Tim Cook, owner of Envi Construction, in Portland, Ore., says he may have been underselling for years before he joined a peer review group to help him understand his numbers.
On a good day, pricing is difficult to master — part art, part science. An economic downturn can throw more than a wrench into the works. Take a recent
Money magazine article, “Home Renovations on Sale,” which suggests that the tight market for jobs and lower prices on many
building materials make it a good time for consumers to negotiate better prices with remodelers. “Overall,” writes Donna Rosato, “experts say you can expect to save at least 10% on the cost of renovation and possibly a lot more depending on where you live and the project you choose.”
This added pressure on remodelers — along with lack of knowledge of estimating, job costing, and markup — can lead to fatal mistakes.
Not Simple Math
What goes into pricing? “It’s different for every company. There are so many elements,” says Diane Gilson, president of Info Plus Accounting, based in Ann Arbor, Mich. But the main thing is to know your costs. “People price according to the competition or because they know someone,” Gilson says. “You have to know your true costs to determine what your price will be to yield what you need to survive, which is merely breaking even. But if you end up with zero on the bottom line, you’ve bought yourself a job. As a company owner, you need to have profit to show for your risk.”
Correct pricing is tied to correctly estimating the costs of both labor and materials. Gilson uses the example of employee salaries: “What does it really cost to have someone working for you?” Maybe his or her compensation is $20 per hour. But what about workers’ compensation, benefits, bonuses, insurances, vehicle and phone use? The employee may actually be costing you upward of $35 per hour.
“You need to mark up accordingly so that you can get what you need on the bottom line.” (Click here to see a demo version of the spreadsheet-based labor burden calculator that Gilson’s company sells. Or use this simple labor burden calculator.)
To earn that amount plus profit means you have to add on to or “mark up” your costs. But many remodeling company owners, especially those new to the business world, don’t understand the difference between markup (gross profit divided by cost of goods sold) and margin (gross profit divided by sales).
When Anthony Slabaugh, owner of AMS Construction, in Stow, Ohio, made the transition from carpenter to remodeling business owner, he just upped his hourly rate. “I thought I’d keep doing that. But I had no information, no knowledge of what I should be charging,” he says. “In my mind, I thought that should be enough. I had no education in business.”
Slabaugh realized that he needed to make more money to survive. “I read Michael Stone’s book Markup & Profit and learned how to figure out my overhead for the year. And based on a projection of what I thought we’d make that year, we could establish a markup,” he says. “It worked for me. I reviewed it quarterly and actually increased it before the end of the year.” Slabaugh also credits industry publications and conferences with helping him get to a point where he is pricing correctly and, finally, after 10 years in business, is making a profit.
“During a time when our company was expanding, we reviewed our QuickBooks job reports and noted our best jobs had 33% left over at job completion. We mistakenly thought this would cover overhead and profit,” says Tim Cook, owner of Envi Construction, in Portland, Ore., who decided last year to get coaching for estimating and production. Striving for an 8% to 10% net profit, Cook realized that he couldn’t get there (his profit) from here (his markup). He recently joined Business Networks, a peer review group, to help him understand his numbers.
Using a Business Networks spreadsheet, Cook now lists all the elements of overhead, including labor burden, to get a picture of his true break-even point and how his expenses affect his volume. “We may have been underselling for years,” he says.
Cook uses past history for preliminary estimates. As the designer gets more details fleshed out on paper, Cook looks at all the information and writes up the entire estimate. Over the years, he has used Xactware Solutions’ XactRemodel software, which “itemizes every 2x4, nut, and bolt,” as well as Microsoft Excel spreadsheets, and information from Intuit QuickBooks for job costing.
"In a perfect world, you’re giving accurate pricing and you are not over or under the estimate." --Greg Harth, co-owner Harth Builders
Photo Credit: Colin M. Lenton/WPN
“The goal of the estimate,” Cook says, “is not just to provide a price for the client. It is also just as important to provide the vital information to the crew about how to put the job together. They need, at a minimum, to know how many hours are expected for each phase, what the material list is, and what specialty items are needed.”
One area he still finds challenging is how to accurately estimate field staff administration time. Workers’ compensation in his state does not allow carpenters to log time in administration or supervision, for example, which carry a less expensive insurance rate than carpentry. Cook posts administration hours, such as safety meetings or phone calls, to the same category of the employee’s daily task. “Our job actuals reports might show more hours in framing or finish carpentry and zero hours for admin,” he says, which makes it difficult to job cost. How many hours were really spent in hands-on production and how many in safety meetings or making phone calls, for example.
There is a way in QuickBooks to customize the insurance burden for each worker and activity, but again, Oregon’s workers’ compensation rules don’t allow for this.
Though it might be tempting to just add in the highest insurance rate when figuring burden, Cook is trying to remain competitive. He has chosen to add in the average insurance rate and make sure his margins are added on top of that. He also is using trade partners more often for work such as framing, which carry a higher insurance rate.
Cook recognizes that the company owner must fill out a time sheet for his or her time spent on production. “If the owner doesn’t do this,” he says, “then they won’t have an accurate picture of what the job actually cost in order to bid on the next one.”
Specialty items are another area of concern. Often, when Cook meets with the designer and the client, the designer has already looked into pricing specialty items such as a hammered copper countertop or high-end wire fabric for cabinet doors. “We always verify pricing independently,” Cook says, “but by the time we need to order this ‘have-to-have’ item, the price always seems to change and it ends up being [more expensive]. Now we know to include a larger contingency for any specialty items.”
Slippage and Grippage
“In a perfect world, you’re giving accurate pricing and you are not over or under the estimate,” says Greg Harth, co-owner with his father Allyn of Harth Builders, in Spring House, Pa.
Harth believes that many remodelers are not job costing and tracking project costs, so they underestimate price and create slippage — the difference between the cost and the estimate in the budget.
Harth outlines three things that “a good remodeler does to close the estimating circle”:
Uses detailed cost codes (Harth uses HomeTech estimating software’s codes);
Keeps up with job costing, an accounting process in which every cost that goes against a job gets placed into an appropriate category;
Performs a job autopsy, reviewing scheduling, manpower, and trade contractor issues, as well as cost overruns and savings.
After a job is completed and all costs are paid, Harth does a walk-through with the lead carpenter, the estimator, and the production manager to discuss where they went over- or underbudget. The estimator uses that information for future jobs. “If you’re doing an addition, and excavation went over by one day, that might cost you $800 because you didn’t consider bringing in dirt or taking out more dirt or poor access to the site,” Harth says. “The estimator will flag that, and the next time there’s an addition, he’ll ask if they need to bring in or take out dirt, so we don’t miss that $800 the second time.”
Harth identified 3% slippage in projects over the last few years and was able to track it to several items, including estimating labor too aggressively and not getting field input into the estimates. To right the situation, Harth Builders now includes a contingency in every estimate that amounts to 3% of total cost. If the contingency funds aren’t needed, they help to offset the production incentive that the company pays to all employees, but which is heavily weighted toward the lead carpenter, production manager, and estimator at the end of each project.
Harth also developed an in-house estimate review checklist for any project that costs more than $30,000. “We use it to confirm we have covered all the major items and past mistakes where we have lost money,” he says. Fire-blocking on basement projects — typically a $1,000 item — has been a thorn in the company’s side and an item that has been forgotten on multiple basement project estimates. After the third job autopsy in which it was discovered that this portion of work had been omitted from the price, Harth implemented the estimate review checklist to help identify these types of omissions that nibble away at the bottom line and create slippage. The checklists are then updated after every job autopsy. (Click here to see Harth Builders’ estimating spreadsheet.)
The company has become more efficient and has decreased slippage by using project schedules in the estimating phase and reviewing project schedules weekly with project managers.
But wouldn’t it be great to be underbudget — have grippage — every time? “No,” Harth says. “A well-run company should have zero slippage or grippage. Two percent is accepted [by most remodeling company owners], but if it’s more than that you have a real problem that should be addressed right away.”
Constantly coming in underbudget might earn you a pat on the back from an individual client but, multiplied across many jobs, it may mean you’re overpricing. “In a tight, competitive market, your numbers need to be accurate,” Harth says. “On a small job it may not make a difference, but [on a larger job], 5% could be the difference between getting or losing that job.”
Discounting Dangers
"[During the 2001 recession], I thought discounting was the way to stay alive, but it was just a slow death." --David Sturm, owner Attention to Detail
Photo Credit: Chris Rank | WpN
It’s tempting, in a tight market, to want to discount your price. “I was practically paying clients,” says David Sturm, owner of
Attention to Detail, in Atlanta, who lowered prices so drastically during the 2001 recession that he nearly went bust. “I thought discounting was the way to stay alive, but it was just a slow death.” That’s pretty much the consensus among business owners and experts.
“It’s a sure-fire way to drive your business to the brink,” writes Michael Anschel, owner of Otogawa-Anschel Design-Build, in Minneapolis, in an e-mail. “It undercuts everything you have worked to build. It undermines the industry. It makes you look desperate. It does not project an air of professionalism, strength, and longevity.” Anschel has actually raised rates by 0.5%, which, he writes, “is not really noticeable to the client, but we feel it is a little additional cash in the door [at] a time when we may have fewer projects.”
One of the main dangers of discounting is that you may not be in business long enough to finish your jobs. “It just leads you faster to disaster,” says Chris Stanton, owner of Novato, Calif.–based KSG Transform, a consulting company that serves the building industry. “Disaster comes from cash flow and running out of money. If you operate at a loss, you will at some point run out of cash.”
You’ve likely seen this happen with trade partners who offer discounted prices and eventually go under — hurting your remodeling company’s reputation in the process.
If you feel you absolutely must lower your price, don’t make a decision in haste. The tendency to want to offer a discounted price may come on when you are in panic mode in a bidding situation. “When the pressure is on, remodelers may be tempted to discount the final price for the homeowner at a presentation meeting if the homeowner says the price is too high,” notes Jerome Quinn, president of SawHorse, in Atlanta. But dropping the price so quickly sends a clear message to the homeowner that there must be a lot of fat in the job.
Quinn suggests telling the homeowner that you’ll review the numbers. “This gives you an opportunity to make a rational decision. It also sends the message that you have taken time to think through the estimate and come up with a fair price. You can also ask the homeowner to think about what they could give up to bring the price down while you’re reviewing the numbers. You may find the client willing to cut back on scope if given some time to think — and save you from dropping the price.”
In other words, you’ll be doing a smaller job at the same margin, so you’re still making the profit you need. You just have to do more jobs. It’s a trade-off, but it maintains your professionalism, and you won’t have to go back to people later on to explain why your prices are now higher. (Click here
to see a discounting calculator.)
“For the longest time, I was known as being heavily discounted, and I had to stop using a lot of old clients because of that,” Sturm says. “When the economy improved and I readjusted my price, clients were astonished. It was hard to get back into the swing of things and charge the correct amount.”
Sturm learned his lesson and has made a lot of changes in his business in the past eight years. He now has a better client base, understands markup and margin, and feels that he is “a business owner and not a field hand.”
Know Your Value
To offer a better deal to clients, you must return to the difference between cost and price: Lower your actual costs and you can appear to offer a “discounted” price. You have to work from true cost figures, otherwise you’re discounting a bad number, which will just hasten your demise. Think about how much you need to survive.
“If I want a 35% margin and I cut my overhead by $6,000 for the year — about $500 a month — revenue can drop $9,000 for the year,” says Leslie Shiner, owner of The ShinerGroup, a financial management consulting firm in Mill Valley, Calif.
To tighten overhead, she suggests looking closely at all costs. “Call your Internet provider and see if you’re on the right plan. Call your cell phone provider. You can’t cut the office in half; you shouldn’t fire the bookkeeper. But you can save money on the little things. We worked with one company that saved $24,000 by upping its health insurance deductible.”
Be wary of saving money on subcontractor fees. If they’re cutting prices, it might seem like a good idea to pass along the savings to clients, but beware: You don’t want to be left with a half-completed job because that subcontractor is no longer around.
The final lesson on price is that you can’t sell on price alone. Even if you have that just-right “Goldilocks” price, you have to sell yourself on the value you bring to a job. Work hard to differentiate yourself from other remodeling companies. Go the extra mile for customer service. “Sell on quality,” Shiner says. “If you’re selling on price, you’ll have a lot of unhappy clients.” Remind your clients that Mr. Half-Price Competitor may not be around to finish the job. You will.
Resources
Free labor burden calculator
Demo version of InfoPlus Accounting’s spreadsheet-based labor burden calculator
Spreadsheet for calculating markup.
Spreadsheet for calculating the effects of discounting.