Calculating a Shop Rate

      An extended discussion on the math and reasoning behind setting a rate for shop work billed by the hour. July 30, 2009

Question
Over the years there's been a lot of people questioning how to price something, or how to determine a shop rate, etc. Here's the formula I use:

Gross Sales Materials/number of work days per month/number of production employees/direct man hours per day per employee = shop rate.

This gives you your loaded shop rate, meaning overhead and profit are already included. If you want to calculate an unloaded rate, you would delete those 2 numbers from the equation.

So for example:
$100,000 - $25,000 / 20 / 4 / 8 = $117 per hour

To check this, you can do it in reverse:
My employees cost me $15 per hour more than what I pay them to cover overtime, medical benefits, vacation, holidays, and unbillable hours. So in my shop a man who makes $25 per hour actually costs me $40 per hour.

So the reverse equation would be:
Employee cost per hour + Overhead per hour (monthly overhead divided by number of production days per month) + Profit (25% for example, calculated as a percent of total gross sales and divided by production days), which in my case would be:
$40 + $70 + $60 = $170 per hour

Forum Responses
(Business and Management Forum)
From contributor S:
"My employees cost me $15 per hour more than what I pay them to cover overtime, medical benefits, vacation, holidays, and unbillable hours."

None of those things except for medical benefits are more than what you pay them. Overtime, vacation, holidays, and "unbillable hours" (whatever that is) are included in what you pay them. Perhaps what you mean is the effective hourly rate is more the actual, direct hourly rate. However, there's no reason to compute that separately because it's included in the overhead rate calculation. In other words, if the overhead rate is expressed as man-hours, then all expenses less materials is included in that rate.



From contributor M:
If our shop rate was $170/hr, we would be priced out of any job we bid on. I took business management in college. And shop rate went like this...

Overhead equals
-Rent or mortgage payments
-Utilities (gas, hydro, water, telephone)
-Front office and sales staff wages
-Maintenance (snow plowing, office cleaning, window cleaning)
-Website, internet

Add to that
-Wages (including - U.I./C.P.P./W.S.I.B.)
- (You can't use overtime - that is why it is a bad thing)

The costs involved in keeping your doors open on an hourly basis. Then you add up to a common time frame, be it annual, monthly or whatever is a common denominator. Then you divide that number by however many hours your doors are open for business in that time frame.

Now in order to keep my pricing down I have 3 wages sets
1. Machining - lead hands make $25/hr, therefore $35 all in.
2. Assembly - $12/hr, therefore $25 all in.
3. Finishing - we do this for other shops as well and no one ever sands their stuff well enough, so we give it a bump to $40 all in.

Our overhead is $32/hr, therefore shop rate is:
Machining @ $67/hr
Assembly @ $57/hr
Finishing @ $72/hr
Materials and profit percentage on top of that.

When we price custom stuff it's time estimates and materials needed. If we underestimate man hours we lose, overestimate we put more in the kitty. The idea in business is to make money. So anywhere you can trim these numbers makes you more competitive. And if you have separate crews running several jobs through the shop, you are getting your overhead paid more than once. Meaning more for the kitty.



From contributor A:
$170 per hour would be at least $380,000 per production man per year (with materials) - that is doing very well in these times.


From the original questioner:
I posted the formula because it's simple and everyone can plug in their own numbers quickly and easily. When I see people talking about shop rates in the $35 range, there's no way they're including all the ancillary costs of running a business. This is a formula that forces you to include those costs.

In order to make contributor S happy, please substitute the following sentence for the original:

"My employees cost me $15 per hour more than their base hourly rate to cover overtime, medical benefits, vacation, holidays, and unbillable hours."

Incidentally, unbillable hours are things like cleaning up the shop, unloading trucks, tool maintenance, etc. I include overtime in the equation because it's an important part of managing our work flow, I allow for it, I know approximately how much overtime we're going to work in any given year, and I want to account for it.

As for the $170 hourly rate, that is a function of my specific market niche, wherein it requires far more front end time in designing and engineering the product than actual fabrication. As I stated, that's a loaded rate meaning that the rate is carrying the overhead of a designer, engineer, and general manager.

If someone comes in and wants a cutting board glued back together, that would not require the services of any of those three, and therefore the shop rate would be less. Any of you who do not get involved in extensive design work, who don't do extensive CAD drawings, and who don't have someone spending a bunch of time managing without contributing direct labor, I'm sure your rates are much lower. But then again, so are your prices.

I didn't say everyone's shop rate should be $170 per hour - I posted a formula to figure out your own.



From contributor C:
Below is a link to video of a webinar that CabinetMaker Magazine put together to go over their annual pricing survey. After watching this video I totally restructured the way I do my pricing.

CabinetMaker Pricing Survey Webinar

Video courtesy of CabinetMaker Online



From contributor S:
"...unbillable hours are things like cleaning up the shop, unloading trucks, tool maintenance, etc."

That's what's known as indirect labor or indirect costs - a part of manufacturing overhead. "Unbillable hours" is a misnomer. Billable or "unbillable" hours relate to service providers. That's why I didn't understand what you meant.



From contributor M:
I understand the business mindset versus the woodworker mindset. But if I tracked numbers as detailed as that, we wouldn't have time to actually build anything.

In the web seminar there are 176 lines of input, and 4 tabs on the spreadsheet. And if I read it correctly you run a 3 man shop where the CEO/CFO (chief cook and bottle washer) is expecting to get paid $150K/annum! Based on the best case scenarios that have been tossed around WOODWEB, a per employee gross income of $120K/annum is spectacular. The boss taking home over 40% of the revenue is an issue for me!

But if I run my numbers backwards, i.e. 4 employees x 67/hr x 75%, versus 3.2 employees = 144/hr, my shop rate = $201/hr. Yikes! And we're still chugging along.

I've worked at only one shop that did real time studies (in another industry) and the employees did everything to skew the production numbers to make it easier to achieve quota.

If your market is repetitive and quantitative, your reputation needs to be beyond the beyond. Because someone is waiting for you to slip. I'm a woodworking whore - I'll build anything. My pricing, I'll admit, is hit and miss. But it is based on 25 years of building things. Not paying people to build things.



From contributor N:
"But if I tracked numbers as detailed as that, we wouldn't have time to actually build anything. In the web seminar there are 176 lines of input, and 4 tabs on your spreadsheet."

Not sure how you do your accounting but most of those numbers are generated from a Quickbooks report in about 5 clicks and 2 minutes. Then they are imported into the spreadsheet and about an hour to update the numbers on the next 12 month projection. In the one day workshop we filled in the numbers for 25+/- companies in about 8 hours. Once you have your initial basis it is just a matter of updating it every quarter which takes about an hour if you actually update your accounting info.

Investing time in this and the pricing system developed saves extreme amounts of time for bidding, plus the mobile showroom makes for super quick sales or no more than an hour with a tire kicker.1-1/2 weeks ago I went to the house of a repeat client to discuss a new fireplace surround. I measured, we discussed options, then picked details and finish, printed proposal and got a deposit check. In 45 minutes I was pulling out of the driveway. Think about the big picture, not just one thing.

"And if I read it correctly, you run a 3 man shop where the CEO/CFO" (chief cook and bottle washer) is expecting to get paid $150K/annum!"

Read again. This is the yearly salary if you did nothing but that full time. It is also based on your skill set and your local market. So if your area would only pay 75k a year for someone with your skills and you only spent 20 hours a week doing it, you would only earn 37.5k a year for that task. And yes, if I was working for another company doing those tasks full time, there is no way I would work for less than 150k a year plus benefits. These variables change for each company and each market. When we are busy enough to have a full time helper (which we don't right now) to sweep the floors, sand, catch parts and load the truck, including salary, 100% family health insurance and IRA account, he/she will make mid 30k a year minimum. Sales can easily make well over 100k. If your market can not support those kinds of packages, I don't know what to tell you. When things are busy, illegal day labor in our area makes 30k a year or more.

"Based on the best case scenarios that have been tossed around WOODWEB, a per employee gross income of $120K/annum is spectacular. The boss taking home over 40% of the revenue is an issue for me!"

The numbers did not include materials and profit per year. That was operating costs with no materials or profit. 120k a year is way too low. September - November '08 was our record breaker average. 4 shop employees including a helper, we averaged 25k a week but outsourced installs or it was delivery only. The only other employees were me doing sales and PM work for about 20 hours a week and wife doing paperwork about 5 hours a week. My goal is to consistently maintain a minimum of 275k a year per shop floor/install employee in today's money. Right now things are slow and we are 5, but the company is designed to be 18 employees at premium efficiency. 6 core competent people in shop, 2 installers, 4 floating helpers/trainees for shop and field, 2 production managers also doing drafting and ordering, 2 sales/project coordinators and 2 office, plus me as executive staff, for a total of 19 which is an average of 174k per year for every single employee.

This is not because we are that good or that fast. We are not. It is because of long term employees who are very self sufficient (I am very lucky to have them), a plan to do it, and because I charge as much as humanly possible because I believe what we provide is worth it. The only thing holding us back from reaching and maintaining that level is me and my ability to sell, manage and grow the company, which is very tough. I see nothing wrong with making as much money as possible in salary and profits if we can charge that much and people are willing to pay it. The company also pays for my car, health and life insurance, clothing, travel/education and miscellaneous expenses.

Should I be embarrassed? If I did all I do for myself for someone else, I would expect the same. Anybody working for any other company in any other industry except for woodworking would also expect the same. I do not understand the mentality that what we all do for a living is somehow not worth the same as any other business in the entire world! It is befuddling.

John Elvrum said a couple of years ago at a CMA dinner: "Geppetto is dead!"

We are business owners and entrepreneurs. For taking the risks and investing the time and money we do, we deserve to be rewarded just like anybody else.

"But if I run my numbers backwards, i.e. 4 employees x 67/hr x 75%, versus 3.2 employees = 144/hr, my shoprate = $201/hr. Yikes! And we're still chugging along."

Shop rate /= hourly rate. Take your $201 and divide it by shop/field people. You don't charge that per person.

"I've worked at only one shop that did real time studies (in another industry) and the employees did everything to skew the production numbers to make it easier to achieve quota."

You need to develop a quota that is not skewable. Bob Buckley of True 32 uses boxes per day/week/month/year. I use gross sales dollar output.

"I'm a woodworking whore, I'll build anything. My pricing, I'll admit, is hit and miss. But it is based on 25 years of building things. Not paying people to build things."

We will build anything, too, for the right price. That is why the company is called Millwork & More. If I were to guess, I haven't worked more than a total of 40 days in the shop in 9 years now, which is what gives me the time to track this kind of stuff. My pricing is not hit and miss; it is hard science based on hard numbers that are tracked and put together using basic mathematics like every single sustainable company in any industry on earth.

If your goal is to work in your shop and make things to make you happy, that is great. Being happy is the #1 goal for anyone. My goal is to have a business that runs on its own so I can make the money and have the time I need to do what I want and then sell it and retire. The more time you spend working on this kind of stuff the more free time you have because of efficiency. The more free time you have, the more time you have to do this kind of stuff. It is a perpetual upward cycle if you maintain it. After a while you will see you have a lot of free time and not much that "has to be" worked on. What you are left with is picking and choosing what you would like to do.

This does not happen overnight. It takes years and never ends, but in my opinion is worth it. Your mileage may vary.



From contributor M:
Contributor N, I've read "The E-Myth Revisited" and find our industry is dependant on skilled labour. And time studies only work for things that are repetitive and quantitative. Therefore the "McWoodshop" business model doesn't fit this industry. There are many shops out there making boxes. We have to differentiate ourselves with our reputation. If you're not charging your shop rate per person, what are you doing with it? Every time I price something it is an estimate on how long to produce it, using man hours at rate "X".

Anytime someone does something for a job, we charge for it. That is what a shop rate is. The rate we charge for our shop to be open to work on the client's job.

Using your shop rate of $144/hr, if my machinist spends a week machining, assembly takes 3 days and finishing is a week. That's 195.5 hours x $144/hr = $28,152 labour for a kitchen, no design, materials, counters or installation. Feel like sharing your client list? All I can say is if you're pulling in 25k/week - that is 1.3 mil/yr on 4 bodies. You're doing something right. More power to you.



From the original questioner:
Contributor M,

"All I can say is if you're pulling in 25k/week, that is 1.3 mil/yr on 4 bodies. You're doing something right. More power to you."

Ironically, those are virtually identical numbers to our own for 2008: $1,344,000 in gross sales, 4 man shop with 1 independent installer. I think it's less unusual than you think. 3 out of the 5 people in our organization made over $100,000 last year, and the company still managed an 18% net profit. The other two workers make $24 and $25 per hour.

We are competitively priced on a wide range of projects from simple to complex, small scale and large. This tells me it's more than just being lucky to be in a good market.

However, unlike contributor S, I have found that we cannot maintain those numbers if we are smaller or larger. It has taken many years of trial and error and studying numbers on a daily basis to find our most profitable size. Without taking the time to analyze and understand numbers, how can you know what works and doesn't work?



From contributor N:
"...the "McWoodshop" business model doesn't fit this industry."

Yes it does, even in a true custom shop, which is what we are. Any wood, any finish, any configuration done in house. But we don't carve or do "art" pieces. I am going to leave my detailed response out for another thread, because the outline and thought process for that is the skeleton for the entire company operations, from marketing to install, it all ties together. Custom woodworking is not hard. It is a complex set of very simple tasks when broken down into individual steps. Which does make it McPlannable. If you carve or do art pieces to others spec, than I would agree.

"There are many shops out there making boxes. We have to differentiate ourselves with our reputation."

Reputation, reliability, professionalism, etc. - yes, I agree 100%.

"If you're not charging your shop rate per person, what are you doing with it?"

Sloppy answer. By shop rate, I meant total per hour for all billable employees - total and hourly rate I meant per each billable employee. Sorry for the confusion.

"Feel like sharing your client list?"

I will share everything except for my customer list. For every repeat client developed, we have to go through at least 20 others who think my pricing is too high. It takes a long time and a well crafted package that we back up with results. We are "to the trade only" now. One big screw-up and we are toast because they all hang out together and talk. You have to climb the ladder of client base. I would say we are doing work for almost all 2% club at this point and the goal is to be the 1% club or even higher.

"All I can say is if you're pulling in 25k/week, that is 1.3 mil/yr on 4 bodies. You're doing something right. More power to you."

You will notice two things I stated in my post. One was that it was a 3 month run because for some odd reason sales spiked dramatically June-August, which is usually lowest sales months because of summer break. The other was that I am the weakest link holding us back and even though I knew things were going to get bad a long time ago, I did not expect the dramatic off-a-cliff stop there was. If we had maintained that pace for 12 months straight, yes, we would have hit that. The total would actually be 1.175M because of only 47 working weeks in a year for us. But once the market took the first big hit in September, sales all but disappeared. The short month of December we built a very large functioning bar display for 100% out of pocket expense. September hired a full time salesman/project coordinator. From then till now we have increased our bidding pool by 50+ new companies. When things turn around it is going to be sick busy.

We have actually done better than that 3 month run. Oddly enough, our best run was 3 1/2 years ago. I know a couple companies who do better than that per man and do it consistently. They are my inspiration and reality check that it is possible. In my opinion the only limit to production output per employee is dedication and time. Yes, there will be some kind of plateau, but what that is, is not even close to what the industry standard is.



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