Before you can develop a properly profitable selling price for your services, you must determine certain factors. The first, most important, and the foundation of properly profitable selling prices, is your true operational cost. I emphasize the word “true” because there is a difference between perceived operational costs and your actual true cost.
The second, and equally important factor, is the application of a proper profit margin to your true cost. The third factor is the delivery of excellence to consumers so they can receive value for the dollars they pay to you.
The importance of true cost
If you forget to include any operational expense in your budget or miscalculate your true operational cost, your perception of your foundational cost will be flawed. When building foundations are flawed, buildings are in jeopardy of collapse. When your business’ perceived operational cost is untrue, your prices will be flawed, and your business’ financial strength and your potential for success are at risk of collapse.
To demonstrate the importance of contractors knowing their true cost, I’ll tell you about my brother-in-law, a retired plumber, who is selling his home. He recently called me for advice. The potential buyer hired a home inspection company to check out the home. The inspector reported to the potential buyer the fact that the forced air heating unit had a crack in the heat exchanger.
My brother-in-law asked me what that meant. After explaining the fundamentals of forced air heating and the steps which determine if a heat exchanger is cracked, I asked him to expandd on the inspector’s report. However, there was no explanation other than the claim that the heat exchanger was cracked.
Since my PHC business does not operate in his location, I suggested he contact a qualified HVAC contractor for a second opinion. With a second opinion of a qualified heating technician, he would know if the inspector’s claim of a cracked heat exchanger was indeed fact or fiction.
My brother-in-law called three HVAC businesses to find out if they performed heating inspections. They all said they did. However, the curious thing, and reason for my relating this incident, was the difference in the selling prices of these three contractors for the same service in the same geographic area. One charged $125, while another charged $180, and the third charged $400.
As fate would have it, the contractor who would come the fastest was the one who charged $125. Since my brother-in-law wanted to get to the bottom of this situation to expedite the sale of his home, he made an appointment with that HVAC contractor.
After thoroughly inspecting the unit the tech found there was no crack in the exchanger. He found the it was actually replaced 10 years ago before my brother-in-law bought the home.
My brother-in-law wanted to get yet another opinion. But, after he received the heating tech’s opinion, he questioned the home inspector’s report. He found that the original home inspector never did any test or inspection to determine if there was a crack in the exchanger. This is the reason the home inspector didn’t realize the exchanger was newer than the original heating unit. He just relied on the age of the original heating unit in totality and assumed the exchanger was cracked. This admission by the home inspector negated the need for any further inspections of this unit.
Now back to the point of this article. Why was there such disparity in the prices charged by contractors for the same service in the same area? Answer: not knowing true operational cost leads to improperly arrived at selling prices.
The true operational hourly labor/overhead cost to PHC service contractors in the U.S. is between $100 and $250, if all available tech hours are sold all the time. That’s what it costs the contractor, not the selling price. In the geographic area where my brother-in-law lives, the cost of labor and overhead to the contractor is minimally between $150 and $250 per tech hour.
My brother-in-law told me the tech was at his home for about an hour. To that, travel time to his home must be added to arrive at the contractor’s true cost. Conservatively, assuming travel time to be at least 15 minutes makes the time spent to perform the service minimally 1¼ hours. That means the minimum cost to a contractor in that geographic area for that service is between $187.50 (1¼ hours X $150) and $312.50 (1¼ hours X $250).
The contractor who charged $125 minimally lost $62.50. The contractor who would have charged $180 would have minimally lost $7.50. The only contractor who had an opportunity to recover his cost and make a profit was the contractor who charges $400 for that service.
Obviously, the contractors who charged $125 and $180 for that service do not know their true operational cost. Or, they like losing money for the services they perform. They could avoid the loss they incur for performing this service by charging at least what it costs them. They wonder why they are not maximizing their profit potential. This problem is pervasive in the PHC industry.
Choosing a proper profit margin
Since the only reason “for profit” businesses exist is to earn a profit, you must apply a proper profit margin, which will set your prices above the true cost you actually incur to be in business. I am often asked by contractors, “What profit margin should I charge?”
Since there seems to be a good deal of confusion in the industry regarding the difference between a markup on cost and a profit margin, I will first explain those differences. Both require a mathematical process. Let’s look at an example: one tech hour cost to contractor of $100 for labor and overhead (the lower end of the aforementioned cost to contractor range in the U.S.); and, a hopeful 10 percent profit.
A markup on cost is arrived at by multiplying the cost you incur for an item by a predetermined markup percentage. When you multiply the $100 hourly tech labor/overhead cost by 10 percent you get $10. By adding the $10 markup to the $100 cost you incur, your selling price for that hour becomes $110.
A profit margin is a percentage of the total selling price. When utilizing the profit margin method of arriving at your selling price, you must use a different mathematical process. You subtract your desired profit margin percentage from 100 percent. Then, you divide the item’s cost by the difference between 100 percent and your desired profit margin percentage. Since 100 percent – 10 percent = 90 percent, you would divide your $100 tech hourly labor/overhead cost by 90 percent. Your selling price for the hour would be $111.11. In this example, the profit margin method would give you $1.11 more than the markup on cost method.
To further emphasize the reason to use the profit margin method over the markup on cost method, look at the results of discounting the 10 percent you thought you were making using the markup on cost method.
If you offered a consumer a 10 percent discount on your $110 (markup on cost) selling price, you lose $1 since 10 percent of $110 is $11, and, $11 subtracted from $110 only gives you $99 for an item which cost you $100 to produce.
The same 10 percent discount on the profit margin method selling price of $111.11 would render a discount of $11.11 making the discounted selling price $100 for an item which cost you $100 to produce. Although you didn’t make a profit, you didn’t incur a loss as with the markup on cost method.
Once you come to the realization that the profit margin method is the one to use, you must choose a percentage which will get you where you want to go. Since your true cost of operation should be calculated on your maximum potentially productive hours, and no one (except for the liars) sells all their tech hours all the time, your desired profit margin percentage should take into consideration your unapplied labor factor.
If your hourly tech labor/overhead cost is $100, if all tech hours are sold all the time, and you only sell 70 percent of your available tech hours on average, your profit margin must be at least 30 percent to cover your cost. This is due to the fact that the $100 cost would actually cost you $142.86 when 30 percent of available time (unapplied labor) if not sold.
If you subtract 30 percent from 100 percent you get 70 percent. Dividing your $100 cost by 70 percent would give you a selling price of $142.86 — no loss, no gain. However, if you are planning on discounting services for senior citizens, service agreements, friends etc. as part of your pricing policy, and you want to earn a profit, your profit margin would have to be higher, unless you really don’t want to make a profit. “Why did you go into business?”
I realize throwing all these numbers at you in an article can be overwhelming. That’s why I always encourage you to call me for your contractor profit advantage. Numbers don’t lie. Using correct numbers is imperative to the calculation of your selling prices and business success.
The delivery of excellence earns trust
The delivery of excellence to consumers is necessary to give value to the consumer for the dollar amounts you must charge to recover your operational cost and earn the reward you deserve for the risks you take being in the business of serving the public.
The home inspector’s claim that my brother-in-law’s heat exchanger was cracked obviously was lacking excellence since he did not deliver value, or truth for that matter, to his customer, and since he didn’t execute the proper procedure for determining such a claim.
Your expertise, honesty and delivery of excellence are as paramount to your business success as your knowledge of your trade, your true cost and your choice and application of a properly profitable margin to your true cost so that your selling prices are profitable for you and valuable to the consumers you serve.
Although the heating company who checked my brother-in-law’s heating system for the second opinion did not know the true cost incurred to run their business, I feel certain that business’ integrity is intact since they performed the service and did not try to sell my brother-in-law a job he didn’t need.
Consumers want to trust the PHC contractors they choose to tell them the truth about their circumstances, and stand behind their workmanship when the job is done. The cheapest price in town is worthless if the consumer really didn’t need or want a service to be performed. It is further devalued if the workmanship is at best mediocre.
Price is third in line after trust and the belief that a contractor will stand behind their workmanship. A $500 job that only lasts a year is more expensive and worth less to the consumer than that same job at $1,000, which lasts three or more years.
Excellence to consumers, knowledge of true cost and the application of properly profitable selling prices will give you the opportunity to attain your contractor profit advantage. If you need help, call me.
Richard P. DiToma has been involved in the PHC industry since 1970. He is a contracting business coach/consultant and an active PHC contractor. For information about the CONTRACTOR PROFIT ADVANTAGE or to contact Richard: call 845-639-5050; e-mail firstname.lastname@example.org; mail to R & G Profit-Ability, Inc. P.O. Box 282, West Nyack. N.Y. 10994.