How to Improve Your Effective Labor Rate
Is your body shop reaching cruising altitude, ascending, or descending?
There’s no better way to gauge that than by monitoring your facility’s effective labor rate.
“If I were a body shop manager, I’d want to make sure that I’m flying at the rate that I’m expecting,” says Peter Kowcz, a trainer with Edwards & Associates Consulting Inc. Effective labor rate, “is part of your dashboard.”
Effective labor rate is a calculation that shows what a shop makes as profit per billed hour—total labor sales divided by total labor hours billed. Many in the collision repair industry feel effective labor rate is the key performance indicator that most accurately shows a shop’s profitability.
To increase profitability and run a successful shop, shop operators must calculate their facility’s effective labor rate regularly, and then consider what can be done in terms of improvement.
“You want to understand different types of labor that you’re selling,” Kowcz (pronounced “coach”) explains. “Basically, effective labor rate is the total hours that you sell, and total dollars you collect for those hours. … The effective labor rate should be at a rate where you’re able to achieve a 65 percent gross profit on that labor, minimum. So, for every dollar you collect, you want to make sure you’re only allowing 35 cents to go to technician wages, and the rest is retaining gross profit.
“If your labor rate goes down, your gross profit’s going to go down. And, if you have less gross profit, you’re endangering the profitability of the shop.”
In the experience of Mike Harmsen, a 40-year collision repair industry veteran, it’s easy for
shops to overlook little things that can add up to big money. And that’s why it’s important to consistently monitor effective labor rate.
“You’ve got to check your parts totals, check your labor totals, and make sure the hours and dollars add up,” says Harmsen, the manager at Saint Cloud (Minn.) Collision Center. And, “make sure the hours match the full total for that sale.”
Below, collision repair experts explain the key steps that shops can take to improve their effective labor rate.
Look for inconsistencies in daily reports.
When monitoring effective labor rate by looking at their shop management system’s daily reports, Kowcz instructs shop operators to take note of several elements. For example, for every dollar that their shop collects, what percentage of that sum needs to be earmarked for technician pay, what percentage needs to pay for expenses, and what percentage is left over for ownership?
And, in Kowcz’s experience, if shop operators don’t closely monitor such figures, then their shop’s effective labor rate could drop as low as the mid-40s—well below anyone’s accepted benchmark.
“I look at inconsistencies,” Kowcz says with regard to daily reports, “to understand and to limit my losses, and to correct whatever the issue may be that’s drawing my labor rate down.
“Insurance companies are setting the labor rates and they’re limiting our gross profit that we can collect on the labor hours that we sell. So, we have to monitor closely.”
Track each estimator’s paperwork.
Often, if a shop’s effective labor rate has reached subpar levels, estimators’ paperwork will offer clues as to why—perhaps too many parts were charged out, or parts were added but a customer or insurance company wasn’t notified via a supplement. That’s why it’s important to keep close tabs on such documentation.
“I track each estimator as they close their paperwork,” Kowcz says, “and see how their effective labor rate is adding up. If I see something that’s below my target, I’m going to look at some of the repair orders that estimators have and see what’s going on. For example, are we paying our technicians, or giving them more flat rate hours, but not collecting the appropriate labor for it?”
Harmsen, whose shop boasts an average monthly car count of 315, agrees.
“As far as controlling your wage, your estimating processes” are key, he says. “A lot of the time advisors get a little lazy. What they want to do is close a file and move on to the next. So, they want to make the number work out at the bottom. The manual entries are what you’ve really got to keep an eye on. If the estimate says it, it should say it on the final bill.
“You’ll get some technnicians that, on the minor stuff, will just fix it and not say anything, because they’ve got to make a trip to the advisor’s desk [if they do]. You’ve got to have trained estimators to make sure that you collect for everything that you do.”
Do due diligence in your area.
A key step in improving effective labor rate is to research what your market will bear in terms of a customer pay rate. Then, if your current rate is below that mark, you’ll want to adjust accordingly.
You need to make sure that you’ve done your market research on what other shops are charging in the area, Kowcz says. That’s why he suggests having shop employees call competitors to learn of their pricing (while blocking the caller ID). After all, he says, body shops who are complacent and don’t do due diligence by looking at rates in their area may fall behind competitors.
Harmsen, meanwhile, suggests sending entry-level employees out to shop at competitors’ facilities to do comparison shopping.
“Shop your market,” he says, “and have [nearby] facilities write out an estimate. Send out [an employee] that would be treated like a general customer—somebody that they try to control. … I try to have somebody look at the whole process; there’s always somebody in your market trying to be a little cheaper, figuring they’ll get a little more work.”
Renegotiate with insurers.
Once you’ve studied what your market will bare, it’s usually a good time to go back to the bargaining table with insurance partners, Kowcz says.
“Manage your insurance companies from a standpoint of rates,” he says. “You need to get with your insurance companies periodically. If, for example, the market rates are going up but the insurance company’s not increasing their rate, then you need to ask for it. Go to your insurance companies and say, ‘Hey, the last time we got an increase from you was X amount of months ago; we need to revisit this, because other shops in the market are getting this amount.”
If your shop is among the market’s leaders in productivity, Kowcz notes, then you’re likely producing efficient cycle times, recording solid customer service scores, and, as a result, lowering an insurer’s rental rates. And, if that’s the case, then you, as a shop operator, hold the negotiating hammer.
In that situation, Kowcz says, insurers “will come knocking at your door—they’ll want you to repair their vehicles … and they’ll start paying a higher rate.”
That helps explain why, in Kowcz’s experience, the best shops monitor effective labor rates each and every day.
“Your finger has to be on that pulse constantly,” he says of effective labor rate. “It’s not the
only thing that a body shop manager should be looking at, but it’s one of the important ones. That’s something I believe every manager should have on the tip of their tongue every day—what’s your effective labor rate?”