Ask the Experts

Pricing Multiyear Service Agreements

Question: How would I price my multiyear service agreements?

Gary Elekes: Well, it depends on how many years and how many systems, but there’s a nice little tool out there on the EGIA Best Practices site that will allow you to do that. And it really is going to ask you a series of ten questions, each step – ten steps – each step is a definitive cost question. What am I paying my technician on an hourly wage, for example, and how many minutes will it take to do a tune-up? And so you go through that process and you really have to cost out, what does it cost you, in terms of direct costs, to run a service agreement? How many events are you going to run? One event, two events, three events? Each event being a tune-up or some form of a work-required event. And travel time, you know, those types of things; materials. It’s just going to walk you through the costing structure. And then the next question becomes, well, do you want to give a discount for multiyear agreements or multi-systems?

So there’s spaces inside of that tool to essentially create a discount structure, so you can play with that and manipulate that. So for our purposes, on a multi-system deal, for example, we’ll give a discount because we’re not traveling twice, we’re walking three feet next door to the next mechanical system in the house. So if there are five systems on the house, obviously we can give a discount that’s broader than if there are two systems.

And then the multiyear agreement – we tend to give a discount on that only if it’s a pre-pay. If it’s a perpetual agreement where we’re collecting on a monthly debit, or you’re using a credit card purchase, you don’t have the benefit of being able to have the cash up front and put that into your accrued liability. In fact here [refers to tools shown on screen] if you just click on the center tab on the worksheet there that says “agreement pricing,” cause right now what you’re seeing is the supervisor’s compensation plan, which is tied to that. So this is an example of the steps, so if you scroll down a little bit you’ll see that this is actually a spreadsheet down there. And so these are the steps, these are the instructions, and then the spreadsheet itself allows you to enter the data. If you don’t know EGIA’s tools, basically anything that’s pastel yellow or some form of a yellow, is an empty field for data.

So at some point you just have to go through the process and say, “What are my cost structures as a direct cost?” And then for me, we always calculate the overhead as well, so that we understand what it costs us to move a vehicle from Point A to Point B – from portal to portal. And that’s something that we would discuss in a class; it’s beyond the scope of the timeframe for this conference call.

But we want the service department to have a separated area as a separate department that would be called “maintenance agreements” or “service agreements.” So while we’re using the service truck and probably a service tech in a lot of cases -- as you grow your company you might specialize with maintenance techs – there are specific costs for overhead that are attached directly to the service agreement platform that are not actually service-related. So to keep demand service clean and to keep service agreements clean, and to understand the overhead, we separate those out into departments. And that’s a relatively sophisticated concept for many contractors. But even if you didn’t, you could estimate the overhead. So that gives us an idea of what it would actually cost us to run one event. So the discount for the ability to price for profit is derived by knowing your costs.

So for me – if you click on the ten-year worksheet there on the left [referring to worksheet on screen] – this is the example. So you can set your compensation plan. The agreement in this example is 179 and you begin to see, by systems or by years, that discounts apply. And those are all random. So the ten-year discount in Cell B11 shows 80%, which means it’s a 20% discount, well that’s just fake data in there. The reality is you get to choose that.

What I do is set up an accrued liability account on my balance sheet. That’s basic accounting. The money you get paid up front has to be earmarked for use. You can’t just take that and spend it. So for us we take that money and we invest that into a bond fund. And it’s part of a company, so it’s not going to be taken out of the company. But the bond fund is going to accrue earnings and interest that are going to be coming back to my company, and that allows me to accept 10 years’ worth of payments. So if you have five systems and we use this example right here, you gave me $6,086, I’m going to put that money away and I have essentially nine years of investment after the first year, and then the second year I have eight years, and so forth. Over a period of time, with the bond fund, I’m more than offsetting the discounts I’m giving in that situation.

So, again, the customer had to prepay me for that benefit and the price was established based on a cost structure that said I’m going to at least break even, maybe better, make some profit on that. And so this is an example of a tool that you could use, and the main thing is that you understand your costs and, as a business, are marketing and selling based on the principles that your costs are recovered first and any discounts you give don’t harm your business. There’s an entire class on this, we’ve probably got a one-hour video on this as well, and there’s a whole series of other videos that are on the site as well.

Listen to the whole Ask the Experts call: Every week, EGIA offers two Ask the Experts conference calls to allow contractors to ask questions and get answers about the issues affecting their business right now.

This is the weekly Ask the Experts free excerpt. To listen to all of this week's calls, or to see the schedule and register for future calls, click here.