A “job shop” sells custom-made parts, produced according to customer specifications, usually in small quantities. Job shops develop a price quote for each job, rather than establishing a standard list price per product.
Their “shop rate” is a bundled price applied to billable labor hours (those spent on the job being quoted), designed to capture enough revenue to cover labor costs, overhead, and target profit. Setting the right “shop rate” is the key to their profitability.
This article provides the techniques for calculating a shop rate. For example, employees may earn $25/hour, but the company may need to charge its customers $75 to $100 per hour spent on a job, to recover overhead and profit as well as labor costs.
Step One: Estimate Costs and Target Profit
First, estimate the costs to be recovered by the shop rate for the coming year. For our example, we assume the following costs are passed through to the customer without markup: materials, subcontractors, shipping. This means the shop rate must recover labor, overhead, profit, and sales commissions.
Labor includes hourly wages (whether or not they are billable on jobs) plus benefits and related payroll taxes. Overhead includes the owner’s salary, benefits, and payroll taxes, plus fixed costs such as rent, utilities, insurance, maintenance, computers, vehicles, depreciation on equipment, etc.
Profit will be a dollar amount, not a % of revenue at this point, because revenue is unknown. Assume the profit target is an amount equal to the owner’s salary.
Sales commissions might normally be 5% of revenue, but we do not know revenue yet. Use one-sixth of salary plus overhead (excluding labor) as an estimate, based on the assumption that salary plus overhead will turn out to be 30% of revenue.
For this example, assume the following: owner’s salary is 50K; other overhead aside from labor is 100K; profit is 50K; sales commission is 25K; non-billable labor cost is 80K and billable labor cost is 120K. This assumes 60% of paid labor time is billable on jobs. The rest is setup/cleanup, training, paid time off, and miscellaneous. Thus the shop rate must recover 425K.
Step Two: Estimate Annual Billable Hours and Calculate the Shop Rate
Second, estimate the number of billable hours for the year. Billable labor cost of 120K less 10% payroll tax and 10% benefits leaves approximately 100K. Divide that by $25/hour to get 4000 billable hours.
The resulting shop rate is 425K / 4000 hours or $106.25 per hour. This is an illustration, not a recommended price! Your shop rate depends on your own numbers: overhead, salary, profit, wage rate, etc. However, note that it is not unusual for the shop rate to be 3 or 4 times the hourly wage rate.
Avoid Two Common Errors
One common error in calculating the shop rate is omitting the target profit. Another is assuming all paid labor hours are also billable hours.
Job shop owners should review their shop rate at least annually. The tip about small changes having big results (see Pricing Tips: Start High; Big Results from Small Changes) applies here as well: raising your shop rate by $2 may increase your profits by 20%. Use your own numbers, and check it out!
Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or firstname.lastname@example.org. See www.tom-gray.com.