The Mathway to Success
I’ve always been puzzled by people who look at money as a taboo topic.
Within any form of business, of course, competitors are restricted by federal anti-trust laws from getting specific in discussions of pricing, overhead and profit margins. But it’s always seemed to me that understanding those factors in broad, general terms (which are legally discussable, by the way) is at the core of the success of any business – especially in the world of contracting.
The reason pricing, overhead and margins are so critical is that they reflect your core values and those of your company with respect to both money and overall business philosophy. It’s my informed view that too many contractors severely undervalue what they do and that those who do so will invariably benefit from taking a step back to look at how they can cost and price their work from a fresh perspective.
In this column, I’ll set up some ground rules and touchstones for that exercise. The rest – that is, what you do with the information I’m about to offer – is up to you.
THE BIG PICTURE
It’s a point that’s been made in these pages many times through the years, but it’s one that applies directly to this discussion: If you find yourself treating watershapes as commodities in how you market and price the product, you may well be doomed to failure. In other words, if you categorize what we do with watershapes as a head count of tons of steel, yards of concrete, feet of pipe, number of fittings and square footage of decking, you’re not seeing the overall picture.
Granted, it’s easy to see things that way, especially for those who mistakenly believe that price is the most important issue in the client’s decision to buy. (Actually, price is much further down the list than most watershapers recognize.) And, worse, there’s a misconception that price is the easiest thing to alter and, generally, trim. This is a slippery slope that leads to cut corners, unprofitable jobs and, ultimately, unhappy clients.
By contrast, when you view what you do as flowing from the concept of providing beauty and lifestyle enhancement, it informs everything you do, from the way you interact with the client to the manner in which you construct your price. At the most fundamental level, this “value-added” mindset lets you abandon the notion that garnering business must be a game of cutting your prices. Instead, you work with an understanding of, and insistence upon, what you need and deserve to make.
This point of view is all about having confidence in your own work and feeling entitled to make what you’re worth. Until you make that transition, it will be difficult to see your way to pricing your work as more than the standard “time and material plus markup.”
Given the right mindset, you must put in place a clear methodology for pricing that reflects value. That process begins with good take-offs.
Back when I was first working in construction, I had a partner who came from a general contracting background. For a long time, he made his living by estimating huge construction projects and taking off the details of the job right down to the count of screws and hinges on the doors. When we started working together, he taught me to do that very thing on every single job – and then, when the job was finished, to go back and run the numbers again so that we could learn exactly what we were spending to get the job done.
That exercise emphasized the differences of each of our jobs, even among those that might have seemed similar to past projects when we started. Through the before-and-after take-off, we could see exactly where things changed and how if we didn’t anticipate and accommodate those variables in the future, we’d be shortchanging ourselves.
We were thorough: We’d count all the materials – all the steel, concrete, plumbing and fixtures, every valve and piece of tile, each skimmer, every piece of equipment and all the little parts and pieces that went into the project. To that we’d add the cost for plans, permitting, trenching, backfilling, supplying soil, hauling trash, pre-filtering the fill water, start ups, customer instruction and everything else that had cost us a quarter either for time or materials.
Cost to Customers
As mentioned in the accompanying text, I’ve observed through the years that many watershapers operate under the false impression that clients see price at the most important of all factors in their purchasing decisions. In fact, I’ve seen some firms work themselves right out of jobs because they kept cutting the price and degrading the project to a point where the job moved along to another company.
Honestly, I think that if you explain everything that will be going into a project from start to finish and ask the customer to give their own estimation of what the price would be if they were doing the job, they’d often come up with a number that dwarfs the pricing we develop.
There have been times when a client has questioned me on price. I’ll tell them, flat out, “Given what’s involved, this is exactly what we need to be paid.” And I’ll sometimes add, “If you were in my shoes, doing this project that way we’re doing it, I’m confident this is what you’d charge.”
I’ve yet to have one client balk at the cost when given that explanation.
In addition to all that, we calculated other factors that weren’t so easily defined, such as warranty work. In our effort to be a top-flight firm, we wanted the freedom in our pricing structure to be able to do absolutely everything we had to do to make our clients happy. So we’d build in an anticipated (small) dollar amount for warranty work as a line item. We put that line in on every job (and we marked it up, too, which I’ll discuss below). That meant that when something came up where the client needed or wanted something, we knew the money was there to cover the extra expense – and we were even making money on that work!
We didn’t run into those costs on every job, of course, but in some cases the amount of warranty or extra work ran high, so in time it all balanced out. The benefits this had with respect to our mindset was just fantastic. Instead of dreading those calls and knowing what the requests would do to our bottom line, we were able to greet our clients’ needs comfortably and enthusiastically.
In some cases, we also included a “miscellaneous” category as a line item (and marked it up as well) to add further to our comfort level. Bottom line: We’d include and mark up every single thing we could think of that went into the process from the point the clients gave us the go-ahead to the time they’d start floating in the water.
Add all of these things up and you have a number commonly referred to as the “cost of goods sold” (or COGS). When you have that fully and adequately estimated, then you can confidently add your mark-up to the project.
This mark-up is a key calculation. Indeed, every business owner should periodically take the time to estimate all non-job-related costs that go into keeping the doors open, the lights on and the wheels turning. This includes a range of items such as office space, utilities, supplies, office furniture and equipment, support-staff salaries, travel, training and education costs, insurance, taxes, depreciation, association dues and entertainment.
Those costs should be tallied up and related to each job as a percentage. If, for example, your business does $1 million in annual volume and it costs you $120,000 to keep the doors open, then you know that your overhead is 12 percent. That means you need to clear that percentage with each and every job.
Overhead can vary substantially, of course, depending on the size of your operation, its marketplace position, advertising and salaries. Overhead also varies greatly with volume, which is why it should be periodically recalculated to follow changes in direct costs.
Once you know your cost of goods sold and the overhead you need to clear, you run into the mysterious and wonderful world of profit. Every business is entitled and expected to earn a profit. Gross profit is the total receipts of a business minus the initial cost of goods sold but before deduction of operating expenses and taxes. Net profit is what’s left after all expenses have been deducted from the gross amount.
Without profit, there’s no reason to be in business. Those who continue without earning a profit are not only essentially working for a salary, but they carry the additional burdens and responsibilities of operating a business with no margin for error.
Exactly what your profit should be is a personal decision, but there are important factors to consider. What do you have invested in your business? What could you make if you liquidated all of your assets and invested this amount in income-producing vehicles such as stocks, mutual funds or real estate? What is the value you should receive for the risks that you take as a business owner or manager? These are all questions you must answer for yourself in establishing your profit margin.
I believe as well that it’s critical to consider the nature of the watershaping business in determining that margin.
Consider this: We are in the business of providing what is for most people their second- or third-largest lifetime purchase. We are also in a business that requires us to understand and apply the skills of a range of trades and work in variable environments while tearing up people’s property.
The following is an example of how my firm calculates a final price. These numbers and percentages are presented strictly for the purpose of illustration and are in no way meant to suggest costs and margins that you should apply in your own business.
Selling Price (X) = Cost of Goods Sold (COGS) + Overhead (12% of X) + Desired Profit (30% of X) – that is, X = COGS + .12 X + .30 X or X = COGS + .42 X.
Looking at it a different way, X – (.42 X) = COGS, that is, .58 X = COGS. Therefore, X = COGS ÷ .58, so X = $17,400 ÷ .58 – that is, X = $30,000.
This makes the Base Selling Price (BSP) = $ 30,000. To this BSP, you must add the sales commission at, say, 5%, so the Selling price = BSP + Sales Commission – that is, Selling Price = $30,000. + 5% of $30,000, or Selling Price = $30,000 + $1,500 and the ultimate Selling Price = $31,500.
Note: Since we have added the commission to our BSP, we must deduct it before calculating overhead and profit because the commission is actually part of the COGS calculation. Therefore, this price yields 12% of $30,000 for overhead, that is, $3,600 and 30% of $30,000 for profit, that is, $9,000 in Net Profit.
We’re responsible for workers who drive big vehicles, operate big machinery, dig huge holes and pump tons of water. From technology and technique to blood, sweat and perhaps the occasional tears, we create environments that will, we hope, provide our clients with an ongoing source of pleasure and enjoyment.
Now compare what we do to what, for example, furniture retailers do. They basically acquire a manufactured item from a factory and place it in a showroom or warehouse, where it sits awaiting a buyer. That activity is much less complicated than our business and carries much less risk. Still, we all know that items such as couches, chairs, tables and beds carry huge mark-ups.
I’d argue that if furniture retailers are entitled to a significant profit margin, which they are, then we are, too, and perhaps more so.
One more key factor to consider: Many companies in our industry are quite small, and in many cases the owner is out in the field doing the work or supervising the project right along with the crews. If that’s the case, you have to calculate what you’d have to pay someone else (as capable as you are) to do what you do.
As an owner, you should not view yourself as someone who is working for a wage, but you do need to ask yourself what you would have to pay to replace yourself. Again, how you factor that into the profit and/or overhead equation is a personal issue. My point is that if you don’t consider your own value and include it in the mix, you’re shortchanging yourself.
And all of that should be reflected somewhere in your costing structure.
There was a time in this industry when a majority of firms applied sets of standard factors to come up with prices, such as a standard cost for X square feet of pool-surface area or X square feet of deck or X square feet of landscaping.
I’d argue that such an approach is obsolete. Not only is it a shortcut and, ultimately, the lazy way to go, but there’s no way in today’s market, especially in custom work, that “eyeballing” a price will accurately reflect both true costs and an appropriate profit margin.
You can use several different formulas to determine a final selling price, and I offer an example of one I’ve used in the sidebar just above. Whatever you do, the key is to consider the full cost of what you do for your clients and how much you want to make. You’ll find that when costing and pricing are based on hard math that can be confirmed in real numbers, you’ll have an increased sense of tranquility as you approach the often grueling challenges of watershaping.
Brian Van Bower runs Aquatic Consultants, a design firm based in Miami, Fla., and is a co-founder of Genesis 3, A Design Group; dedicated to top-of-the-line performance in aquatic design and construction, this organization conducts schools for like-minded pool designers and builders. He can be reached at [email protected].