Frank Blau
Contributing Writer
It would be fair to say that most contractors take a shot in the dark when it comes to pricing service agreements, just as with their other prices. Most contractors price service agreements just like time and material contractors price hour of labor – by calling their competitors, asking what they charge and setting their price accordingly.
A better approach is to base the price on sound financial examination. The following hypothetical example shows the correct process for arriving at a service agreement price.
Type: HVAC labor-only service agreement.
Covers: Pre-season clean and check once a year.
Time: Estimated .75 hours from the time the technician enters the home until he leaves.
Direct Labor Costs: $30 per hour.
Overhead Costs: $70 per hour.
Break-even: $100 per hour.
Now, multiply these numbers by .75.
Direct Labor Cost for One Service Agreement: $22.50
Overhead Cost for One Service Agreement: $52.50
Break-even for One Service Agreement: $75.00
Now let’s add in 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} profit for one service agreement. Remember, profit gets figured as a percentage of the selling price, not of the break-even price. So it’s NOT $75/10 = $7.505. $75 + 7.50 = $82.50. WRONG!
INSTEAD – the correct way to figure this markup is $75/.90 = $83.33.
Loss Leaders: In the real world it is not so simple to get the profit margins we need. This is especially true in markets where utilities are actively selling service agreements.
This does not mean you should give up in these circumstances, however. Many contractors have concluded that the value of a service agreement goes beyond any profit that might be made on the purchase of that agreement. In fact, service agreements make for terrific “loss leaders” because of other benefits, namely:
1. “Locking up a customer” during the term of a service agreement. When there’s a problem, the agreement customer is unlikely to call anyone else except that firm.
2. Additional service and sales opportunities arise during the clean and check calls. The real value of a service agreement is that it affords you automatic access into customer homes once or twice a year, depending on how many calls the agreement specifies.
Because of these other benefits, many contractors have decided to sell service agreements at a loss. However, there is no need for you to absorb the cost. What you can do in is exactly what the public utilities do – cross-subsidize your service contracts. That is, losses you incur should be put into your general overhead expense, which you convert to a dollar-per-hour figure that gets included in your sales prices. Example:
Break-even cost for a single service agreement: $75
Your selling price (due to market conditions): $55
Loss for every service agreement sold: $20
If you expect to sell 300 service agreements with each losing $20, you must budget $6,000 into your overhead to cover these losses.
Assuming you have total billable hours of 6,000 hours per year, this would add $1 per hour to your overhead total. Because profit dollars emanate from overhead as well as materials and direct labor, if you are achieving 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} net profit on sales, you will make $666.66 per year on losses incurred in selling service agreements!