How can I justify my service rates?

By Abner Huertas
*This is my first post in english




In 2010 a customer asked me the following question: —How can I justify the rate I charge to my clients?— That’s really a good question, specially in a shared services company.
Our customer wanted to demonstrate that his rates were fare, but the question kept revolving in his head because they didn’t knew how to do it, every begging of a year the CEO of each company they deliver services asked how their rates were integrated, they wanted to know why they have been charged the amount written  in the bill.
We went to the white board and start designing how to justify the rates. A rate is composed, at least, by five components or sub-rates, these are:
  1. Operational rate.
  2. Supervision rate.
  3. Infrastructure rate.
  4. Administrative rate.
  5. Corporate rate.
Let’s quickly examine each one.

Operational rate

An operational rate identifies how much your service cost to operate, in other words, how much it costs your direct labour. 
To calculate an operational rate first we need to identify the personnel that works directly in the service, using just the job positions its fine.  Once they are identified, we need to calculate how much an hour or minute it costs each job position, why? We’ll discuss it in a minute.
Now we need to know what they do to deliver services. Here is where the Value Chain appears, just realise that we need to identify just the core activities. After that we need to calculate time rates for each activity and service, for instance: delivering one unit of service «A» requires 10 minutes of activity «T».
After that we calculate how much time for each activity a job position is required. At the end the requirement of each job position is calculated according to the demand of a service, then just multiplying the hourly rate plus time requirement will give the cost to operate.
Of course this is a little bit more complex because a company might have dozens to thousands of products, with this information we can start to justify why we’re charging an amount of this type of rate, how? Well, you know which activities are needed to deliver a service and you know the effort each one has, with this information you can demonstrate the endeavour you require to deliver the service to your customer.

Supervision rate

I haven’t met a business that didn’t need supervisors. The main responsibility of supervisors is to guarantee that your services are delivered on time, with high quality and with good customer service. That’s why it needs to be explicit in the service rate.
Supervision is a «tax rate», why do I mean by that? This means: «I’m charging you this amount of money to guarantee that you are receiving what you expect: quality, time and a good service»
This rate applies only to those areas where they supervise. As I mention, this is a «tax rate», its calculation can be as simple as the rate between the total costs of supervisors divided by the total amount of costs of operation. 

Infrastructure rate

This rate is simple: is the rate related to the use of the companys infrastructure such as: servers, buildings, equipment, materials, etc. As in the operational rate the infrastructure rate has their own consumption rates for each service.
This rate needs a pretty good analysis of the Total Cost of Property of each fixed assets used to deliver services. For instance a high technology services company, will calculate their  servers’s TOC that will include: depreciations, maintenance, energy, etc. 

Administrative rate

Every company has administrative expenses, these include human resources, IT, finances, and more.  A part of this cost must be included in the service rate. Now, this rate is can be included as a «tax rate», this means that we define a percentage to be added to the service rate; this percentage depends on each company, you will have to find the best «tax rate» to apply to the operational rate. 
This «tax rate» will serve to cover for the administrative expenses. Going further, this «tax rate» will help to justify an increase, or decrease, in the administrative headcount because now you have linked both types of expenses. If the demand is increased, you might have to adjust not just your operational headcount, but your administrative as well.

Corporate rate

This type of rate serves to guarantee the continuum of your business. With this rate, a company will cover the expenses of the senior management.  Just like the administrative rate, you have to define a «tax rate» to apply to the operational rate.

Conclusion

One way to justify your rates is by diving it in sub-rates, these can be: Operational, Supervision, Infrastructure, Administrative and Corporative rates. Each sub-rate has its own set of rules and its own definition. There are sub-rates that are described as a «tax rate», this simplifies the analysis and let us focus on the core of the business.
In this article we didn’t cover the difference between the accounting cost and the service cost (service rate*demand), we’ll cover this in another article; by the moment you just need to know that this difference is called capacity.
Hope to see you in the next article.
If you would like to discuss a little beat more about this methodology, you can contact me at: contacto@abnerhuertas.com, or leave a comment below.


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