtime customers stop calling and realize the same or better service is available elsewhere at better rates. They realize someone has to pay for the new uniforms and new company look. They realize it’s them.

After two or three years, profits are still strong, but the customer base is dropping off, suggesting more advertising dollars are required. The advertising dollars do the job — for a while — but at a substantial added expense, forcing another price increase.

After five years, the advertising budget and pricing methods need to be adjusted again. Direct mail and aggressive marketing campaigns are needed to prop up the longstanding customer base, which now dwindles. The rates are raised still again to cover spiraling overhead, resulting in even more serious complaints about price increases.

This typically and simultaneously evolves into cross-training service techs to become salesmen — not uncommonly at the expense of advanced technical training. Owners and managers of businesses using flat-rate systems come to believe that sales will drive profits, not technical excellence and the highest quality work possible. Occasionally, sales quotas are imposed on techs, implicitly suggesting they condemn equipment rather than repair it because of the financial rewards involved.

The problems that flat rate created were heretofore unknown, because quality work at reasonable cost and the referrals it generated were the best, most efficient, and least expensive forms of advertising possible.

By around the tenth year, the customer base declines are serious. The economic “boom times” of the 90s are gone. Having capitalized on both boom times and the flat-rate profit surges of years past, the contractor fails to realize that he is now dependent on flat rate alone. The contractor believes flat rate was the basis of his economic improvement, not the general economy.

Now it’s 2003, and the economy is relatively soft. The upscale customer who thought little about an $800 water heater price now does. The T&M shop has picked up the customers the flat rater lost during the heyday of a vibrant economy.

The need to advertise to overcome a diminishing customer base frequently mandates the sale of the business. The multigenerational family business, which could have been a one-man shop turned into a large enterprise, teeters on the brink of financial instability.

The owner then sells the company to former employees, a consolidator, or perhaps a fellow competitor. Or, on occasion, enough equity remains to buy into a new opportunity akin to a “franchise.” The new franchise name allows one to distance oneself from the “baggage” of the past, and suggests a promising new beginning.

Flat-rate advocates suggest time and material pricing are old-fashioned and that flat rate is new and modern. Flat rate has been around since the five-cent ferry ride to New York City came into being a century ago, making it neither new nor modern.

The method of pricing is what is suspect. T&M is based on the notion that the client has the right to know what he is paying for. Flat rate is based on the notion that if the customer knew what the labor rate actually was, he would not accept it.

The point now is — and has always been — that customers have the right to know what the labor and the materials charges are, as well as all the details in between. And the consumer protection laws of many states demand that they do.

Ken Secor is CEO of Palmer Heating LLC, a design-build wet heat service and installation contractor in Rahway, N.J.

What Do You Think?
Is flat rate the way to go, or is time and materials the best way to price a repair? Let us know which method your company uses. Drop us a line at The News, P.O. Box 2600, Troy, MI 48007. Letters may be sent to LetterstoTheNews@bnp.com or faxed to 248-362-0317.

Publication date: 03/24/2003

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