Where Are All the Profit Dollars?
“My company has high service sales and yearly growth, but it doesn’t translate into bottom-line profits. I don’t know why it’s happening or how to fix it.”
This is a recurring lament I often hear from business owners. You work hard running your business, carefully pricing service and parts to earn a sufficient gross profit, yet your profit and loss statement shows lower or zero net profit.
Example case study: A company I worked at priced its service labor and parts as usual. I calculated that they were achieving a gross margin of 77 percent. However, when I reviewed their profit and loss statement, it showed a gross margin of only 38 percent. So, where did the gross profit dollars go?
STEP ONE
The first step is to understand why it’s happening. HVACR companies typically have significant labor costs, making it a major cost driver. Even small errors in pricing and efficient use will negatively affect profit. As such, it is absolutely critical to properly track labor utilization in all its forms and measure individual technician performance.
Too often, companies hire, train, and offer the services of their technicians with no method of performance tracking.
Hint: Job costing is only part of the answer.
STEP TWO
The second step is to find out where it’s happening. If we drill down, I generally find underperforming service managers or technicians. The problem is even more challenging to correct considering HVACR companies typically utilize labor (hours) for more than simply demand sales (time and material). Typical additional labor uses include service agreements, call backs, first-year warranties on new installations, shop time, picking up parts, and service technicians assisting on installations (labor drifting).
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Each of these categories must be accurately tracked to ensure each technician is performing to a standard set by the company.
Let’s examine two categories: demand and agreements.
DEMAND SALES
Assumption — you pay your technicians a blended rate for labor, fully loaded with all required costs, of $40 per hour. You sell each hour of labor to customers at a rate of $80 per hour to achieve a desired gross margin of 50 percent. The example provided illustrates paying a technician for an eight-hour day, selling all eight hours, and the resulting gross margin.
Customer pays: $80 x 8 hours = $640 of revenue
Technician costs: $40 x 8 hours = $320 cost
Calculate: $640 revenue - 320 cost = $320 gross profit or 50 percent gross margin
Now, let’s see what happens when only five out of eight hours are sold to customers
Customer pays: $80 x 5 hours = $400 of revenue
Technician costs: $40 x 8 hours = $320 cost
Calculate: $ 400 revenue - 320 cost = $80 in gross profit or 20 percent gross margin
The above is illustrative of only the demand sales of one technician for one day. Imagine the impact for multiple technicians over a period of a full year.
The other categories of labor usage must also be measured to ensure proper profitability for each.
SERVICE AGREEMENTS
You calculate it will take 50 hours in a year to fulfill and provide service to a particular customer.
The labor sell price to achieve 50 percent gross margin is $80 per hour.
The technician labor cost is $40 per hour.
Agreement hours and sell price: 50 hours annually x $80 = $4,000 agreement price
Agreement hours required to service: 50 hours annually x $40 = $2,000 labor cost
Calculate: $4,000 revenue - 2,000 labor cost = $2,000 gross profit on service agreement or 50 percent gross margin
If it actually takes 75 hours to fulfill, you’ve lost 25 hours on this one agreement alone.
Now, calculate the effect of 25 additional hours not compensated.
Agreement hours and sell price: 50 hours annually x $80 = $4,000 agreement price
Agreement hours required to service: 75 hours annually x $40 = $3,000 labor cost
Calculate: $4,000 revenue - 3,000 labor cost = $1,000 gross profit on service agreement or 25 percent gross margin.
If your overhead is 30 percent of sales, you’ve lost 5 percent on servicing this one agreement customer. Again, think of the impact if you have dozens, hundreds, or thousands of agreements.
STEP THREE
The third step is to carefully track all categories of service labor. To ensure your service profits don’t shrink away, you must track all categories of labor for the reasons just discussed. In addition, once implemented, this will allow you to track not only the individual performance of each technician, but also your service manager or dispatcher performance to see how they are utilizing total labor assets at their disposal.
STEP FOUR
Once you have successfully tracked hours, you can use this information to create a profit and loss statement for management purposes to provide accurate feedback in a timely manner.
CONCLUSION
Managing for profit requires that you perform more than job costing. It’s usually the inefficient use of labor that results in significant profit shrinkage or loss. Tracking technician performance on an individual basis, and offering accurate and timely feedback, provides each technician with their own personal report card. This creates an environment for self-improvement — see where technical training may be needed, and consider paying bonuses if they exceed company metrics. Once implemented, this is a tool to help develop and assist your technical staff to grow and become more valuable to themselves, your customers, and the company.
Publication date: 4/9/2018