Finding the best margin can be more art than science. Setting the price that returns a good profit while satisfying the customer can be difficult, even when a remodeler has a good handle on all costs, including variable vs. set costs, undocumented expenses, consumables, material estimates, and all the other expenses.
A remodeler should aim for a mark-up of between 40 and 50 percent, stresses Leslie Shiner, president of the Shiner Group, a Mill Valley, Calif.-based consultant who works with remodelers on business management. Many don't go that high, fearing they will lose work. Others think they're getting that much, but in fact are getting significantly less. And some misunderstand the difference between margin and mark-up, using the wrong one and eliminating their profit.
Many financial statements display the company's margin, and contractors assume that's the percentage by which they should mark up their costs. But in fact, it's the percentage of the total bill that is profit — and that's entirely different:
- On a project that costs the remodeler $100,000, a 50-percent ($50,000) mark-up means the project will be billed at $150,000.
- That same project has a margin of 33 percent, because one-third of the total amount billed ($50,000) is profit.
Too many contractors take their cost ($100,000), mark it up by their anticipated margin (33 percent, to $133,000) and then can't figure out why they aren't making as much as they should. It's because, in this case, they just undercalculated and left $17,000 on the table, while thinking they're receiving a 33 percent margin. In fact, their margin was actually about 25 percent — and they won't live long on that.
Labor and materials
Some contractors try to create different markups for different aspects of the estimate, providing more detailed breakdowns for clients, especially for materials and labor. Shiner discourages this, as it encourages an a la carte approach — and with the Internet providing easy access to discounted pricing on every product from lighting to appliances, displaying detail can work against the contractor. "It's a real danger to provide too much explanation," she says.
Some remodelers feel they have to mark up products less than labor because so much information is known. That also leads to problems. "Too many owners think they have to compete against Home Depot, but they can't do that. You're not selling products; you're providing a service. Don't provide breakdowns, even if you do use different mark-ups on different projects or sections."
Remodelers who mark up their labor-billing rate significantly to keep material costs lower can be caught short on jobs that are not labor-intensive and thus don't cover their own costs.
"You can end up with a significant billing shortage if you try to vary mark-up and make one aspect carry more weight," she warns. "You have to understand where your profit comes from in each component if you're going to mark up different activities or materials differently." That requires a salesperson and estimator — usually the owner — who understands the relationships.
One of Shiner's clients, a high-end remodeler, made his profit by marking up the rates his subcontractors charged. Later, forgetting the impact it would have, he decided to do his own framing. Those jobs lost money, because he hadn't marked up that labor or material sufficiently enough to cover his costs, as he'd always been covered by his sub costs.
"It is absolutely vital to create a process to analyze your costs on each job to see how they vary and where you really make your money," she stresses. "You have to know exactly what you spent and what you made and why. Until you know those variables, you're flying blind. Too many remodelers are fooling themselves that they are making more money then they are."
That ultimately will come back to bite them — and by that time, they won't know why it happened.
