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As a contractor, you know your selling prices should be based on the estimated time you think it will take to perform a task, the material you will consume in the performance, and the profit you would like to earn. At least, that’s the way it is supposed to be done.
However, as we all know, humans tend to be lazy. Many lackadaisical contractors find out what their competition charges for the same task and then charge a dollar less.
This practice is, at best, foolish. It is imperative to consider the possibility that the contractor whose prices were copied may not have properly calculated his true operational business costs. The contractor may be following the competitor contractor off a cliff into the abyss of business failure, extreme stress and ultimate frustration.
Contractors who use the prices of others to arrive at their company prices are using the wrong numbers. This is true not only because those factors could be erroneous for the competitor contractors being copied but, more importantly, those numbers do not reflect the true operational business cost of the contractors who are emulating and implementing the prices of others. It is important to realize that wrong numbers produce wrong results.
As a PHC contractor, I concluded so many years ago that most contractors don’t know their own true operational business costs. It led me to fill a void in the industry, so I became a contracting business consultant. As a consultant, when I ask contractors how much they charge per tech hour, the answer flows off their tongues as quickly as if I asked them to name the state in which they live.
However, when I ask those contractors how much a tech hour truly costs them to produce, the overwhelming majority answer with silence or babbling of misinformation, which tells me they don’t know their true operational business costs.
The truth is that the miscalculation of true operational business costs has a devastating effect because it causes contractors to shortchange their businesses. And, for those contractors who charged a dollar less than their competitors, the devastating effect is further exacerbated.
Since you only have three choices regarding the selling prices you charge for your services — at, below or above your true operational business cost as it proportionately pertains to any service — it is wise to know that cost.
You might be wondering why I refer to operational business cost as true operational business cost.
It’s because many contractors don’t look at the whole picture. They consider items constituting business expenses — such as wages, salary expenses, trucks, vehicular expenses, insurance, advertising, rent, communications, and a myriad of other legitimate business costs — as their total operational business cost.
And, they would be correct since those items must be considered, but they do not accurately represent all their operational business costs. They are only a part of the true operational business costs they incur to operate their businesses.
Fixed vs. variable expenses
Before you can properly identify your true business expenses, you must understand that business expenses come in two varieties — fixed and variable. In identifying business costs, you must also understand those two varieties fall into two other categories — tangible and intangible.
By fixed expenses, I mean that although you may buy a gallon of gas for your truck at a certain dollar amount per gallon, the price charged for it is always in a constant state of flux, especially during this turbulent time. It was fixed at the time of purchase; however, as things change in the marketplace, the cost becomes variable.
Variable means your cost also changes depending upon your business protocols. For example, your total tech salary cost and related salary expenses change every time you add a new technician to your business. In addition, you need to purchase another service vehicle with all the ancillary expenses that come with ensuring it is properly equipped.
As your business grows, your administrative staff costs could rise if you need to hire more office personnel to help manage your growing business. These variables, in turn, will affect the hourly tech cost you incur to calculate your selling prices in a proper and profitable manner.
Intangible vs. tangible costs
All the aforementioned tangible business costs you, as a contractor, incur are subject to change by forces beyond your control. Even fixed expenses vary to some degree. So, you must constantly monitor your business costs to adjust your prices accordingly.
In addition, you must consider those business costs that you don’t see a dollar amount affixed to but that you do incur. Those costs may be intangible but they are costs in operating your contracting business. Even the most fastidious contractors get callbacks — an example of an intangible business cost that must be calculated into your budget so you can properly and profitably arrive at your prices.
Another intangible cost is bad debt, such as when a consumer doesn’t pay for your services in totality and as agreed. Even if you believe you always get paid for your services, I’m sure you have some consumer-generated bad debt.
It comes in different forms. You may have knocked off a few bucks when the customer argued about the price after completing the service, even though you gave him the price before starting the service.
Or, for those contractors who take consumers to court in order to receive their payment, going to court costs your business even if you act as your own attorney. And then there’s the fact that getting a judgment in your favor doesn’t guarantee you will get the money into your bank account without further costs to your business.
Yes, all contractors have an intangible bad-debt expense in their business, whether they believe it or calculate it into their prices.
To arrive at your true operational business cost, you must include all your tangible and intangible expenses in a correct, fundamentally mathematical and logical manner.
Then, to arrive at your properly profitable selling price of any service, you must appropriately proportion the cost of the service based on your correctly calculated true operational business cost and apply a proper profit margin to said true cost.
Calculating tech hours
Another factor must be considered in establishing selling prices because it affects the true cost of any service: the number of tech hours you will sell in a year. However, unless you possess a crystal ball allowing you to see into the future, you need an educated estimate of how many hours you actually will sell annually.
You needed to have statistically tracked that type of information to do it accurately. If you are guesstimating now, start gathering statistics for accuracy in the future.
If you calculate your true hourly operational business costs based on selling your maximum annual amount of potentially revenue-producing tech hours and sell less, your true hourly labor/overhead tech cost will increase.
For example, suppose you calculated your labor/overhead cost for one qualified tech and one properly equipped service vehicle to be $100/hour to your business but only sell 70 percent of your maximum annual potentially productive hours. Your true cost rises to $142.86 per tech hour.
In that instance, you would need a 30 percent profit margin and sell the hour for $142.86 to break even on your true labor and overhead business cost. The formula to apply a profit margin is to subtract from 100 percent your desired profit margin (100 percent — 30 percent = 70 percent). Dividing $100 by 70 percent gives you a selling price of $142.86 ($42.86 ÷ $142.86 = 30 percent).
In this example, keep in mind that you only recover your true operational business cost; there is no profit. It means you have not attained the goal for which your business existed in the first place.
Imagine losing $42.86 for each tech hour you sell. In a year, that’s more than $51,000/tech. You would need an excessive markup on your material to make up for it. And remember, consumers can find the price of anything in today’s internet-based society.
If you use a contract-pricing method (aka flat rate or upfront pricing), your material prices are camouflaged in your total selling price that need not be itemized.
But if you are a time-and-material pricing contractor and must itemize your bill, the cascading effect would present more arguments when the bill is expected to be paid. In turn, the aforementioned bad-debt factor would increase dramatically.
Let’s look at the effects of shortchanging your selling prices per tech hour at different levels in Figure 1 when you sell your maximum annual, potential revenue-producing hours of 1,708/tech.
As you can see, it’s a lot of money to leave on the table. Addressing this problem by properly calculating your selling prices could make you profitable and help you pay for any bills that are piling up. If you need help with your numbers, give me a call.
In more than 30 years of contracting business consulting, I’ve found that many PHC service contractor owners shortchange their businesses by $30/tech hour. It’s bad for the contractor, employees, consumers, creditors and the industry
Calculating your costs and selling prices properly and profitably surely beats the anguish caused by the miscalculation of selling prices.