Contracting in the 21st century is a complicated business with many moving parts, and one of the critical success factors to be able to produce positive cash flow and a 20 percent-plus profit structure is pricing.
Pricing touches virtually every aspect of your business, fitting snugly inside the marketing discipline and artfully tying together your business philosophy as well.
STRATEGY IS A MAJOR FACTOR
The very first issue a contractor should engage is what the actual strategy for pricing is. What is your pricing trying to accomplish for the company? What are you trying to communicate? What value are you establishing?
Once you figure that out, here are some pricing rules to follow:
- Know your costs, including the costs of goods, overhead, and seasonal changes.
- Be departmental to a gross profit line (sales minus cost of goods leads to gross profit).
- Understand your desired company strategy — boutique/value/volume — and price accordingly.
- Understand your methods.
- Know your target business segments. Each segment of business has its own pricing methodology (service, maintenance, change-out, new home, plumbing repair, commercial service, commercial contract, etc.).
- Price to your market value — recognize that the market may bear more than your cost + profit — so study the market and know your true value, not just your costs.
- Establish a company policy for discounting, and coordinate it with your desired profit goals.
If you followed these rules to their fullest extent, you may find how your pricing system and possibly your strategy could be enhanced.
Most contractors know that high-material, low-labor jobs make for better profitability. On the other hand, high-labor, low-material jobs are usually not desireable due to the payroll expense. I am excluding a shoulder season choice to accept high-labor jobs intentionally, which can be useful when you have capacity and little or no work.
This is where your pricing methodology can either help or harm you. Not all pricing systems can differentiate the good jobs from the harmful ones.
We want to use the methods that assign overhead as it is, not what we want it to be. For that, we use dual overhead. It is the one method that evaluates how any cost of overhead is occurring in our company, and we use two factors to define the overhead in a job price: one for labor costs and one for all non-labor costs.
Dual overhead will price high-labor jobs at a higher breakeven than, say, a high-material job of the same base cost of goods sold. Why? The overhead creation occurs because in contracting, labor drives overhead.
Years ago, I worked with a company in Akron, Ohio. They were not making a profit and were selling many attic jobs, taking lots of labor and very little materials. We pinpointed that their pricing was the issue. The choice was to either raise the prices using dual overhead, since the method would force recognition of this cost, or stop accepting so many of those style units in high-labor areas. We opted for dual overhead, raised the price, learned to sell better, and presto, the company began making a lucrative profit.
Not all pricing methods are equal, and some are downright deceptive, so be careful to learn the strengths and weaknesses of each method and how they apply to your business.
EXAMPLE PRICING METHODS
None of these are detailed here, but you should take it upon yourself to learn more about each method and its application in contracting.
SWAG (guessing) — My Dad used it, I use it. A common method in trades.
Divisor method — Simple, but very dangerous, so avoid it. It is by far the most common method used. It treats labor and material as equals in overhead creation, which just “ain’t so” in life.
Markup/multiplier — Same issues as the divisor method … also simple, but avoid. In this method, contractors assign a target multiplier that gets a desired gross margin percentage on a job. But we don’t spend margins to pay our bills; percentages will fool you. You spend and need raw dollars.
Gross profit per man-day — Assigns a target to gross profit per hour, day, or man and allows you to cover up overhead per day (a number you calculate by segment of your company). This is the method that gets you to the raw dollars per day that you want or need as a company. It’s a better method than divisor or multiplier, but it requires some financial discipline.
Dual overhead — Assigns overhead to material and labor, creating two factors. We then use those to apply to each job to breakeven before adding desired profit. Requires financial discipline, which is why it’s not used more, but it’s the most precise method to know the true effects of contracting work.
Flat-rate service — We assign a labor time, a retail labor rate, a parts cost, and a parts markup and create a known price for any given repair, inclusive of costs. Done well, with knowledge of overhead, it’s a very effective service pricing strategy.
You as a contractor owe it to yourself to study the methods more. The basics of financial management come into play as well, meaning if you lack good, solid information from your accounting systems, these methods may seem out of reach or confusing. But that is not a good reason to ignore them.
In fact, it is the primary reason our industry suffers from lack of profitability. Not being able to see our decisions in pricing as results occurring in real life makes it “out of sight, out of mind.” It contributes to death by a thousand paper cuts over time.
Get your financials departmentalized and organized, timely and accurate, then move to a method by segment, and don’t be afraid to ask for help.
To learn more about the financial side of your contracting business, visit EGIA.org/ACHR-financial to download a free training package that includes industry research, instructional videos, financial plan development documents, and much more.
Publication date: 9/10/2018