In 1980, debates among PHC contractors began regarding whether to charge consumers by the hour or by the job. Some contractors sided with time and material pricing while others raved about the benefits of quoting prices before commencing services. Four decades later, the debate continues between T&M contractors and contract pricing (flat-rate) contractors.
Change among human beings is often difficult to accept. However, the way humans act and the circumstances surrounding them are in a constant state of flux. We don’t rely on a horse and wagon to transport personnel, tools and material. We drive motor vehicles that get us where we are going faster. That change allowed us to be more productive.
Sometimes the more things change, the more they stay the same. Whether you use a horse and wagon or motor vehicle to get personnel, tools and materials to consumers, the intent has always been the same. That is, to bring in more money than it costs to provide your services. To take risks and absorb the operational expenses associated with being in business and not have that intent would undoubtedly be foolish.
The dollar isn’t worth the same today as yesteryear. And today, you need more money to operate your business and live your lives. Circumstances change, as does the pressure to bring in more money to your company and to live your lives. It requires the help of increased efficiency.
Since increased productivity increases revenue potential, your ability to bring in more money than it costs you to operate your business increases the chances you have to reach your goals. Simply put — you must be ready to change.
Contract pricing allows you to bring in more money because it affords consumers the ability to know the price before any service commences. Otherwise, they’re anxious as they watch you work, crossing their fingers and hoping you complete the two-hour job in 10 minutes.
As an additional benefit, knowing the price they must pay for any service before it is performed allows consumers to know whether or not they can afford other services from your business at that visit.
The decision you must make is whether to change or not to change. Before you make the decision, let’s look at the pros and cons of T & M pricing versus contract pricing.
And keep in mind a few things. One, you probably already implement contract pricing for some of your services, such as water heater and water closet replacements. Two, if you can do it for those tasks, you can do it for any task. And most importantly, three: “Fair is a two-way street.”
Which method is fair to consumers?
T&M advocates have argued that contract pricing isn’t fair to consumers since it could force them to pay for time or material not used by the contractor in completing the job.
As you should be well aware, products and services the public purchases cost the manufacturers and providers of those products and services money. All successful business people are successful because they charge their customers for the legitimate business expenses they incur and make a profit above those expenses.
This is true unless they forego profit and pay for those expenses themselves, which would defeat the purpose of being in business.
When you buy a sweater in a department store, the price you must pay for it not only covers the cost of the material and the labor to produce it. The price also reflects the rent and utilities the store incurs; salaries and salary-related expenses of the sales and administrative personnel; shoplifting; damaged goods; returns and restocking; and any other legitimate, proportionate cost the business encounters regarding that sweater. A profit margin is included, as well, if the company is to remain in business.
As a consumer, you want to know the price you must pay for an item before you decide to make the purchase. That makes sense since we all have limited discretionary funds from which to make our purchases.
T&M pricing does not give consumers the price of your services before they decide whether or not to purchase said services. That certainly cannot be considered fair.
But quoting the contract price for any described service, and sticking to that price, cannot be considered unfair. The consumer knows precisely the service he is to receive and the price he will pay before he authorizes you to perform the service.
Your responsibility as a contractor is to identify and calculate the labor, overhead and material costs of any typical task. Then apply a profit margin to your costs to develop a properly profitable selling price. Quote that price to consumers, ask for their acceptance of the service and quoted price, and if the consumer accepts, deliver excellence in performance.
For example, most 8-inch kitchen deck faucet replacements take about 75 minutes on average at the jobsite. This includes speaking with the client and creating an invoice/contract that contains the task description, price, terms and conditions. After obtaining the client’s signature, the technician prepares the work area and gathers the tools/materials from the truck. Once the replacement faucet is installed, the tech tests for leaks and proper operation. After cleaning up, techs ask for and receive payment, and thank the client.
Some of those typical replacements might take a bit longer, while others take a bit less time. By using averages for a standard task, the argument of time not spent doesn’t hold water (pardon the pun).
To arrive at the average labor/overhead/material task cost, you must add the faucet price and some additional potential material to the average travel time you incur, as well as your cost for a 75-minute average task time. Apply your chosen profit margin to the total cost. Now you have a fair contract price to quote to consumers before they accept and you perform the task.
That is the essence of fairness. It’s fair because consumers know the price they are accepting before you perform the service, and you recover your cost and earn a profit.
By applying logical reasoning and the fundamentals of mathematics, you can quote prices for any task before starting it.
Since no contractor sells all their available revenue-producing hours all the time, when you use T&M pricing, hourly rates would have to fluctuate constantly. Those hourly rates, if properly calculated, would rise to heights that would not be palatable to consumers, thus causing them to purchase fewer services, if any. That’s less money flowing into the business; earning a profit is less likely since recovering operational costs is more complicated.
Which method is fair to contractors?
When contractors correctly calculate their actual costs, apply a profit margin allowing them to get where they want to go in business, and quote prices before the commencement of services while delivering excellence to consumers, nothing could be fairer to either party.
Even typical tasks have the potential for not being cut and dry. It’s the reason you use average costs to develop your selling prices. Some typical tasks take a little longer and use a little more material while others a bit less time or material. But the consumer has the price ahead of time and only pays the preauthorized price for the predescribed task. Anything outside the described task is another task that should have another quoted price.
When you have a task such as a leak in the ceiling, you have to address each step as a separate task. Cutting a hole to gain access to the plumbing is a different task that may be needed to locate the leak, assess the situation and gain access to the cause of the leak so that repairs can be made. The repair is a separate task.
Doctors call it exploratory surgery, while lawyers call it research. And they both charge their patients or clientele for those services. PHC contractors are quasi-doctors of buildings and self-styled lawyers since they enter into contracts. You would be wise to follow the example of doctors and lawyers who enjoy productive livelihoods.
Making a contract price guide
By sitting at your desk or kitchen table with a pad, pen, calculator or computer, you can start to describe the typical tasks you perform. Then, calculate your real annual operational costs in total and per hour, based on selling all your available potentially revenue-producing hours.
When choosing the profit margin to apply to reach your goals, you must take into consideration the annual number of revenue-producing hours you actually sell. If you only average selling 70 percent of your available tech hours annually, you’ll need a 30 percent profit margin on your labor/overhead cost of a task just to break even.
If you have never tracked the number of hours you sell annually, you’ll have to take an educated guess. But from that point on, start tracking the average annual hours sold. Statistics will give you the proper factors to use in the future.
Next, calculate the average tech times for travel to the jobsite and performance of each typical task. Multiply the sum of time by your hourly labor/overhead cost to arrive at the cost of labor and overhead for the job. Add your average material cost. Divide the sum by the percentage that reflects 100 percent less your chosen profit margin percentage to arrive at your selling price.
Example: A profit margin of 30 percent requires a profit margin divisor of 70 percent. If the cost to perform the service, inclusive of all the properly calculated factors, is $500, and you chose to apply a 30 percent profit margin, you would divide the $500 by 70 percent to arrive at a selling price of $714.29.
This process gives you the task price for the first task of any service call visit. If you do a second task at the same visit, by not including your average travel time (since you are already at the consumer’s location), you can offer to perform the second task at a lower price level than that of the first task. This will allow you to bring in more money to your business.
You also can enhance your guide by including discounted prices for specific clients such as senior citizens, volunteer workers or service agreement customers, or premium rates for after-hour emergencies.
Putting together a price guide is a lengthy process. And it must be kept current. If you need assistance, give me a call. But keep in mind, the times change and if you do not change, you may be using a horse and wagon when you should be driving a motor vehicle.