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% + profit structure is pricing.
Pricing is a massive topic, with many aspects, so in this article we’ll explore the high level areas of how a contractor can improve pricing systems and implementation.
Pricing touches virtually every aspect of your business, fitting snugly inside the marketing discipline. It also has a touch of artwork, tying to your business philosophy as well. So much of pricing is mathematical, yet we should not forget that pricing also ties to the ever changing market place conditions and choices you make as a contractor.
Strategy is a Major Factor in Success of Pricing:
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?
Pricing Rules to Follow:
If you followed these rules to their fullest extent you may find how your pricing system and possibly strategy could be enhanced.
The next logical question is: Does the system I use as a contractor give me the best results?
Most contractors know high-material, low-labor jobs make for better profitability. And high-labor, low-material jobs, while they keep our field personnel busy, usually are not that desirable since we know overhead expenses climb upwards with the use of each labor payroll dollar. Quite the opposite of material, hence the reason we generally appreciate high material jobs. 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 separate the good jobs from the harmful ones.
We want to use the methods that assign overhead as it truly is created in our company not as we hope it is created, and 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 related on the job, and one for all non-labor related on the job.
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. A duct modification job with no rooftops has lots of time, trips, and labor using resources that cost money. Versus that same rooftop equipment set with no real labor, we can finish quickly and the equipment received a nice markup that didn’t cost the company 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 their pricing was the issue. The choice was 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 at a higher price and presto, the company began making a lucrative profit structure.
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 in detail here and 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 unless jobs are one day – avoid. It is by far the most common method used in our trades and a reason for weak profits. It treats labor and material as equals in overhead creation which just “ain’t so” in life.
Markup/Multiplier – Same issues as divisor – also simple, but avoid. Assign a target multiplier that gets a desired gross margin percentage on a job, except 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 or 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 you want or need as a company. It’s a better method than divisor or multiplier, but requires some financial discipline.
Dual Overhead – Assigns overhead to material, and labor – creates two factors. We then use those to apply to each job to get breakeven before then 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, a very effective service pricing strategy.
We have much more detail in each of these areas, and 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. 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.
ABOUT THE AUTHOR
Gary Elekes is serial entrepreneur with a passion for helping others become more successful by sharing what he has learned over the past 3 decades working closely with all facets of the contracting industry. During his career, Gary has held senior management positions at Lennox and Service Experts. In 2000, Gary moved into entrepreneurship and started his training and consulting business EPC. Today, EPC continues to support growth oriented businesses aspiring to reach 20% EBIT. He also designed the very first web based learning platform for the residential contracting industry, which acts as a support system for training and learning in HVAC and plumbing trades, and has over 5,000 subscribers.
In 2003, Gary began acquiring contracting firms with a focus on developing turn-around opportunities. He also opened and operated several start-up businesses. In 2010, he added web design/SEO and online marketing to his company portfolio starting Imarket Solutions as a co-founder. Gary graduated from Ohio State University with a BSBA and also holds a Master's Degree in Business and Finance.