Effective Labor Rate, or ELR, is probably one of the most important numbers in your Service Drive. It never ceases to amaze me when I'm on strategy sessions with Service Managers and Shop Owners, and we'll be reviewing their financials and I come to realize that they don't understand Effective Labor Rate. That blows me away.
This happens all the time, and it’s shocking and disappointing how many Service Managers don’t understand their Effective Labor Rate. So let’s set the record straight, because ELR is one of the most important Key Performance Indicators (KPIs) for every Service Drive, whether you're a dealership or an independent shop owner. It's also used to calculate other KPIs, such as Hours per RO, so you need to understand how to calculate ELR.
What is Effective Labor Rate?
This may come as a bit of a shock to you, but your posted labor rate doesn't matter. It’s an imaginary number that you hope to collect for every hour of labor. I hear it all the time in strategy sessions, a Service Manager will say, “Oh, well, my posted labor rate is $120,” but when we actually look at it, we’ll find that although your posted labor rate might say $120, your Effective Labor Rate is actually closer to $80.
Why is that?
Well it's pretty simple, really…. Are your customer pay rates the same as your posted labor rate? How about internal rates, service contract rates, and warranty rates, are those all the same? Do you not offer any discounts? Does your posted labor rate take any of these variables into account?
So if your posted labor rate is $120, but you're not actually charging $120 for a particular service you provide (like an oil change), then is your posted labor rate an accurate representation of how much money you're actually making from the half-hour your Technician spends on that oil change?
That's why your posted labor rate doesn't matter, and why you need to know how to calculate your Effective Labor Rate, because if you don’t know your ELR, then you ultimately don’t know what you’re actually collecting for every hour of labor you're selling.
To put it bluntly: If you don't know your ELR, you don't know what you're going to pay your bills with.
How do you calculate Effective Labor Rate?
The formula for Effective Labor Rate is:
Total Labor Dollars
Total Flagged Tech Hours
That's your total labor dollars divided by hours flagged by Technicians in the shop. That's how you calculate Effective Labor Rate. So, for example, let’s say you sold a total of $7000 in labor, and your Technicians flagged 7 hours. Your ELR would be $1000.
One Major Consideration
Now, there is one big variable that you want to take into consideration when it comes to calculating your Effective Labor Rate:
If you have hourly Technicians, and they aren’t flagging their hours, then you aren’t going to get an accurate number for your cost of labor. Without an accurate number for your cost of labor, you won't have a real number to figure out what your Effective Labor Rate is, so you need to have everybody flagging their hours.
Calculating Effective Labor Rate becomes easier when you really have a shop that is invested in flagging their hours consistently. If they're not flagging for oil changes, but you're collecting the labor, it throws your off your ability to calculate your ELR.
The main lesson here is that it doesn't matter what you have as a posted labor rate. What really matters is what you actually collect for every hour of labor you sell, and that’s your ELR.
Where can I learn more information like this?
This calculation was originally featured on our Service Drive Revolution podcast as a part of our Terms You Should Know segment, and you can watch the full episode here. We pack every episode of Service Drive Revolution with tons of valuable information just like this, so don't miss out! Make sure to subscribe today on Apple Podcasts, Spotify, YouTube, or wherever you get your podcasts!
If you’re in need of Service Department training, or professional coaching for your Service Drive, you can learn more about Chris Collins Inc. by browsing our products and services. Our motto is: “Training isn’t something that we did, training is something that we do!”