Starting a rental business comes with its fair share of head-scratchers, and figuring out how to price your stuff – especially what to charge for labor – tops the list. Why? A couple of reasons. First, math is hard. It’s even tougher when you need to balance covering your overhead and labor costs, making a profit, and trying not to scare your customers away. Sometimes, figuring this part out can cause stress for business owners or feel downright impossible.
And yet, getting this part right is crucial for your rental company’s success. So what do you do? In this blog, we’ll dive into common approaches taken to pricing labor and share some tips and tricks that will help you hit that perfect balance!
Common Approaches to Pricing Labor
When it comes to pricing your labor or services, there are a few factors you must always consider:
- How much does the service cost your business?
- What do customers think the service is worth?
- How much are your competitors charging?
Since these three questions are so important, they are the pillar points for the most common approaches to pricing labor in the rental market.
Cost-Based Pricing
Figure out how much the labor costs your business. Do you pay your workers an hourly wage? Do your workers have to use a company vehicle to perform the service? What tools do you use for the service, and how much did it cost to acquire them?
Crunch these numbers. It is extremely important to understand what a service is costing you because you will always need to charge more than it costs to perform the labor.
Value-Based Pricing
Do some research and figure out how in-demand the service is. Is it a premium service that customers are willing to pay more for, or is it something that doesn’t take much skill? This is also known as “Value Based Pricing”, which means that you price the service according to market worth.
Competitor-Based Pricing
Do some digging and find out what your competitors are charging. While you don’t always need to charge less than competitors – the saying goes, “You get what you pay for” – it is good to know whether your prices are significantly different. When you know how much competitors are charging, you can re-evaluate your pricing strategy to make sure that it is competitive.
What Approach Is The Best?
The best approach to pricing takes all three of the above factors into account.
If you charge more than a customer believes the service is worth, they won’t order from you. If you charge too low, they may not order from you because they fear your work will not be quality.
And if you don’t consider your competitors’ prices, you may lose out if their packages are more attractive.
But ultimately, understanding your labor costs is inarguably the most important factor to consider if you want to avoid losing money.
Understanding Labor Costs
This gets tricky in a rental company where everyone does a variety of tasks, from counting inventory to chatting with customers. It’s not as straightforward as a factory job where someone earns a set wage for repeating the same task. Each order and day brings new challenges, making it tough to pin down your exact costs.
There are two types of costs you should account for:
- Fixed Costs: These are expenses that stay the same, no matter how many orders you receive. Fixed labor costs include managers’ salaries, guaranteed hours for employees, and employee benefits.
- Variable Costs: These costs go up as you get more orders. Examples of variable labor costs include the time it takes to prepare orders, deliver them, and set up or take down items for customers.
Why Fixed and Variable Expenses Matter
Your labor expenses combine both fixed and variable costs. You’ll have fixed costs even if you don’t process any orders, and your variable costs will rise with the number of orders you handle.
To figure out your costs, start by separating fixed and variable costs. You can use historical data and choose from two methods to determine the ratio of fixed to variable costs. Remember, these methods are most effective within a certain scale. Scaling your business significantly, like going from a $1 million company to a $10 million company, will alter cost behavior.
- High-Low Method: This simple method uses just two data points—your highest and lowest costs—to break down costs into fixed and variable components. It’s straightforward but less precise.
- Linear Regression Method: This method is more complex and accurate. It analyzes all your data points to distinguish between fixed and variable costs.
While I won’t dive deep into the mathematics behind these methods here, I’ve prepared a spreadsheet that simplifies the process. The spreadsheet comes with explanatory notes to help you understand how the calculations work.
Calculating Labor Price
Gather Your Data
Start by gathering your labor cost data. I recommend using at least 12 months of data for accuracy but be mindful not to use data so old that it doesn’t reflect current labor cost trends, as these costs tend to increase over time. Then, note how many orders you processed each month.
Here’s some fictional data for our example:
| Month | # of Orders Delivered | Labor Costs |
|---|---|---|
| Jan | 100 | $9,000 |
| Feb | 70 | $7,500 |
| Mar | 150 | $14,000 |
| Apr | 120 | $8,500 |
| May | 130 | $12,500 |
| Jun | 110 | $9,000 |
| Jul | 90 | $7,500 |
| Aug | 140 | $12,000 |
| Sep | 160 | $10,500 |
| Oct | 170 | $15,000 |
| Nov | 115 | $8,200 |
| Dec | 80 | $7,000 |
How to calculate your variable costs
Compare the highest and lowest cost months. The difference is your total variable cost. For example, the variable cost increase is $7,500 from a change of 100 orders, making the variable cost per unit $75.
In mathematical terms, variable cost per unit equals the change in costs divided by the change in orders. Our spreadsheet can automatically calculate this for you.
How to calculate fixed costs
take the total costs at the highest point ($15,000) and subtract the variable cost component ($75 variable cost per unit * 170 orders = $12,750).
The remaining $2,250 represents your fixed costs. Again, you can use our spreadsheet to calculate this data!
Segmenting Costs
To figure out your costs accurately, you need to look at different parts of your business separately. For jobs related to labor in rental companies, think about breaking it down like this:
- Pickup Orders: This is when the cost to get orders ready should be included in the price you charge for renting out items.
- Delivery Orders: Think about the cost of just delivering items.
- Delivery Orders with Setup: This is when you deliver items and also set them up. This should be its own category because it involves more work.
You can also split delivery orders into more specific groups. For example, orders with lots of items versus orders with just one item. The more you break down these categories, the better you can understand your costs.
High-Low Method
The High Low Method uses two data points—the highest and lowest—to estimate costs, ignoring other data. This method may not fully capture your business model’s nuances. For instance, if these points are outliers, they won’t provide a useful analysis.
For a more precise data representation, the Linear Regression Method analyzes all your data points to establish the best fitting line, offering a clearer picture of your cost behavior.
Linear Regression Method
The Linear Regression Method, also known as Simple Ordinary Least Squares (OLS) Regression, uses all your data points (not just the highs and lows) to determine your fixed and variable costs.
The great news is you don’t need to do the math yourself; Excel and Google Sheets can handle it for you. The key to making informed pricing decisions lies in interpreting the results. I’ve prepared the formulas in Google Sheets, which is freely available to everyone, though Excel offers more advanced linear regression tools. If you prefer Excel, simply follow the instructions here.
To use Google Sheets, navigate to the second tab in the provided spreadsheet, labeled “Linear Regression Method.” Replace the sample data with your own, and the sheet will automatically update with your results.
Referencing the same data from our earlier example, you would see a scatter graph generated in the sheet, complete with a line that best fits your data points.
Here are three key metrics to focus on in your regression model:
- R-squared (R²) Value: Located at the top of the line graph area, the R² value shows how accurately the model predicts real-world outcomes. In our model, it gauges the correlation between the number of orders delivered and labor costs. For example, an R² value of .748 indicates a 74.8% accuracy in predicting labor costs based on the number of orders. The closer this value is to 100%, the more reliable the model. An R² of 0 suggests no correlation between the number of orders and costs.
- The Intercept (Fixed Cost Estimate): The intercept represents the expected total cost when there are no orders (x=0). It gives us the fixed costs, which are automatically calculated in the spreadsheet.
- The Slope (Variable Costs Per Unit): The slope indicates how costs vary with order volume. It measures the rate at which total costs change as the number of orders increases, providing a calculation of variable costs per unit directly in the spreadsheet.
While the high-low method allows for analyzing a single variable, the linear regression method can incorporate multiple variables for a more nuanced analysis. This is especially useful for assessing how fixed and variable costs might vary by the number of orders and time of year, for example, to adjust pricing seasonally. For multi-variable analysis, Excel is recommended over Google Sheets for its advanced capabilities.
To explore both methods, use the provided spreadsheet, which simplifies the calculations. Simply enter your data to see a breakdown of fixed versus variable costs.
Break Even Analysis
The break-even section of the spreadsheet calculates how many units you need to sell to cover your fixed costs. The Contribution Margin represents your profit from each order after paying off your variable costs. For instance, if your labor charge is $100 and variable costs are $75, your contribution margin is $25.
You reach your break-even point when the number of orders covers all your fixed costs. In our high-low example, with fixed costs at $2,250 and a contribution margin of $25, it takes 90 orders to break even (90 x $25 = $2,250). Any orders beyond 90 bring in a profit of $25 each, since you’ve already met your fixed costs with the first 90 orders.
Understanding your contribution margin is crucial for maximizing profits.
How Much Should Rental Companies Charge for Labor?
Let’s quickly review the common types of pricing methods:
- Cost-Based: Now that you’re familiar with your costs and break-even point, you can apply a cost-based approach and include a profit margin.
- Customer-Based: Price your services based on what your customers are willing to pay.
- Competitor-Based: Set your prices by looking at what your competitors charge. You might choose to price lower to attract more business, higher to signal better value, or match competitors to neutralize price as a factor.
Combining all three methods is often the best strategy. Now that you know how much your labor costs, it’s time to add in some market insights.
Common Pricing Strategies
| Strategy | Description |
|---|---|
| Penetration Pricing | Initially set prices lower than competitors to capture market share. Used by newcomers to attract customers from established players. |
| Premium Pricing | Charge more than competitors to reflect the added value you provide, such as unique services that justify a higher price point. |
| Loss Leader Approach | Price certain items below cost to attract customers, making profits on additional purchases. E.g., low-priced tents with higher delivery and setup fees. |
| Skimming Strategy | Charge a high price for being the first to offer a specific service, until competition grows. Effective during high demand when supply is low. |
| Economy Pricing | Maintain a low profit margin, expecting volume sales to cover profits. Requires precise cost management to avoid losses. |
| Simplicity Pricing | Straightforward pricing, including potential extra fees, to enhance transparency and customer satisfaction. Inspired by Amazon's Prime service. |
| Skimming Strategy | Charge a high price for being the first to offer a specific service, until competition grows. Effective during high demand when supply is low. |
| Economy Pricing | Maintain a low profit margin, expecting volume sales to cover profits. Requires precise cost management to avoid losses. |
| Simplicity Pricing | Straightforward pricing, including potential extra fees, to enhance transparency and customer satisfaction. Inspired by Amazon's Prime service. |
Using the spreadsheet, play with the price you charge for labor and see how it affects your break-even point. You may choose to make changes such as using Total Labor Hours Billed instead of Number of Orders Shipped, which will help you determine what your hourly rate should be.
Set a Price, Then Analyze, Test, Adjust, and Repeat
To keep your business on track, it’s crucial to continually analyze, test, and adjust your prices. Don’t just set a price and forget about it. Mark your calendar to revisit your pricing strategy at least once every quarter, or at the very least, annually. Use your analysis, customer feedback, and a look at what your competitors are charging to refine your pricing approach.
Other blogs you may find helpful:
Choosing the right equipment for your rental business is a big decision. It’s not just about what you think might be popular. Making smart choices is important, especially when you have a budget to stick to. Before you spend any money, it’s a good idea to figure out the potential Return on Investment (ROI) on the equipment. Equipment ROI means understanding how long it will take for the equipment to pay for itself and start making you money.
We’ll go through three ways to calculate equipment ROI so you can see how much value the equipment could bring to your business. Then, we’ll show you how to use an equipment ROI calculator to quickly calculate equipment ROI without the hassle!
1. The Payback Period Method for Calculating Equipment ROI
The Payback Period Method is a straightforward way to figure out how long it will take for an investment to start paying for itself. In other words, this is an extremely easy way to calculate ROI in the short term.
When starting a rental business, you can use this method by dividing the cost of the equipment you buy by its yearly profit. The answer tells you how many years it will take for the equipment to earn back the money you spent on it, which is essential when calculating equipment’s overall ROI.
How The Payback Period Method Works
Let’s say you buy a piece of equipment for your rental business for $10,000, and it helps you earn an extra $2,500 each year. To find out how many years it will take to pay off the equipment, you would divide the cost of the equipment by how much money it helps you make each year. In this case, $10,000 divided by $2,500 equals 4 years. This means it will take 4 years to get your $10,000 back.
This method is popular because it’s easy to use and gives you a quick idea of when you’ll start making a profit from your investment. But remember, it doesn’t consider other costs you might have or any money you make after those first 4 years. This means this method may not give you the most fleshed-out idea of the total ROI.
Pros of The Payback Period Method
- Understanding and calculating ROI is straightforward, making it accessible even for those without extensive financial knowledge.
- It provides a fast way to evaluate the return on investment, showing how long it will take to recover the initial outlay.
- It helps identify investments that pay back quickly, potentially reducing the risk associated with longer-term financial commitments.
- Useful for comparing multiple investment opportunities, helping to prioritize those that recover costs faster.
Cons of The Payback Period Method
- It only focuses on the period until the initial investment is recovered and does not account for any profits or cash flows after this period, which means that it does not give you a full picture of your ROI.
- Because it only looks at how quickly money spent is recovered, it does not evaluate the total profitability or overall return of an investment.
- The method may favor investments with quick returns over those that may be more profitable in the long term but take longer to pay back.
2. The Accounting Rate of Return Method for Calculating Equipment ROI
The Accounting Rate of Return (ARR), also known as the Simple Rate of Return, method calculates ROI by accounting for the average yearly profit you can expect as a percentage of your investment. To find the ARR, divide the average annual net income by the initial cost of the equipment.
How The Accounting Rate of Return Method Works
Let’s say you’re considering buying a new sound system for your rental business. The system costs $20,000 and is expected to generate an average net income of $5,000 annually. To determine the ARR, you would calculate $5,000 (average annual net income) divided by $20,000 (initial cost), resulting in an ARR of 25%. This percentage helps you understand the yearly return on your investment compared to its cost.
Pros of The Accounting Rate of Return Method
- Unlike the Payback Period Method, ARR provides insight into the profitability of an investment, not just how quickly it pays for itself.
- Easy to calculate and understand, ARR gives a clear percentage result that indicates the earning efficiency of an investment.
- Helps predict future profits, aiding in more accurate financial planning and budgeting for your business.
Cons of The Accounting Rate of Return Method
- ARR calculations do not consider the time value of money, which can lead to overestimating the attractiveness of longer-term investments.
- It focuses on net income rather than cash flows, which can be misleading if the investment impacts cash flows differently due to varying costs like maintenance or upgrades.
3. Net Present Value Method (NPV) for Calculating Equipment ROI
The Net Present Value (NPV) method is great for evaluating investments because it helps you see the value of future cash flows in today’s dollars. This method balances the incoming and outgoing cash related to an investment, adjusted for its time value — essentially, it tells you if the money you make from the investment is worth more than what you put in.
Overall, this is the method we recommend to get the best calculations for whether a piece of equipment is worth investing in for your rental business.
How The Net Present Value (NPV) Works
In the past, calculating NPV could get quite complex, requiring a present value table and a detailed formula. However, with modern tools like Excel or Google Sheets, this process is now much simpler. We’ve set up a Google Sheet that does the heavy lifting for you! This is one of the best ways to calculate your equipment investment return.
To use this sheet, you’ll need to know the following information:
1. Determine Your Discount Rate
The NPV method’s first step is to decide on a discount rate. You expect to earn this rate as a return on your investments. For instance, if you’ve found through experience that returns below 30% aren’t satisfactory, then you’d use 30% as your discount rate. This is your benchmark for comparing potential investments.
2. Calculate Your Net Cash Flows
Next, you’ll need to estimate the net cash flows that your investment will generate over its useful life. To do this, follow these steps:
- Determine how often the equipment will be rented out during the year and the rental fee per event. Multiply these numbers to estimate how much revenue the equipment will generate annually.
- Figure out all expenses related to the equipment, including maintenance, repairs, and any staffing costs directly linked to its operation. Don’t forget to include the costs of supplies or additional services necessary for the equipment. Subtract these expenses from your total estimated revenue to find your gross cash flow.
- Consider the tax implications of your revenue and expenses. Calculate the tax you’ll need to pay on the earnings from the equipment.
- If you financed the purchase of your equipment, include the interest payments as part of your costs. This will give you the net cash flow from the investment.
Once you’ve made these calculations, you have the information available to you to do this calculation!
Example of NPV Using Our Calculator
Imagine you’re considering a $9,600 investment in a piece of equipment. According to the calculations in our Google Sheet, the NPV of this investment is $57,256.39, indicating a financially sound investment. Remember, this figure considers not just the cost but also the potential earnings from renting out the equipment.
The spreadsheet we provided automates the NPV calculation. As a rule of thumb, if the NPV is greater than $0, it’s a good financial investment. If it’s less than $0, the investment would underperform compared to your discount rate. An NPV of $0 means the investment just meets your required return rate.
Pros of The Net Present Value (NPV) Method
- Offers a precise measurement of an investment’s profitability by considering the time value of money.
- Evaluates both the incoming and outgoing cash flows over the entire lifespan of the investment.
Cons of The Net Present Value (NPV) Method
- While tools have simplified this calculation, understanding and setting up the correct parameters can still be challenging.
- Accurate NPV calculations rely heavily on the accuracy of the estimated cash flows and discount rates.
Other Tools for Evaluating Investments for Rental Businesses
Internal Rate of Return Method (IRR)
Think of the IRR as the break-even rate of your investment. Technically, IRR is the rate that sets the Net Present Value (NPV) to zero. This means the IRR compares the cash flows generated by the investment with the discount rate your company requires.
For instance, if you decide that an acceptable return is 30%, and the IRR exceeds this, then it’s considered a good investment. You can easily calculate the Internal Rate of Return using this Google Sheet. Remember, if the IRR is greater than 1, your investment is earning more than what’s required by your discount rate, making it a solid choice. If the IRR is less than 1, it’s not meeting your financial goals.
Project Profitability Index (PPI)
The PPI is an excellent tool for comparing multiple investment options. Start by calculating the net present value of each option. Next, calculate the Profitability Index by dividing the net present value of the project by the initial investment required. This measure is highly useful when evaluating several investment opportunities simultaneously. For example, if the Profitability Index is $5.96, it indicates that for every $1 invested, you are generating $5.96 in return.
Simply visit this Google Sheet to handle the calculations. As a general rule, a Profitability Index greater than 0 indicates a good investment (positive net present value), while a PI less than 0 indicates a poor choice (negative net present value). If PI equals 0, then the net present value of the investment breaks even.
When comparing several options, the Profitability Index helps you determine which investment will yield the largest return for every dollar invested today.
Ready To Get Started?
Investing in the right equipment is crucial for the success of your rental business. By using the tools and methods we’ve outlined—like the Net Present Value, Rate of Return, and Project Profitability Index—you can make informed decisions that will drive profitability and growth. Don’t just guess; use these proven strategies to ensure your investments pay off.
Start now by checking out our easy-to-use Google Sheet for calculating these financial metrics. It’s designed to simplify your investment evaluation process, helping you focus on growing your business with confidence.
Invest smart and watch your rental business thrive!
Other blogs you may find helpful:
Ultimate Guide to Cycle Billing for Rental Businesses
How 28-Day Billing Unlocks an Extra Billing Cycle
Frequently Asked Questions
Fixed costs are the expenses your business has that do not change, no matter how many products you rent out or services you provide.
This includes things like the rent for your shop and your employees’ salaries. On the other hand, variable costs depend on how much business you’re doing. For example, if you have to deliver more items, you’ll spend more on gas and maybe even pay for extra helping hands.
To calculate your fixed costs, add up all the expenses that stay the same each month, like rent, utility bills that don’t fluctuate much, and regular salaries you pay to your employees. These costs remain constant regardless of your business activity.
To figure out your variable costs, track expenses that change as your business volume changes. This includes materials, extra labor you need for busy times, and transportation costs for deliveries. Look at these costs over different times or seasons to see how they go up or down with your business activity.
The high-low method helps you understand your costs based on your busiest and slowest business periods. You take the costs from your highest and lowest activity months and use the difference to find out how much your spending changes with your business volume. This can give you a rough idea of your variable costs per unit and help identify your fixed costs.
Linear regression is a more detailed way to analyze your costs using all your data, not just the extremes. It uses a formula to predict your spending based on how your business activities change. This method is great because it considers all your information, giving you a clearer picture of how costs behave as your business grows or enters different seasons. It’s especially useful for planning your pricing strategy because it helps you see the real impact of changes in your business volume on your costs.