Sometimes, you know something is true but just can't find an example that screams out your point adequately. If you have children past age 10, you know what I mean.
You keeping trying to get them to make smart choices, or stop making dumb ones, and they look at you like you're completely clueless and out of touch with their world. No matter how many examples or analogies you come up with, the end result is "Dad, you're crazy. Go bug mom."
I thought coming up with persuasive examples would be easier as my girls aged. Foolish me. It's still tough to find examples that either girl responds to with "Wow Dad. You're right. I should do that."
Ah, but sometimes you DO come across a simple, persuasive example that makes your point dramatically and effectively. That happened to me the other day while working with a client on his budget.
If you've been a long time reader of these articles, or have read my report The 10 Biggest Mistakes Contractors Make, you know how often I beat the drum for selling. It feels like my drum has been falling on deaf ears. My fault. I just haven't been able to find the crystal clear example that emphasizes the dramatic impact selling can have on your bottom line. Well, I finally struck pay dirt.
I stumbled across a simple example that demonstrates how much more effective selling is at increasing net income than is reducing field costs. I'm going to share the example with you and show you how to calculate the comparison for your business.
First, we are going to talk about the general basics, then I'll show you the stunning numbers.
Gross Profit: Your Source of Net Income
My business partner, Guy Gruenberg, loves to point out that gross profit is where net income comes from. It's where contractors should focus their attention if they wish to maximize their income and grow their businesses.
He's right, of course.
You should always be striving to increase your gross profits. You have only two ways to do that:
(1) Lower your field costs
(2) Raise your price
Nearly every commercial contractor, and the vast majority of residential contractors, I've met has reached the same wrong conclusion. "I can't raise my prices. I wouldn't get any work." Of course, operating with that assumption leads them to focus on lowering costs. It's not a bad thing. It's just not the only thing. There is a better way.
Field Cost Savings Only Improve Net Income Marginally
Obviously, you can't afford to be at a serious cost disadvantage, can you? I am a huge advocate of keeping field crews productive and motivated, keeping material waste to a minimum, and making sure your foremen and superintendents do enough planning to keep projects running smoothly.
The mistake most contractors make, hopefully not you, is they get wrapped up in trying to make money by saving money in the field. Field costs are a funny thing. They can cost you an arm and a leg. Heck, they can put you out of business pretty quickly. What they rarely can do is make you money.
With every one of your competitors striving to reduce their field costs, just like you strive to reduce yours, what is the likelihood you're going to find some magical solution that gives you a 20% cost advantage? Pretty darn slim.
Despite crossing paths with hundreds of contractors, I can count on one hand the number that had a real, significant cost advantage. Of those, two lost their advantage when their operations manager left for greener pastures.
Those five companies certainly made money with the incredible cost advantages, but they are the rare exceptions. Why try to play against the odds? That's like going all in while trying to fill the inside of a straight flush with one card to go. You've got a 1 in 52 chance of making it. It isn't the wise play.
Once you get your crews are moving at industry average speed, savings in field costs tend to be quite small and have minimal ability to grow your income. The coming example will drive home how great you'd have to be at reducing field costs to make a significant improvement in your bottom line.
Selling Minimizes Price Competition
To refresh your memory. In our industry, selling should be defined as winning work when you're not the low bid. Ideally, you would land the work without any price competition but that's not really the point. Your sales goal is to get paid a premium for your services.
My New Example Should Ring the Bell For You
I call this my "1% GM = 2,000 Man-hrs? You've got to be kidding me!" example.
Your ratio will be different, but it will probably be stunning. Here's how to calculate your ratio.
1. Grab last year's income statement.
2. Subtract your labor, materials, equipment, and subcontractor costs from your revenue. The result is your gross profit.
3. Divide your gross profit into your revenue. That is your gross margin.
For my client, we're going to say his gross margin was 26% (not the real number).
I wanted to see how much impact a slight increase of price would have had on his net income, so we calculated the revenue that would have created a 27% gross margin, assuming costs stayed the same. Turns out it would have meant an extra $50,000 in revenue! All of which would have dropped right to the bottom line!
We were both quite surprised by the impact 1% GM made on his income. Then we got curious about how much improvement in the field would be needed to produce a similar improvement. I asked him what his average wage was with burden and insurance. We cranked some numbers and came up with $25.00 per hour.
He would have had to save 2,000 man-hours to equal the income gained by raising his margin by 1%! Which do you think will be easier for him? Getting his crews to work 10% faster or raising his price a little more than 1%?
How to Increase Your Gross Margin
There are three basic ways to increase your gross margin.
1. Focus on the right clients - those who value your services.
2. Improve your selling skills.
3. Eliminate bad clients and bad projects.
Since the how to tips for these three methods are presented in my special report, The 10 Biggest Mistakes Contractors Make (available at www.FilthyRichContractor.com) I will not repeat them here.
Ron Roberts, The Contractor's Business Coach, teaches contractors how to turn their business into a profit spewing machine. To receive Ron's FREE Contractor Best Practices Newsletter visit www.FilthyRichContractor.com.