Many contractors tell us they use a variable markup (also known as multiple markups) or margin to price their jobs. There is a widespread belief that using a variable pricing methodology works best. The mindset is that sometimes you have to adjust your price to get the job.
It might be a widespread belief, but too often we’ve seen contractors lose money in the long run when they adjust their markup based on the size of the job or for some other reason.
Why do they lose money? It’s easy to reduce your markup for a particular job. But when a job appears that should have a correspondingly higher markup, there are too many reasons to not raise the markup. We’re human, and we fall victim to that human trait called fear.
We fear that if we don’t get our price “just right”, we won’t get the job. We fear that if our price is too high, we’ll be considered dishonest. We fear that if we don’t cut our markup just a smidgen, we won’t be able to keep our employees working. Having sold both remodeling and specialty trades, I’ve been down that path and know that fear. We fear, fear, fear and as a result we don’t discipline ourselves to use the numbers that are needed to maintain a good profit percentage.
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I’m not going to walk through the process of how to calculate your markup or gross margin, I’ve talked about it before and in detail in our book Markup & Profit; A Contractor’s Guide Revisited. Instead I’m going to talk about using your markup, on every job.
In my study of construction companies, I haven’t seen one company using a variable markup that’s more profitable than another company that is doing the same amount of business using a fixed markup. Not one. I’ve seen many companies, using a variable markup or margin, that are less profitable.
You see, when you “adjust” your markup or gross margin to get your price in line with your competition, or what you think your client wants to see, or whatever rationale you use, you promise yourself that you’ll make it up on the next job. Or the next two or three jobs. The reality is that you don’t. You won’t increase your markup on the next job or several jobs for the same reason that you reduced your price for that first job. And the result is that by the end of the year, your overall markup or gross margin is not what it should have been. The reduced price directly reduced your profit (and sometimes, reduced the funds you had available to pay your overhead or your own salary). You did a lot of work for little or no pay.
If you calculate the correct markup for your jobs, then decide to reduce that markup for selected jobs, you must increase the markup for other jobs or you’ll lose money.
Why do contractors cut their prices? Fear. Is it normal for a business owner to be fearful? Of course it is. If you don’t feel fear sometime, you must be of a different species than the rest of us humans.
One of my heroes, John Wayne, said, “Courage is being scared to death, but saddling up anyway.” If you want your business to be successful, there are some disciplines you have to develop and one of them is doing what scares you. It isn’t easy to present a price to a client knowing they might think it’s too high. So you need to adapt a mindset that says this is my price, and if the potential client doesn’t like it, they can get someone else to build the job for less money. They can cause someone else to lose money – you don’t need that.
Think about it. When you talked to your attorney, they told you their rate per hour. Most attorneys aren’t interested in working for less than the rate they need to make a profit in their business. Doctors are the same way and ditto for dentists. This is our price, and if you don’t like it, take your aches and pains elsewhere. Their rates are non-negotiable.
So quit being fearful of your price. Price might be the most important thing in your mind, but it’s not the most important thing to most of your potential clients. Studies have shown that most potential clients place price seventh or eighth on their list of priorities. Of course if you keep focusing on the price, you can make it their number one concern! If more contractors would spend as much time polishing their sales skills as they spend worrying about their price, they would sell more jobs and at a good markup.
Calculate your markup or gross margin to cover all your job costs, all your overhead expenses and to make a minimum 8% net profit. That should be your minimum price. If you do the math correctly, how can you reduce your markup without losing money? When you cut your markup, it comes first out of your profits and when all the profit is gone, it eats into the money for overhead (and your salary is the first thing that doesn’t get paid). You make up for the loss out of your own pocket – or, looking at it another way, you’re paying the client so you can build their job. It’s dumb. There isn’t any nice way to say it.
Having one markup or gross margin will make you far more money in the long run than trying to adjust your prices depending on the job.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.