The Cost of Not Knowing Your Cost
I conducted a seminar before my largest crowd ever at the International Liquid Waste Haulers convention. More than 800 people attended. As always, when I asked for a show of hands asking how many people knew what it costs them to do business per productive hour or per gallon of waste hauled, almost nobody raised their hands.
It’s an all too sad and all too familiar story. As a result, their industry, like ours, sells its services short. Many of their members charge between $60-75 to dispose of 1,000 gallons of yuck. In most cases they need to charge three to four times more to earn a decent living for their families and be able to operate in a professional manner. Instead, just like our industry, they slave away for 70-80 hours a week trying to make ends meet.
Of course, some people say that I’m too greedy. Take away the big executive salaries that I believe in for PHC contracting firms and the “going rate” out there is about what it should be. So “they” say.
Numbers Crunching Time: I say, let’s crunch some numbers. Here are some actual cost figures from a large service company that generated over $4 million in net sales last year on 24,663.5 productive (billable) hours of work.
Total dollar per hour overhead = $97.50. Direct cost of labor (wages and fringes) = $36.03. This brings us to a breakeven point of $133.53 per hour. Aiming for a modest 10% net profit, this company would have to charge $148.37 per hour for its labor – which the market would probably reject in view of the customary “time & material” rate of $55-60 per hour. Only under a flat rate pricing system could this company make it work.
I know that many of you are scratching your heads wondering how I came up with $148.37 as the selling price when you figured $146.88. Rest assured I am correct. If you want to find out the right way to calculate selling prices, attend one of my seminars or send for my “How to Make Money in the Contracting Business” book mentioned at the end of this column.
In our sample company, salaries for four executives total $650,000. Let’s eliminate those “greedy” salaries altogether. Instead, the people who own and manage this company will work for slave wages – zero.
Those “greedy” leaders who routinely put in 60-70 work weeks account for a grand total of $26.36 per productive hour worth of overhead. Subtract that from $97.50 and it leaves us with an hourly overhead cost of $71.14. Add the direct labor cost of $36.03 and it gives us a breakeven billable hour labor cost of $107.17. Add a modest net profit of 10% for a labor-selling price of $119.08 per hour.
The Overhead Numbers: Remember, the customary “going rate” for labor by time & material firms in this market is around $55 an hour. So even if those “greedy” business owners and top executives choose a life of slavery for themselves, this company still would end up with more than double the hourly operating costs of most firms in its market. Many would say that not only executive salaries, but also the rest of this company’s overhead is “out of line.”
Is it? Salaries aside, the next biggest overhead cost on this firm’s profit and loss statement is advertising, amounting to some 6.1% of sales. After that comes truck maintenance at 3.88%, followed by telephone and office expenses at 2.49%. One cannot very well run a service business without those kinds of expense allotments.
How then can some firms get away with charging $55 an hour?
First, they don’t really “get away” with it. Many are charging less for their labor than it costs to deliver it. They just don’t realize it because they don’t bother to crunch their numbers – they don’t get a profit and loss statement every month. An accountant does it for them once a year and that’s when, lo and behold, they find out they didn’t earn a profit – more likely, they experienced a loss! That big year-end payment they were counting on never appears.
The other scenario is that somehow they do eke out a living by charging $55 an hour, but only by shortchanging their employees and customers. They offer few employee benefits or pension plans. They nurse along decrepit, “rust bucket” vehicles long beyond their useful life, they scrimp on tools and equipment, etc. Most of all, they cheat themselves and their families. They are little more than slaves to their business.
A Challenge: I am willing to be proven wrong about the price structure of this business. It could be that some people can make money selling labor for $55 an hour while still paying decent wages and salaries and operating their business in a professional manner.
It’s just that I’ve yet to see a P & L statement that can support that kind of pricing while providing all the necessities of running a PHC business in a professional manner. I wish someone would enlighten me by showing me such a document that breaks down total sales and total billable hours. Only then can we come up with an accurate cost of doing business, hour by hour. I promise to keep your figures confidential if that is your wish. You can even send it to me anonymously.
I don’t expect to get too many takers on this. Not too many of the $55-an-hour folks can tell me what their hourly cost of overhead might be. For all we know they might be charging too much! It’s impossible to say whether you need to raise or reduce your prices without first getting a handle on your cost of doing business.
I’m serious about looking over the P & L statements of my critics. Please convince me that there is a way to succeed in this business charging far below $100 an hour for labor. The entire industry could rejoice if this were the case.