Moving 10 Year Parts and Warranty In-House - Part 3: Creating a Premium Maintenance Agreement
Tuesday, September 22, 2015
In previous blog posts, we introduced the new in-house parts and warranty program. We talked about how things fail based on a normal curve and showed how the warranty dollars would be offered to the customer by incorporating the cost into the initial purchase of the equipment (part 1). We then talked about how to handle the money and the necessary paper trail (part 2).
This is the final article in the series, and we’ll talk about creating a Premium Maintenance Agreement.
Setting up a Maintenance Agreement Department
When the company has enough maintenance agreement work to keep the equivalent of one tech busy full time, then it’s time to create a totally separate department for maintenance agreements. If a tech spends one hour of wrench time at the customer’s home, twice a year, that will total two billable hours. The average service tech bills out approximately 1,000 hours a year. That means the company will need 400 to 500 agreements in place to create a totally separate department.
Advantages of Having a Separate Maintenance Agreement Department
When it comes to spreading overhead costs, most fixed overhead can be spread across other departments besides maintenance. The end result is predictable. The generated hourly rate for the maintenance department will be low (little overhead assigned) and, therefore, the cost of the maintenance agreement can be held down. Obviously, if the company shifts fixed overhead to other departments, the cost of operating those departments will go up as will the necessary hourly rate to make a profit. The hope is that the company has more flexibility in pricing within those departments than it does in the maintenance department.
When it comes to setting proper hourly rates for residential service work, there are two ways the company can handle the diagnostic fee.
• Include the diagnostic fee in the pricing calculation. If the diagnostic fee is included, it tends to lower the required hourly rate.
• Exclude the diagnostic fee in the pricing calculation. If the diagnostic fee is excluded, it tends to increase the service hourly rate; however, that means 100% of the diagnostic fee collected is pure net profit.
Note the difference. As an example, the Sample Company from our Labor Pricing software shows the hourly rate with the diagnostic fee included is $115.52. When the income from the $85,000 of diagnostic fee is NOT included in the calculation, the rate jumps to $151.01. That’s roughly a difference of $35.00 per hour. That is not a big deal if you are on flat rate. It is a big deal if you are on time and material.
Advantages of Excluding the Diagnostic Fee
There are significant advantages to excluding the diagnostic fee when calculating your hourly rate for service.
• Waiving the fee. When the fee is NOT included as part of your service rate, you then have the ability to waive the fee at any point in time, for whatever reason. Why? The dollars are NOT included in your pricing. It doesn’t cost you anything.
• Maintenance agreements have an additional “plus.” Since the company now has the ability to waive the diagnostic fee, without hurting the bottom-line profit, another benefit of being an annual maintenance agreement customer is that you can waive all, or are least 50%, of the normal diagnostic fee.
Maintenance Agreement Sales Will Increase
The new maintenance agreement customer now gets annual or semi-annual maintenance of the equipment, a 10-15% discount off of any additional repairs made during the year, priority service, AND they save the diagnostic fee. That adds up to real savings.
Now Add Full Coverage for All Repairs to the Maintenance Agreement
When coverage for ALL repairs (labor and parts) are part of the annual maintenance agreement, the program has SUPER value to the consumer.
The annual agreement now has 100% coverage for any breakdown once the agreement is in place.
The math for including full coverage is simple. Since we know the retail price is $550 for 10 years, the “annual” cost is $55. Simply add $55 to whatever your standard annual maintenance agreement is. If your current price is $140, the new full-coverage price would be $195 ($140 + $55).
Monthly Credit Card Charges
If you charge your customer’s credit card each month, that means you would only need to increase their monthly charge by $4.58/month. That will NOT be a stumbling block to selling the agreement.
New Premium Maintenance Agreement Customers must have new Equipment
Simply allowing all customers to take advantage of the program can sink the ship. If you were a customer, with an old system that had not been properly maintained, would you sign up? You bet you would! The new maintenance program is strictly for customers who have installed new equipment. Note, you can now offer the full 10-year parts and warranty as either part of the purchase price or through the new maintenance agreement program. The choice is yours.
Cost of Premium Maintenance Agreements
You will remember the cost of a 10-year agreement was set at $550, which is equal to $55/year added to the maintenance agreement. Based on our last discussion you may want to increase the added cost by more than $55/year for older equipment.
The first step is to create a “PMA Current Liabilities” account which will necessitate a totally separate checking or saving account be set up to hold the money.
Unlike the account set up for to hold the new equipment funds, the “PMA Current Liabilities” account will hold all funds for all years. You will not need to create an additional account each year like you will for the newly installed equipment.
Again, when PMA money is received (either monthly or all at once) the warranty portion of the money received will need to be placed into the PMA Current Liabilities account. When repairs are made, like on new equipment, the customer will be provided an invoice showing the cost of the repairs with a “No Charge – Covered by Warranty” written on the invoice. The company will want to keep a copy for year-end money transfers.
End of Year Transfer
At the end of the year the company will need to move 50% of whatever is in the PMA Current Liabilities account into income. If the money transferred is greater than your actual cost during the year, you made money. If the amount transferred to income is more than the actual repairs, the program lost money…for that year. Keep in mind the repair money has profit built into it through your hourly rate and the agreement has a gross profit built in as well. The only way the program will not make money is if repairs on new equipment do not follow the standard deviation curve.
Let’s assume the company has sold 200 extra value agreements. The extra value portion of the of the agreement was $55, so $11,000 needs to be transferred into the liability account during the year ($55 x 200 = $11,000). At the end of the year half of the money in the account needs to transfer as income to the company with the remaining 50% staying in the account, untaxed.
Keep in mind the $55 figure and the 50% transfer figures are suggested figures. You may choose to change one, or both, of the figures. The actual numbers chosen are not nearly as important as the fact that you have logic backing up the numbers you use.
What to Do at the End of Year Two
You will remember we needed to create a different liability account each year for the new equipment sales. However, when it comes to the PMA program, all the money, each year, will be transferred to the one PMA account.
By the end of year two, the company has renewed 85% of the year-one customers, plus 250 additional PMAs were sold, plus half the money from year one is still in the account. The bottom line is that there is now $28,600 dollars in the PMA liability account. Half that money, or whatever percentage you are using, will then need to be transferred into the checkbook as income leaving the remaining $14,600 in the account, untaxed.
Uncle Sam’s Perspective
Remember Uncle Sam in more interested in the fact that you have a logical plan to hold and transfer funds then he is in how you do it. Therefore give YOUR program some serious thought and pick numbers that you can back up with logic. Once the plan is created, stick to it. Be sure you document both the plan and the fact that you carried out the plan. If you do Uncle Sam will be happy…and so will you!
As was mentioned in the original article, be sure to touch base with your CPA before starting the program as state laws for remaining funds for warranty are often different.