My 450-mile January drive to Jackson, Wyoming, for our annual brainstorming meeting was uneventful. Uneventful, that is, until 10 miles from my final destination. As I rounded a curve on U..S. Hwy. 191 something seemed out of place on the road ahead. Through the evening darkness, I saw the lights of cars and pickup trucks catawampus to the road. Many were making U-turns.
I had just missed an avalanche that covered the entire highway. Fortunately, no vehicles were smothered in the hundreds of tons of snow. Even more fortunate, no vehicles had been swept off the road into the adjacent Hoback River.
The brainstorming meeting went well. Forty-five attendees from 20-plus companies throughout the U.S. all participated in the discussions on topics they chose. Not surprisingly, the No. 1 topic was the shortage of industry labor and the upward pressure on labor rates for 2017.
The cost of field labor has risen sharply in the past three years. Some reasons include the rise in minimum wage, the rise in the cost of H-2B labor from nearly $10 per hour to almost $15 per hour in many parts of the country, the talk about a living or sustainable wage rate and so forth. Add to this the shortage of qualified laborers and a demand for the same as the economy improves, and you have a supply-demand curve that shows pay rates being pushed higher and higher.
Business profitability is all about controlling risk. Field labor, due to its volatility, is responsible for roughly 80 to 90 percent of the risk in business operations. If your company is going to be profitable, you have to control labor productivity and its cost.
Inaccurate but helpful.
When calculating field labor rates, I use a fairly detailed Excel worksheet that I’ve developed over the years (see the example on the L&L website). After I create a budget for a client, calculate their company’s overhead cost, figure the labor burden rate and include the crew truck and a reasonable net profit margin (NPM), quite often the resulting labor rate is roughly three times the crew’s average wage rate. In other words, the rate charged to clients for a three-person crew with unburdened wage rates of $24, $18 and $16 per man-hour turns out to be roughly three times the average wage rate. I don’t use this formula to calculate labor rates for clients as it isn’t always accurate. However, it is useful to estimate a labor rate.
($24 + 18 + 16) = $58
$58 ÷ 3 = $19.33 crew average wage rate
$19.33 x 3 = $58 per man-hour charged to clients
The man-hour rate using my Excel worksheet is $56.28 (with a 15 percent NPM) and $60.12 (with a 20 percent NPM).
How it works.
All of this means that for every dollar your labor wage rate increases, you have to increase what you charge your clients for labor by roughly $3. If you don’t increase your prices to your clients, you’re doing your company, yourself, your family, your employees and your industry a disservice. Most of my clients throughout the U.S. have seen a $2 to $3 an hour increase to their average hourly cost of labor in the last three years. As a result, they’ve had to increase the price of such labor to their clients by a factor of three.
Useful industry benchmarks.
If your crew members work 45 man-hours per week 40 weeks a year, they each produce about 1,800 billable man-hours per year. An increase of $1 to your crew’s average wage translates to a $3 increase to the rate you charge. It works out as follows for a crew of five people.
1,800 man-hours x 5 people = 9,000 total billed man-hours
$1 increase to your cost of labor x 3 = $3 increase per man-hour in the price of labor charged
$3 increase per man-hour x 9,000 billable man-hours = $27,000 in extra net profit margin for your company
The average cost of field labor for my clients at the meeting and in Jackson will increase anywhere from $1 to 3 per man-hour in 2017. Virtually all of these contractors will have to increase the price of labor to their clients by $3 to $6 per man-hour. While they don’t necessarily like the increase, they realize they have little choice. Because most clients know the cost of labor is increasing, now is the time to increase the labor rate that you charge.
Just like my January drive to Jackson, the path that your business takes is filled with risk. Hopefully you’ll prepare for the hazard that labor cost increases pose to your bottom line. If you do, your bottom line will remain on track. If not, you could be smothered in an avalanche of thousands of hours of underpriced labor.