BodyShop Business
A ‘How-To’ Guide for Increasing Labor Rates, BodyShop Business, February 2006

2/1/2006

Rather than belabor the exhaustive list of reasons labor rates need to rise, let's focus on what type of market conditions act to create higher – or more frequently increasing – prevailing rates in individual markets.

By Tigger (from his view in the Thousland Acre Wood)

No one in the collision repair industry would argue that labor rates, with a few market area exceptions, have dramatically failed to keep pace with even the most basic measures of cost of living and inflation over the past 20 years.

This disturbing trend is especially evident over the last five years. Just take a look around the retail automotive mechanical market as a quick comparison. You’ll see rates today that are typically double or higher than the collision repair rate, while 30 years ago, mechanical labor rates were virtually the same as body repair labor rates.

The lack of labor rate increases has substantially eroded the collision repair industry’s ability to reliably provide service and quality — and to maintain profitability.

A rate increase is absolutely essential to allow collision repairers to continue to provide acceptable value to their employees, customers and stockholders. Typically, the process of obtaining a door rate increase is linked to the labor rate market survey. It is suspect, however, that those who are poised to benefit most are the very insurers who determine the prevailing rates through confidential, indisputable surveys and then impose the resulting interpretation on shops in the market as an asserted prevailing rate.

Ironically, at the same time, those surveying insurers in many cases internally recognize a need to reward their own employees at rates that may well exceed inflation, the cost of living and, most disappointingly, the rate increases granted the collision industry. It certainly seems a little hypocritical for a company to acknowledge a need internally to annually — and significantly — increase pay to its own staff and yet to act externally to dramatically suppress the rates paid to outside collision and glass service firms.

Effective Door Rate to Total Hours/RO

Much evidence exists to support a need to increase labor rates, but the fact is that many repairers are so small and leveraged in their businesses that they’re not willing to risk an accelerated demise by being the lightening rod rallying the masses to demand reform.

Rather than belabor the exhaustive list of justifications illustrating why labor rates need to rise, I’ve instead chosen to illustrate what types of market conditions favorably act to create higher — or more frequently increasing — prevailing rates in individual markets. Consider it a “what you need to do” checklist.

How Did We Get Here?
Why can’t I get paid $74 per hour like they do in Northern California?

Good question. But before answering that, we have to examine what has happened to the collision industry’s labor rates since 1970.

In the late 1960s, early ’70s, the hourly door rate for collision repair was higher than the non-dealer mechanical rate in most areas. In many markets today, the basic collision sheet metal hourly rate is now less than 50% of the mechanical rate charged by dealers in that same market. Consider the following rate comparison in Table 1 between dealer mechanical rates and body shop labor rates, along with some key economic indicators over the last 22 years. This is contrasted with some key indicators in Table 2. It’s appalling to note that minimum wage has grown more than door rates in collision repair over the last 22 years (minimum wage at 94% vs. collision door rates at only 64%).

TABLE 1:
Auto Industry Historic Rates 1983 ’05 Growth%
CA dealer mech labor rates $31 $80 158%
CA collision repair labor rates $22 $36 64%
CA paint material rate $10 $26 160%

NOTE: Rates are for the same business on actual closed ROs.

TABLE 2:
Economic Indicators 1983 ’05 Growth%
Postage Stamps $0.15 $0.37 147%
Federal avg. house price $70,300 $185,200 163%
CA average house price $114,370 $450,990 294%
Federal minimum wage $3.35 $65.0 94%
CA minimum wage $3.35 $6.75 101%
U.S. avg. purchasing power of consumer dollar (1983 = 100) $1.00 $0.50 -50%

Table 1 and Table 2 indicate just how effective the insurance industry has been at implementing a “prevailing rate” paradigm. This prevailing rate is what’s used to establish or justify the “negotiated” rate (read: “only rate they’ll pay”) in a particular market. Note that this is a different rate than the negotiated concessionary rate called the “DRP rate,” which presumably is lower given the fact that the shop no longer has to expend any marketing dollars to attract this work and the “prevailing” rate is the negotiation starting point. (See box titled, “The Marketing Expense Savings Justification of the DRP” on pg. 34 for more information.) The incredible dichotomy that exists is that this “prevailing” rate can vary dramatically over a geographic area that’s only 50-60 miles apart (Santa Ana, Calif. = $36-$38 “posted $40” and Escondido, Calif. = $42-$44 “posted $48” — this equates to Santa Ana being 14% less than Escondido or Escondido being 16% higher than Santa Ana). It’s also worth noting that the cost of living in these two markets isn’t dramatically different when considering things like housing and pricing of durable goods.

When we consider a geographic environment the size of an entire state, the labor rate differential can be almost hard to fathom, let alone justify. Consider prevailing rates in the Santa Rosa area of $74 per hour (recently in early 2005 receiving a $5+ increase per hour) and contrast that with Los Angeles rates of $34-$36 per hour (recently receiving a modest $2 increase during the same period). This imbalance of increases is acting to further increase the door rate pricing gap, yet both areas have essentially the same labor laws in effect and arguably similar costs of living.

We need to recognize that other states have similar regional pricing environments, so California shouldn’t be viewed as a unique situation. The irony is that the insurance industry tries to rationalize this dramatic rate differential with inferences that fewer hours per repair are paid in the high labor rate geographic areas, thereby equalizing the average RO value.

However, regression analysis done on eeffective door rates and total number of billed labor hours/RO data extending back three years indicates that shops in high labor rate areas on average actually have more hours of repair per RO than their lower labor rate counterparts. Refer to Plot 1 on pg. 32. Specifically, the correlation coefficient of a least squares regression was a positive slope value, indicating that you were likely to see a higher number of hours per RO when the labor rate was high. (For explanation of regression, see box, “What the Heck Is a Least Squares Approximation?” )

While we need to interpret this data cautiously since it was done over a narrow sample size and individual sales mix will affect the data, the data is clumped in the $30-$50 range, clearly showing that, on average, the higher rate areas do not seem to have measurably fewer hours per RO. At a minimum, the analysis seems to refute the assertions that fewer P-page operations are conceded to shops in high labor rate environments and that fewer hours are paid on judgment times simply because the labor rate is measurably higher.

What Factors Drive Rates Higher?
To better understand this prevailing rate differential and perhaps identify the conditions that influence rates higher, I polled several shops from high door rate areas. I asked them to describe their respective marketplace’s dynamics, as they see them.

The shops interviewed identified a number of characteristics that seem to be quite common in those high-labor-rate environments. While clearly there are other causes that act to drive the prevailing rate in any specific market, the following four factors seem to frequently be present in one form or another in each market where there exists a higher rate than a comparative local area. The premise is that when these factors exist in a market, they act to drive labor rates higher or rate increases faster than those in other markets.

The four identified labor rate drivers are:

  1. Price leader a. Who really sets the price in your market?
    i. Individual price leader
    ii. Price leading market

  2. Number of competitive alternatives
    a. Capacity is tight
    b. Is there a shop on every corner?

  3. Our willingness to say “No”
    a. Sometimes excess capacity drives “Yes”

  4. Retail rate (standard rate) is present
    a. How is the rate derived?
    i. Survey? — Who does it?
    ii. Survey? — What does it look like?

Each of the these drivers alone seem to affect the local prevailing rate. But when more than one driver exists in a market area at one time or if all four exist in an individual market area, the local prevailing rate appears significantly higher and rate increases occur in the market area prior to other markets acting to lead the rush for a rate increase for an entire area. Because these rate drivers seem to hold the key to higher overall labor rates, let’s discuss them in detail.

1. A Price Leader Is Present in the Market
Individual Price Leader — A price leader is any entity that predominantly drives prices upward through first increases and is typically higher-priced than direct competitors. Many factors can lead to this dominance, but ultimately the price leader singlehandedly defines price in that market.

Typically in the collision industry, the price leaders are the shops that actively pursue a heavy consumer advocate approach to marketing their businesses. The competing firms in this type of market benefit from the strength of the price leader without incurring any of the risk of retaliation.

However, it’s important to note that when competitors choose not to follow a price leader, it can dramatically suppress prevailing rates as well as protract the pace of rate increases. In extreme cases, lack of market support can act to undermine the price leader and ultimately negate the price leader’s affect on the market. As in most market economies, greed seems to play a role, and many believe that being the low-price provider will drive volume — which can negate the price leader’s positive influence on rates.

Price Leading Market — There also may be conditions that exist to create an entire “market” that’s a price leader. This type of environment typically makes similar decisions about timing of pricing and costs based on similar interpretation of market factors. This particular environment seems to be most favorable from a prevailing rate perspective — typically having the quickest or most frequent rate increases, as well as higher overall prevailing rates in a given geographic area.

One factor that contributes to a price leading market is that major insurers don’t have a local presence in the area and work to support it remotely or with independent adjuster/appraiser contractors. Another factor may be an external condition like unionization that’s used to “adjust” the door rate.

By far, the most powerful condition is when a healthy trade association is present, active and working to elevate the education and technical sophistication of the membership. This similar view of the industry shared by the association members promotes applying similar rules and principles to making business decisions, resulting in similar timely decisions regarding pricing and quality. Conversely, in areas where there’s little to no activism by the trade association, prevailing rates can be the most suppressed and fragmented.

2. Number of Competitive Alternatives
When the level of competition is low (capacity is tight), it contributes to an environment where there are few collision repair options. A key indicator of a tight-capacity condition existing in a market is observing shops in an area that are perpetually at capacity — with this demand leading to long lead times for booking repairs.

A factor that can create capacity issues is a rapid increase in residential development growth in the immediate or surrounding market area, which acts to increase the local population numbers, both commuting and residential. This extra population brings cars with them, and unless additional shop capacity is brought on stream to address the growth, a capacity issue quickly begins to develop.

This short-term situation can lead to prevailing rate increases that, in the future, are never given up. More importantly, when this population growth occurs in a market that started out with relatively few repair centers, the repair supply-side capacity issue can accelerate door rates even faster.

Another factor that can limit capacity is related to geographic or political restrictions in an area. Highly developed areas may no longer have room to add additional repair facilities, so the existing shops are all there is unless great expense is incurred to obtain change-of-use permission from local government. Currently in many developed markets due to urban renewal initiatives, existing repair centers are being forced to relocate, creating windfall capacity changes benefiting the shops remaining in the market area.

On the other hand, there can be tremendous pressure to gain volume through discounting in an environment where a number of facilities are below capacity and breakeven sales volume or where the area experiences a dramatic decline in collision volume. This discounting pressure will continue until the discounting creates an environment where facilities begin to produce work for a price below what it costs them to generate that work. This losing money on each job will continue until all cash resources and financing avenues are exhausted and the capacity imbalance is equalized when the affected facilities claim bankruptcy.

3. Our Willingness to Say “No”
Many shop owners make financial decisions without a thorough understanding of how that decision will affect their business from a profitability and cash flow perspective. Consequently, in an area where relatively few businesses actually apply a sophisticated cost/benefit analysis to financial decisions, many shops don’t say “no” to bad business deals because they don’t fully understand what that decision might ultimately cost.

In the example below, a parts discount may, in fact, not only wash out the cost-of-living increase gains accumulated over many years, but also a couple of rate increases (assuming $2 per increase).

Equivalent Labor Concession to a 10% Parts Discount — This really depends on individual sales mix, but as an example, I’ll assume the following:

Typical Data:
Average RO$ = $2,400
Labor % sales = 46% = $1,104
Parts % sales = 40% = $960
Labor rate = $39/hour
Parts discount is: $960 x 10% = $96
Parts discount as % of labor sales is: $96/$1,104 = 8.7% labor discount equivalent.

Based on this situation, a 10% parts discount is financially equivalent to an 8.7% discount on labor sales. This would imply that if the prevailing rate paid/charged was $39 per hour, the 10% discount is the same as discounting the prevailing labor rate by $3.39 — to only $35.61.

Shops that have an excellent understanding of their financial performance are far more critical of concessions and requests for additional incentives to attract incremental volume as they truly cost/benefit their decision.

When a market has a high concentration of facilities that look at making business decisions applying a cost/benefit approach, it works to delay or deflect concession requests — preserving or increasing the prevailing rate relative to areas that lack a cost/benefit approach.

Characteristics of shops that have a degree of financial sophistication are those that:

  • Produce monthly financials within one week or less of the close of the prior month;
  • Use a robust managerially focused chart of account to effectively identify breakeven sales points and manage the operation rather than simply accounting for tax purposes;
  • Use technology-based accounting, managerial, CSI and estimating systems;
  • And, most importantly, actively manage their “sales by source” to limit individual source collision volume to no more than 20% of their total sales volume (to prevent too many eggs in one vendor basket).
The bottom line is, know your numbers well enough to understand the financial implications of your decisions and you’ll have the confidence to say “no” to a bad business deal.

4. Retail Rate (Standard Rate) Is Present
Customer-pay volume is now at record levels due to an increasing reluctance by consumers to submit claims. This reluctance to submit claims is the result of several market environment factors, such as rising deductibles, the decline of ACV vehicle values and the threat/perception of cancellation or being dropped by their insurer.

It’s estimated that currently customer-pay repairs represent more than 19% of billable collision repair job opportunities, up from 14% three years ago. This increase in consumer-pay traffic has highlighted a gap in the current repair-center pricing model related to dealing with a retail consumer.

The concept of a retail or standard door rate is similar to the existing wholesale arrangement with most parts and service vendors, where a lower wholesale price is applied when a purchaser repeatedly purchases a significant volume of product. This wholesale discount contrasts with a higher retail price that a typical motoring consumer is likely to pay when he purchases individual items on an infrequent or inconsistent basis from that same parts vendor. The consumer may, in fact, also make that purchase on credit, which is different than the terms maintained in a typical wholesale relationship.

The point is that a differential price usually exists between a “retail” purchase and a higher volume “wholesale” purchase of an item. Too frequently in the collision industry, the posted rate a facility displays is equal to the highest negotiated rate an insurer has agreed to pay.

This posted “wholesale rate” has two consequences:

  1. It creates a lower price that infrequent purchasers benefit from.

  2. When a retail rate differential does not exist, market labor rate surveys typically only capture the wholesale rate and skew any surveyed average market-area prevailing rate downward.

This lack of a retail rate distinction sets the maximum rate for any purchaser (consumer or infrequently encountered insurer) at a rate determined by the volume purchaser of services and does not reflect the higher transactional costs to accommodate lower volumes purchased by the infrequent purchasers of service, i.e. paying by credit card, unique billing and documentation procedure, long receivable delays, long distance communication charges, lack of a credit application, etc. (For more information on the credit card effect, see box, “Customer Pay and the Credit Card Effect” on pg. 46.)

Clearly the most costly effect is the resulting lower prevailing rate survey results. Labor market surveys are the established way to identify a prevailing labor rate in most U.S. market areas. When labor surveys are completed in markets to establish this prevailing rate, typically they’re completed by an interested party, the insurer, which may have something to gain from a favorable interpretation of the outcome.

Surveys based on wholesale pricing certainly do not favor a repair center’s bottom line and, conversely, few repair centers understand the incremental costs of catering to low-volume customer-pay clients and obscure insurers. Given the accelerating proportion of customer pay and the increasing number of low-volume purchasers of services seeking a free ride on other companies’ established pricing, it’s crucial that repair centers establish a retail pricing methodology when determining prevailing pricing practices in order to end the cycle of decreasing profitability on labor.

Survey practices currently employed to establish a region’s wholesale prevailing rate are rife with one-sidedness. Unfortunately for the collision industry, the rules are not well-defined (the industry’s own fault for not unifying) and, simply put, are beyond shop deliberation. The methodology is suspect in that the methods are not clear, the data is not shared and the rates are not weighted based on size of volume completed or how well-equipped a full service facility might be when compared to smaller, specialized repair shops.

It would seem that the only reasonable solution is to have surveys completed by an impartial third party that’s required to not only survey, but interpret the survey and calculate the arithmetic mean rate and the standard deviation to better establish how far ranging the surveyed values are apart. Rather than having the fox decide how the chickens should be protected, the fox should fund an impartial third party to complete the survey and transparently provide that data to all affected parties. The arguments against disclosing each shop’s door rate is moot if you consider the fact that a simple drive around town to every shop would permit every individual to view the posted door rate sign.

Two candidates that come to mind for this type of project have already performed this service for other markets and industries — CPA firms and (perhaps the most cost-effective option) university/college business department graduate students.

What You Can Do
How can you do your part to increase labor rates?

  1. Establish Power/Leadership —Take the lead in raising prices and be sure to have a significantly higher retail door rate to hedge against higher deductibles being paid with credit cards, while establishing pressure for the lagging prevailing rate to increase. The irony is that if all shops raised prices, no work is shifted but profitability improves. Greed is the motivator for a single shop to cut rates to increase volume at marginally lower levels of profitability. Consider that the fastest growing segment due to the increasing deductibles is “customer pay” work. Failure to price correctly and this undercutting approach will create a bubble of low-margin, high-volume work. This low-margin-contracted environment may be difficult to sustain if the highly-leveraged, rapidly expanding, DRP-laden repair centers find the new environment of rising interest rates too rich.

  2. Assert Expertise — Who is really the expert and decides which operations are necessary to correctly repair a car? Reinforce this when challenged over which operations are billed for when repairing a vehicle. Full interpretation of the database guides should be done to ensure a uniform application of repair operations across the country. The assertion made by vendors that, “We don’t pay for that” or “You’re the only one charging for this operation” should be exposed as an attempt to not fully indemnify the insured fully for his loss rather than as a shop trying to “nickel and dime” an insurer. If the selected database indicates that it’s a not included operation, secure and submit the documentation for payment and stick to it — even if it means introducing a co-pay to the insured. The dirty secret is ... “You are not the only one asking!”

  3. Organize the Industry — User group meetings/associations can work to establish rules for everything from methodologies for surveys to quantifying the economic drivers that trigger the timing of rate increases. There is strength in numbers.

  4. Level the Quality Playing Field — Lack of poor shops ensures apples-to-apples pricing. If all repair centers have similar technical requirements, the overhead platform is similar and will create an environment that demands similar compensation.

    * Equipment standards/facility size;
    * Training for all staff/third-party inspection of final repair quality.

  5. Educate Competition and Industry — Educating all industry participants will help them make business decisions that make sense and increase their confidence in saying “no” to bad or one-sided arrangements. Many decisions do not factor in all of the considerations of a true cost/benefit analysis.

    * Technical process for safety;
    * Business procedure for efficiency;
    * Financial knowledge for profits.

Do It Now
If you learn only one thing from this article, let it be this: Nothing will change unless body shops clearly calculate the financial impact on their businesses that concessions create. Hoping that you’ll make a profit by getting more cars with a lower labor rate is not a strategic plan for long-term success.

In June 2005 at IBIS in Switzerland, a presenter indicated that the projected decrease in the number of shops in North America is forecast to be reduced a staggering 40%, from 46,092 to 27,655 by 2010 due to an assertion that there exists excess collision center capacity in North America. Simply put, they’re predicting that four out of 10 existing collision centers will be gone by 2010.

To compound this prediction, during hallway conversations at NACE 2005, a North American insurance representative indicated that due to this overcapacity (excess supply of collision bays), he believes that labor rates are poised to decrease over the next four years.

This is a telling perception by the insurance industry and something that could very well come true. I can think of many consolidators and independent repairers who are desperate to fill centers that are at, or slightly below, the leveraged breakeven of their collision center. This is the price of leveraged expansion. The real problem is that some of them do not know this and may make decisions that, long term, will cripple them but short term prevent the “prevailing” door rate from increasing in a specific market area as they try to create enough lower gross margin volume to keep the boat from sinking.

To see labor rates increase, it would seem that action needs to be taken by shop owners to educate themselves “en masse” because if they don’t act in an intelligent fashion, labor rates definitely won’t increase and, in fact, may actually decline — and it will be the collision industry’s own fault.

Writer Tigger is an industry professional with more than 30 years of experience in the collision repair industry.

Determine What Your Labor Rate Should Be
I recently found a really great Web site that enables shop owners to use a government CPI calculator to determine what their current labor rates should be based on their labor rates from a previous year — http://data.bls.gov/cgi-bin/cpicalc.pl. This site permits a current comparison from any past year to today.

For example, I plugged in California’s 1983 collision repair labor rate of $22, and using the calculator, that rate should be $43.65 in 2005 dollars (the 2006 equivalent will be slightly higher, but the CPI calculator for 2006 hasn’t been published yet).

The cool thing is that since it’s based on government-generated data, it’s usually overly conservative and relatively indisputable. With this information, it’s almost conclusive proof that the collision industry has been affected negatively by DRP agreements when discussing achieved door rates (with legal steering potentially the culprit).

My key point: In this article, we discuss how California rates for 2005 were set at $34-$36, which means California collision repair shops are operating on 1998-’99 dollars, assuming the CPI calculator is accurate. Of course, curiously, 1997-1999 are the very years DRP programs really got into full swing.



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