by Charlie Greer
People often comment that running an HVAC service and replacement business is not an exact science. Yes it is. “Science,” in its broadest meaning, denotes systemized knowledge in any field, and is usually applied to the organization of objectively verifiable and repeatable experience. This definitely applies to running an HVAC service and replacement business, particularly as it applies to pricing.
Once you understand the math behind your budgeting and pricing strategy, and how to apply it, you’ll no longer guess at what your profits will be at the end of the year. You’ll know.
Many well-intentioned consultants in the industry recommend shooting for, say, a 20% net profit, then advise basing your pricing strategy on percentages, which I consider just this side of useless. You can't take a percentage to the bank. You take money to the bank.
Using the procedure described here, you’ll ensure you’re charging enough to cover expenses and make an honest profit. On the way, you’ll learn how to sell top-of-the-line systems at a lower price than your cheapest competitors, and still reach your financial goals.
Your “Break-even Point”
Prior to setting pricing, you’ll need to determine your break-even point, which is how many dollars you need to charge per billable hour to stay in business. This isn’t a percentage.
The most important thing you’ll ever do is determine your breakeven point.
Is the labor and overhead to install a high-end air conditioning system significantly greater to the labor and overhead to install low-end equipment? Most say, “No (assuming you’re not providing different in-house warranties). It's about the same."
If your pricing strategy on replacement equipment is to shoot for a 30% contribution toward overhead and a 20% gross margin, you'll have different dollar amounts of contribution toward overhead, based only on the efficiency rating of the equipment, and that ain't right!
Is the overhead on a $6,000 system $1,800 and the overhead on a $3,000 system only $900? No, your overhead expense on both systems is nearly the same.
How much is the overhead, in terms of actual dollars, on these installations? To obtain that information you'll first have to:
•Departmentalize your company if you have dedicated installers. Why? Because installations departments have a lower overhead cost and nearly double the billable-hour efficiency than service departments. Obviously, some overhead costs are easily applied directly to each department and some are shared between departments. People especially wonder where to allocate the costs of office employees who juggle their time between both departments. Allocate percentages of the costs of each employee according to the percentage of their time spent working in each department.
•Add up all your expenses for each department, except parts and equipment.
•Divide that number by the number of billable hours per tech or installer. On the average, of about 2,080 hours available during a year (40 hours per week x 52 weeks), technicians seem to consistently bill out about 1,000 hours per year. Installers have a higher efficiency rating (due to less travel time) and usually bill out about 1,750 hours per installer per year. If you have three technicians, divide your service department’s expenses by 3,000 hours. If you have two installers, divide your installations department’s expenses by 3,500 hours.
That number is how much money you need to charge per hour to break even. Normally, your installations department’s break-even point is lower than that of your service department.
Heart-attack Time
Be advised that if you haven’t previously calculated your break-even point, you’re in for the shock of your life. It costs a phenomenal amount of money to run an HVAC service and replacement business and, when you divide these departments by the number of hours you bill out per year, you’ll wonder how you’ll ever be able to charge that much.
Do you realize that if you’re the type of contractor who would like your technicians to be able to earn $75,000 per year or more, at the very common benchmark of 50% efficiency, your technicians will have to generate about $75 per hour in labor only, just to cover their own paychecks? Your costs of doing business will usually more than double that number.
How to Price Jobs
1) Determine the number of hours it will take to do a job.
2) Multiply the number of labor hours by your break-even point.
3) Add up parts and materials costs.
4) Decide on a sales commission. Commissions are a cost and should be treated the same way as a part. That math will be a lot easier if you convert from expressing commission in terms of percentages and start flat-rating them, where you pay a set fee for selling a given product or service.
Service technicians working on an hourly rate usually are spiffed a lower amount than salespeople who are working on straight commission. Add both to job costs.
5) Add together Steps 2, 3 and 4.
6) Divide the sum of Step 5 by your desired profit percentage in terms of a decimal. That’s your pricing for profit.
For a desired profit percentage of 20%, divide Line 5 by .80. For a desired profit percentage of 15%, divide Line 5 by .85. I realize I’m talking in terms of percentages here, but these percentages result in hard numbers that you can count on to pay your costs of doing business when you’re paid for the job.
What About Parts Mark-up?
Contractors basing their service pricing on percentages tend to have complicated, unscientific sliding scales to determine their parts mark-up. The scale varies according to the wholesale cost of the price of the part, with lower-priced parts having the highest multipliers, and highest-priced parts getting the lowest multiplier.
When pricing jobs using your break-even point, all the vague, hard-to-determine costs associated with parts, such as your acquisition and warranty costs, are already covered.
Breakeven Point vs. Percentage
When your pricing structure is based on percentages, you're just guessing and hoping when you price out a job. Those using percentages to price jobs are the people who wonder why they don’t have any money.
Once you know your true cost per billable hour just to stay in business, and base pricing on your break-even point, you’re working scientifically, and you know exactly how much you’ll make prior to doing any installations or repairs.
As you can see in Examples 1-4, (see page 48) pricing replacement jobs using percentages is perilous and inaccurate and makes high-end systems unnecessarily expensive.
Departmentalizing and using your true break-even point to price equipment replacement jobs usually results in an increased price for low-end systems and a decrease in price of high-end systems, while still providing you with every dime of profit you desire.
CALCULATION EXAMPLES
Examples using a $100 break-even point. Don't use $100 as your break-even point. Use the actual figure.
Example 1: Low-end system using breakeven point method:
- 16 hours of labor X $100 (your breakeven point) = $1,600
- Equipment and materials = $1,000
- Sales commissions ($300 for salespeople working on straight commission, $100 for service techs who close sales on their own) = $400
- Total direct cost (including labor burden and everything) = $3,000
- Selling price with a desired net profit of 20% is $3,000/.80 = $3,750 (selling price)
Contribution Toward Overhead = $1,600
Net Profit = $750
Example 2: The same low-end system using percentages (30% overhead and 20% profit):
- 16 hours of labor @ $20 = $320
- Equipment and materials = $1,000
- Sales commissions = $400
- Total direct cost = $1,720
- Selling price with 30% contribution toward overhead and 20% profit is $1,720/.50 = $3,440
Contribution Toward Overhead = $1,032
Supposed Net Profit = $688
Something’s wrong. These are the exact same job, priced differently. They both have the exact same costs, where our break-even point calculation clearly shows the overhead cost to be $1,600.
In reality, Example 2 barely covers overhead expenses while providing a piddling 3% net profit, which happens to approximate the average net profit of HVAC contractors.
Example 3: High-end system using break-even point method:
- 16 hours of labor x $100 = $1,600
- Equipment and materials = $2,000
- Sales commissions ($500 for salespeople working on straight commission and $100 for service technicians who can close sales on their own) = $600
- Total direct cost (including labor burden and everything) = $4,200
- Selling price with a desired net profit of 20% is $4,200/.80 = $5,250
Contribution Toward Overhead = $1,600
Net Profit = $1,050
The contribution toward overhead in Example 3 is the exact same amount of money as in Example 1, which is as it should be. Your overhead cost on both systems is the same. You do, however, get an extra $300 in net profit for doing the exact same amount of work.
Example 4: The same high-end system using percentages:
- 16 hours of labor @ $20 = $32
- Equipment and materials = $2,000
- Commissions = $600
- Total direct cost = $2,920
- Selling price ($2,920/.50) = $5,840
Contribution Toward Overhead = $1,752
Supposed Net Profit = $1,168
Pricing using percentages results in inconsistencies in contributions toward overhead on jobs requiring the exact same overhead expenses, skews your projected profits, causes you to under-price lower-end replacement jobs and over-price higher-end replacement jobs.
Charlie Greer is the creator of TEC Daddy’s Service Technician Survival School on DVD. Contact Charlie by
calling 800/963-HVAC, e-mailing [email protected] or visit him on the Web at www.hvacprofitboosters.com. Fall sessions for Greer’s four-day HVAC Sales Survival School in Fort Myers are: October 5-8 and October 26-29.