Single Discipline Leads, Referral Fees

A note we received:

I have a question about mark up. I followed the steps in your Markup & Profit book to calculate the proper markup for my business. I run a general contracting & design/build firm.

Occasionally I receive requests to, example, refinish hardwood floors which we do not do ourselves but utilize a subcontractor. I would consider this to be a specialty trade and my markup is based on a general contractor. So when I use my markup it really pushes that number and I feel that I should lower it to a reasonable markup for a specialty trade.

I know your book mentions a general range for a specialty contractor markup to be 1.40 to 1.50. I don’t typically take on projects like this, only if I have been referred to the client and essentially the client is looking for someone to manage and oversee the work. They want to deal with one person not multiple contractors.

Should I just use my calculated markup or reduce it to the general range for specialty contractors? Or maybe apply a consulting fee in lieu of the markup?

I ask as in the past, I have had a couple of prospects advise me that my “number was too high”, I obviously did not do a good job of selling my company, but they went direct to say a flooring contractor. Because I’m the middle man, my subcontractor loses out a potential project. Not sure how to address this. I’d appreciate your insight.

First off, as she mentions, it’s important to calculate your own markup and use it. If you’re a remodeling or renovation firm like this one, almost always your markup will be at least 1.50. If you’re a specialty contractor, your markup might be in the range of 1.35 to 1.50. Whatever type of work you do, it’s important that you do your own math to be sure all your overhead is covered and you can make at least an 8% net profit.

It’s also important to use your markup on every project. Don’t lower it for any reason. So what do you do in a situation like this?

In my opinion, as a general contractor, you shouldn’t take on a project that uses only a single discipline or even two disciplines. Leads for projects like this should be passed on to a specialty contractor who will pay you a referral fee for the lead.

I realize the client might be looking for someone to manage and oversee the work, but if you refer a responsible subcontractor, you aren’t needed. Explain that to the owner. Let them know they’re in good hands, and give the lead to your sub. If they still want you involved, tell them you’ll charge a job supervision fee as outlined in Chapter 4 of Markup and Profit Revisited, but I’d try to avoid this. A project like this will eat up your time, keeping you from the work you should be doing.

The note stated, “Because I’m the middle man, my subcontractor loses out a potential project.” That’s true, and it’s one reason you shouldn’t get into the position of being a middle man. If your specialty contractor is dependable and conscientious, you aren’t needed. If they aren’t dependable and conscientious, don’t recommend them. You shouldn’t take on any project unless you can add value. You’re wasting time that could be spent doing business with another client who needs the work you do.

A referral fee is appropriate because it was your advertising dollar or your previous experience with this client that generated the lead. But since you aren’t doing the work, don’t get greedy on the referral fee.

I often hear from contractors who are offered a lead, but the person offering the lead wants a referral fee of ten to twenty percent of the sales price. That’s too much. You don’t spend ten to twenty percent of your revenue on advertising, so why should you spend that much for a single lead? Look at it another way; your goal should be a minimum net profit of eight percent. Why would you pay more than that as a referral fee?

Referral fees should be two to three percent of the sales price of the job. They should also have a “not-to-exceed” clause for larger jobs. For example, you’ll pay (or you’ll ask for) 2.5% of the sales price of the job, not to exceed $500 or maybe as high as $750. A referral fee is a courtesy; it shouldn’t be a major moneymaker.

As a reminder, when a client says that your “number was too high,” it’s because you’re quoting prices before you’ve gotten the budget for the job set. We discuss how to handle that in Profitable Sales, A Contractor’s Guide, and you can read more about it in this article on our website.