Using Labor Value Multiple to Price Projects – Week #17 of The Financial Operating System®
Last week, we looked at Labor Value Multiple (LVM) as a key metric for labor productivity and market value perception. This week, we focus on how to use Labor Value Multiple to price projects, ensuring businesses achieve strong gross profit margins by aligning labor costs with profitability targets. Whether your business follows hourly billing or fixed-price engagements, Labor Value Multiple to Price Projects offers a structured pricing method.
Key Concepts of Labor Value Multiple in Pricing
1. How to Calculate Labor Value Multiple (LVM)
- Definition: LVM is the ratio of pre-labor gross profit (PLGP) to the wages of direct labor staff.
- Purpose: It determines how much revenue needs to be generated per dollar of wages paid to achieve target profit margins.
2. Setting Hourly Rates with Labor Value Multiple to Price Projects
To set hourly rates:
- Calculate the wage rate of employees or contractors.
- Multiply the wage rate by the target LVM, adjusting for utilization rates (percentage of time spent on billable work).
Example:
A salaried employee earns $40/hour with 70% utilization. Their effective hourly cost becomes $57 ($40 ÷ 70%).
With a target Labor Value Multiple to Price Projects of 2.8, the hourly price is set at $160 ($57 × 2.8).
Why LVM is Essential
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Maintains Profit Margins:
- Ensures that pricing accounts for labor costs with a healthy profit margin left over
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Simplifies Pricing
- Once you determine your LVM taget, you can set hourly and fixed price rates consistent with your profit targets without extensive modeling
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Simplifies Capacity Planning:
- With a defined LVM target, managers can make hiring and capacity decisions without complex income statement modeling. For example, as we reviewed last week, if a manager maintains an LVM of 2.8, they have a “salary cap” for staffing decisions. Managers can hire or adjust staff levels as long as the team achieves the LVM target.
Conclusion
LVM is a critical tool for small businesses to price projects effectively, ensuring profitability and aligning labor costs with revenue.
Next Step:
Business owners can self-implement The Financial Operating System. Chapters are available to download at smartbooks.com/resources or you can buy the whole book from Amazon (the marketing firm version or the general business version).
If you would like assistance with implementation or would like to accelerate results for your business, please contact author Cal Wilder at cwilder@smartbooks.com or book a free consultation with our team directly using this calendar link.