This past month I received a phone call from a very worried contractor. His sales were down by over 30 percent from this same time last year, and he doesn't seem to think that it is going to get any better in the near future. He also shared that he thinks he is losing so many bids because he is higher in price than area competitors. His plea for help was, "What do I do? Just cut my prices to get work?"
My answer in a word was, "Maybe!"
After he picked himself up off the floor of his truck, he composed himself and allowed me to probe about his overall strategies regarding the way he priced his work. It didn't take very long for me to realize that he had no strategy about pricing. He had made an "executive decision" this past winter that he wasn't making enough money so he would immediately begin to price his work not at a 1.4 mark-up value but a 1.9 factor.
I have no idea why he jumped from a 1.4 to 1.9 factor, but his move nonetheless was proving disastrous. This contractor's strategy to increase his mark-up value is unfortunately all too common for many contractors across the United States. Many contractors, and some that are very successful in spite of themselves, have no strategy! Let me share some thoughts that might help you to avoid what my latest contractor friend has all too clearly experienced - a pricing disaster!
First of all, a "mark-up value" (MV) represents what we basically add to our estimated costs to complete a job. If we have determined that we need a particular amount of money to cover our overhead, then this amount must be figured into and added to each job estimate. Additionally, if we want to make a particular amount of profit for each project, this too must be considered and added to the estimate.
Most strategic-minded contractors look at their costs, overhead and desired profit in terms of percentages. If a contractor's overhead represents 30 percent of his or her annual expenses, then a 0.3 MV must be added to the estimate. Therefore, an MV of 1.3 would represent what a contractor would need to make in order to cover his or her overhead of about 30 percent.
However, an MV of 1.3 does not take profit into consideration. If the contractor desires to make a 20 percent profit, then an additional 0.2 must be added to the MV. Using our same contractor's example, his new MV would now be 1.5 to cover both his overhead needs (that's the bare minimum we need to pay our salaries, rents, utilities, etc.) and projected profits. However, what happens if a 1.5 MV still isn't getting a contractor the amount of work he desires to land? This is where having a strategy can help.
Track all your numbers.
It is important to know what the historical numbers have been for your company. You should track how many bids you have generated and bids you won, the percentages, and by the sizes of projects bid. Likewise, you should track the average MV used for each bid generated. You should also track the gross profit you made on each project, comparing this figure against the average MV for each job.
Keep your overhead as low as possible!
This is a growing problem with contractors as they juggle growth. It is difficult to know when to move into a larger building or office or add that yard for all their trucks or when to add another administrative person so the contractor's wife (or husband) can focus on other areas of the business. Remember, every time you add expenses that are not directly tied to the delivery of work, those expenses increase the amount of overhead you need to account for when sales are low or you are in the "off season" time of the year.
Continue to look for methods to lower your actual production costs.
The more efficient you and your crews put work in, the more gross profit can be realized. For instance, if your crews have a high percentage of customer callbacks or rework, then you would do well to get the root cause identified and correct the problems. Rework does not just cost you twice the original amount estimated to do the job right the first time, it often costs three to four times the original amount.
Be sensitive to competitors' pricing.
While you may not know the exact bid strategy your competitor is using - and remember, most contractors don't have a bid strategy - you should be able to piece together by how much money you are losing jobs. Often a customer will share with you that you were too high by a certain amount or within a percentage. Always ask what the difference was in losing a bid. Over time you may be able to see a pattern that you are 5 percent or 7 percent too high. Likewise, when you win jobs, don't be shy about asking how close some of your competitors were to your price; you may find out that you are pricing your work too low.
Mix your bids with different mark-up values.
Be strategic implementing this step, but try bidding similar type of work at different MV factors. You may be able to circle your competitors and find what MV will land more work for you. If a 1.5 MV factor gets you 70 percent of the work you bid you might try a 1.8 MV factor to see where the up limit is. If you continue to get 60 to 65 percent of the jobs you bid at 1.8 MV, I would suggest you are still leaving money on the table and should raise your MV to 1.9, maybe even 2.1, just to test the up limit.
Now, if you want a lot of work at a particular price range and you're getting 60 to 70 percent of the jobs you bid then leave well enough alone. Just remember, if you're winning percentage is high (greater than 60 percent), chances are just as high that you are pricing work too low.
Setting your MV is both science and art. The reality is that you need to price work to get the work. However, if you are pricing work just to stay busy then you will find it very difficult at some point to make any money. Don't be price foolish, but determine your historical MVs and what your market will accept and then price accordingly. «
Brad Humphrey is President of Pinnacle Development Group, a management consulting firm to the construction industry. Brad has written several books for business owners and leaders and has begun to put many of his writings onto CD. For more information about Brad and his company, visit www.pinnacledg.com.