Are You SURE You're Profitable?By Howard M. Cohen | Print
Service companies don't have a chance at profitability if they don't know the meaning of the term "fully burdened cost."
Profit. One of your favorite words, and something that’s easy to figure out when all you’re selling are things. Things are sold to you by manufacturers or distributors at a specific cost and you sell them to a customer at a price higher than your cost and it's very likely you will generate a profit. Very likely only because you could set your price to cover your costs of shipping and handling and other costs related to the thing you sold.
Fully Burdened Cost
One of the most frequently made mistakes for new service companies is to fail to fully “burden” the cost of the services you sell. What does this mean?
When you sold a product you subtracted your cost from the price you charged. You may have charged your customer for shipping, but...
What about the cost of shipping the product from its vendor to you?
How much did the receiving clerk who received the product cost?
How much are you paying for the building it was received into?
How much did any phone calls you made to process the order cost?
How much did it cost you to generate the purchase order?
How much will the interest on the credit you used to purchase the product cost?
You may be thinking, “well, these are all costs of doing business!” And you’re right. But they’re still costs. They need to be allocated to the business you do. And this is just for a product you sold!
Services Are Even More Burdensome!
When selling services, there are even more burdens to be included, and we didn’t really include all of them for products.
Most service managers divide a technician’s annual salary by 2088 to arrive at the approximated cost of an hour of their labor. Those who pay by the hour have it easier. They then subtract that from the hourly rate they charge to their customer and smile at all the profit they generated.
Well, not so much.
If they’re a full-time employee you’ll be paying a portion of their taxes and benefits. That needs to be calculated into your burden.
Your technician takes up some space in your office, uses a telephone, travels to and from customers. You will periodically send them for training and provide them with certain tools and materials. Those all need to be calculated into the burden. Then there’s the cost of you and your management team. You should sit down with your accountant or CFO to develop a comprehensive list. It will surprise you, and probably not happily.
But Wait, There’s More!
Remember back when we divided the technician’s salary by 2088 to get their hourly rate?
What says that every one of those hours will be billed to a customer? Not likely.
Let’s say for argument’s sake that you manage to sell half of that technician’s hours. To calculate recapturing your costs in half the hours, you need to double your totally burdened cost, or divide by the percentage of the hours that were actually utilized. Many managers get tripped up by leaving out the utilization factor.
And getting tripped up means miscalculating your profit. And profit pays the bills.
The Difference Between the Great Service Company and the Not So Great
Decades ago I had the opportunity to talk with a widely-respected service executive from a now-legendary IT company. At one point he asked if he could ask me a question. Taking a deep breath I prepared for one of his lengthy lessons. When I agreed he asked me, “what’s the difference between the great service company and the not so great one?”
Convinced I’d better settled in for the long haul, I asked him to tell me the answer. His answer was stunningly brief. One sentence.
“The great service company knows its costs.”
Howard M. Cohen is a 35+ year executive veteran of the Information Technology industry who today writes for and about the IT channel. He’s a frequent speaker at IT industry events that include Microsoft Inspire, Citrix Synergy/Summit, ConnectWise IT Nation, ChannelPro Forums, Cloud Partners Summit, MicroCorp One-On-One, and CompTIA ChannelCon, frequently hosts and presents webinars for many vendors & publications.