Why Effective Labor Rate Matters
Effective Labor Rate, or ELR, is probably one of the most important numbers in your Service Drive.
It still surprises me how often Service Managers and Shop Owners do not understand Effective Labor Rate. It usually comes up while we are reviewing their financials during a strategy session.
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.Â
Here is another video you can watch to understand how to calculate effective labor rate.Â
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 often find that the posted labor rate might say $120 while the Effective Labor Rate is closer to $80.
Why Posted Labor Rate Is Not Enough
It’s simple: customer-pay rates, internal rates, service-contract rates, and warranty rates are not always the same as your posted labor rate.
Discounts also change the real number. If your posted labor rate does not account for those variables, it is not showing what you actually collect.
For example, your posted labor rate might be $120, but you may not charge $120 for every service, such as an oil change.
When that happens, the posted rate is not an accurate picture of what you actually make from the half-hour your Technician spends on that job.
No.
That’s why your posted labor rate does not matter by itself. You need to know your Effective Labor Rate because it tells you what you are actually collecting for every hour of labor you sell.
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 to Calculate Effective Labor Rate
The formula for Effective Labor Rate is:
Total Labor Dollars Ă· Total Flagged Tech Hours = Effective Labor Rate
That’s your total labor dollars divided by hours flagged by Technicians in the shop. That’s how you calculate Effective Labor Rate.
For example, let’s say you sold a total of $7,000 in labor, and your Technicians flagged 7 hours. Your ELR would be $1,000.
To get in-depth training on how to calculate effective labor rate, go check out our OnDemand!
One Major Consideration When Calculating ELR
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 are not flagging their hours, you are not going to get an accurate number for your cost of labor.
Without an accurate labor-cost number, you will not have a real number to calculate Effective Labor Rate. That is why you need to have everybody flagging their hours.
Calculating Effective Labor Rate becomes easier when the shop is consistent about flagging hours.
If Technicians are not flagging oil changes but you are still collecting the labor, it throws off your ability to calculate ELR.
The main lesson is simple: your posted labor rate is not the number that matters most.
What matters is what you actually collect for every hour of labor you sell. That is your ELR.
Watch: Calculating Effective Labor Rate to Retain Technicians
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