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Before you can solve any problem, you must recognize the fact that a problem exists. Then you must identify the problem. Not properly pricing services to maximize profits is the biggest problem contractors encounter. Many contractors sell their services below their true cost and have no profit to maximize as they accrue deficits and scratch their heads in bewilderment.
Not knowing how to identify actual costs is the foundational cause of this mathematical problem. If you don’t know your actual expenses, it is impossible to know whether you are selling your services above the cost you incur to provide said services.
You can guess at your true cost, but guessing is not knowing. And since you only have three choices — sell at, below or above your true cost — the odds that your guess will be wrong are 2-to-1 since only selling above your actual cost can fulfill the reason your business exists in the first place. Not choosing a properly profitable margin to apply to your actual costs exacerbates the problem.
A lack of confidence in your prices combined with the fear that consumers will question or not accept your prices brings up another problem: consumer questions. Address consumer questions about your prices or any issue regarding your business in an honest, intelligent, informative and rapid manner. It will give consumers confidence in your abilities to professionally address their requests.
If you employ technicians who lack confidence in your prices and do not know how to properly serve your clientele, your problems fester by proxy. Dealing with this problem requires you to hire techs who are qualified as good business surrogates as well as good technical agents representing your business.
The three biggest problems you, as a contractor, face are improper and nonprofitable selling prices; not knowing how to give consumers a reason to trust your business; and not hiring and retaining good techs.
Knowing your true cost
Knowing your true cost is the foundation of appropriately profitable selling prices and requires identifying all your tangible and intangible expenses. Tangible means you spend actual dollars, such as buying a truck or a gallon of fuel for the truck.
Intangible means those issues that cost you money through actions, such as callbacks, consumer relations, etc. All contractors have callbacks, even the one-person operation who never admits mistakes or shortcomings. Therefore, ignoring the existence of callbacks when calculating your real costs and developing your selling prices is foolish.
Identifying your real costs requires you to address all administrative and technical salaries and salary-related expenses such as FICA matching funds, unemployment and disability insurances, vehicular expenses and a myriad of miscellaneous expenses.
Once you accurately identify all your true costs, you must apply a proper profit margin to fulfill the reason your business exists — to make and maximize a profit above your true cost.
Maximizing your profit requires you to consider your goals and the issues that can affect your ability to earn and maximize your profit. A profit margin is not the same as a markup on cost. Profit margin is the percentage of money related to the selling price you get to keep (before taxes) after all your expenses have been met.
For example, if your labor/overhead cost (based on selling all your tech hours all the time) is $700 and your material cost is $300 for a task, your total task cost is $1,000. If you want a 10 percent profit margin, your selling price would be $1,111.11 ($1,000 ÷ 90% = $1,111.11). Your pre-taxed profit is $111.11. That $111.11 represents 10 percent of the selling price ($111.11 ÷ $1,111.11 = 10%) and that 10 percent is referred to as a profit margin.
If you marked up the $1,000 cost by 10 percent, your profit would only be $100 ($1,000 x 10% = $100). Your selling price would be $1,100. In that instance, you would have missed the opportunity to bring in $11.11 to your business and your profit margin is only 9 percent ($100 ÷ $1,100 = 9%). In other words, you neither attained a 10% profit margin nor maximized your profit.
If your strategy is to set your prices and offer discounts, your profit margin must absorb the discounts without jeopardizing your ability to bring in more money than the service costs you to deliver. Therefore, a 10 percent discount on a task that only has a 10 percent profit margin defeats your purpose for being in business — it would only recover your cost if you sold all your tech hours all the time.
However, since no contractor sells all available tech hours all the time, an unapplied labor factor must be considered in choosing your profit margin. As I describe this factor, I will refer to tech hours. Please understand that I do not recommend time and material pricing. I believe in contract pricing (aka flat rate or upfront pricing), which gives the consumer a price before commencing service.
Contract pricing is based on the average tech's average time to perform a service, multiplied by the hourly labor/overhead cost if all tech hours are sold all the time. The average material cost spent on the task in question is added to that task’s average labor/overhead cost to arrive at the total task cost to you, the contractor. Next, your profit margin is applied to the total task cost to arrive at your contract-selling price.
With this pricing method, combined with the excellence of techs who are above-average and administrative personnel who know how to purchase material wisely, profits can be maximized.
True cost per tech hour should be calculated on selling all your available tech hours all the time because it is the only constant. Business hours sold fluctuate; sometimes you sell more hours than other times. Therefore, your profit margin percentage must be higher than 10 percent to attain your 10 percent goal.
If you only sell 70 percent of your available time on average, you need a 30 percent profit margin just to break even on labor and overhead expenses. If you only earn a profit on material, you should consider getting out of the contracting business and open a material supply house business. However, there, too, you will encounter labor and overhead costs for the personnel, equipment and real estate you employ, use and occupy.
If all tech hours are not sold all the time and you only sell 70 percent of your available revenue-producing tech hours, the previously mentioned example task estimated to cost $1,000 to perform would increase. The estimated labor/overhead expense would increase by 42.86 percent, making your actual labor/overhead cost $1,000.
When you add the $300 material cost, your total true task cost is $1,300. In which case, instead of earning a profit, you would incur a loss.
Properly applying mathematics to your business numbers is as important to your business’ health as measuring the pipe's length twice before cutting the pipe is to perform a task.
Addressing consumer questions
I don’t know anyone who likes to be told untruths. Misinformation is the foundation for a lack of trust. If consumers don’t trust you, they will have difficulty with any price you quote to them. When that happens, you will have difficulty closing the deal.
Understand that consumers prefer honest, intelligent, precise and rapid answers to their questions so they can decide whether they want your business to perform a service for them.
The following example is an excerpt from my book, “Solutions Management Theories and Methods for the Contracting Business:”
“A consumer asks, ‘How much do you charge per hour?’
“By not charging by the hour and implementing contract pricing protocols, your honest, intelligent, precise and rapid response could be:
“‘We do not charge by the hour. We charge by the job. Think about it, (caller's name); you don't want to pay by the hour. You want to know the cost of the job before you authorize the work to be done.
“‘When you pay by the hour, you don't know the cost until after the job is finished. If the person performing the work is slow or unfamiliar with the task you need performed, you, (caller's name), will be paying for that slowness, inefficiency or lack of ability.
“‘If you pay someone by the hour, (caller's name), it would be in that person's interest to stretch the job as long as he/she could. This would cost you more money.’
“Using a contractor who charges by the hour is like ordering a meal from a menu with no prices. When it comes time to pay, they both may be hard to swallow.”
With an answer like that, consumers with a modicum of intelligence will know you are an upfront, elegant and intelligent businessperson. They will understand that knowing the price beforehand is wiser than getting sticker shock after the job is done.
Striving for ‘Star Techs’
A “Star Tech” is a technician who possesses certain assets and strives to be the best. If you want “good help," you must know what to look for before hiring anyone.
There are seven top assets a candidate for employment must possess. People either have them or they don't. Star Techs must have them all: integrity, loyalty, aptitude for the position for which they are being considered, great mental attitude, self-motivation, excellence in performance, and the intent to follow legitimate orders. There are many more than those seven needed, but they can be taught.
Once you have ascertained that the candidate for employment possesses those assets, you must decide whether or not to give probationary employment for a short term (one to six months) to see how things work out.
This means you must objectively evaluate the probationary employee’s performance. And if you keep the person on staff, you must continue to evaluate performance throughout the employee’s time at your company. Performance evaluation requires a list of issues you must critique without prejudice.
Retaining great employees requires you to make them feel comfortable in their employment and content in their compensation. If they feel comfortable but under-compensated, or feel contently compensated but underappreciated, you are asking for problems and may not be able to retain them in your employment.
Appreciation is easy to show; put on a smile and give a pat on the back. Content compensation is more complex to deliver. I believe a bonus or commission incentive program based on employee performance and doable goals can enhance compensation above salaries and keep your staff content.
By rewarding techs who perform in a superlative manner, you are giving other techs a model to emulate.
If you have any questions regarding the information contained herein or need help in solving any business problems, please give me a call.