The science (and art) of mark-up Washington DC

Last month I received a phone call from a very worried contractor. His sales are down more than 30% from this same time last year, he doesn't think that's going to get better soon, and he thinks he's losing work because many of his bids are priced high. "What do I do," he asked, "just cut my prices to get work?"

My answer was, "Maybe!" After talking with him about his overall pricing strategies, it didn't take long for me to realize he had no strategy about pricing. He had made an Executive Decision last winter that he wasn't making enough money, so this year he would price his work not at a 1.4 Mark-up Value but a 1.9 factor.

Now, I have no earthly idea why he jumped from a 1.4 to 1.9 factor, but his move nonetheless was proving disastrous. Unfortunately, this strategy to increase Mark-up Value is all too common among U.S. contractors, and many contractors, including some successful in spite of themselves, have no strategy! Here are some thoughts to help you avoid what my contractor friend all too clearly experienced: a pricing disaster!

First of all, a Mark-up Value represents what we basically add to estimated costs, including overhead, to complete a job. And if we want to make a particular profit for each project this too must be considered and added to the estimate.

If a contractor's overhead represents 30% of annual expenses then a ".3" must be added to the Mark-up Value. Therefore a Mark-up Value of "1.3" would represent what a contractor would need to make in order to cover overhead of about 30%.

But a Mark-up Value of 1.3 does not take into consideration any profit. So if the contractor desires a 20% profit then add an additional ".2" to the Mark-up Value, making the new Mark-up Value "1.5." But what happens if a 1.5 Mark-up Value still isn't getting a contractor the amount of work he desires to land? Here's where having developed a strategy can help.

1. Track all your numbers. You should track how many bids you have generated, bids you won, the percentages, and by size of projects bid. Likewise, you should track the average Mark-up Value used for each bid generated, and the gross profit on each project, comparing this figure against what the average Mark-up Value was for each job.
2. Keep your overhead as low as possible! This is a problem with contractors struggling to grow, but remember that every time you add expenses that are not directly tied to the delivery of work you increase the overhead you need to cover in the offseason or when sales are down.
3. Continue to look for ways to lower actual production costs. The more efficient you and your crews are, the more gross profit can be realized. For instance, if your crews have a high percentage of customer call-backs or rework then you would do well to get the root cause identified and corrected. Rework can cost two, three, or even four times the estimate.
4. Be sensitive to competitors' pricing. While you may not know the exact bid strategy your competitor is using, and remember, most contractors don't have a bid strategy, you should be able to piece together how much you are losing jobs by. Often a customer will share with you that you were too high by X% or dollars, but always ask what the difference was in losing a bid. Over time you may be able to see a pattern that perhaps you are 5%, 7%, etc. too high. Likewise, when you win jobs don't be shy about asking how close some of your competitors were to your price. You may find out that you are pricing your work too cheap.
5. Mix your bids with different Mark-Up Values. Be strategic, but try bidding similar types of work at different MV factors. You may be able to circle your competitors and find what Mark-Up Value will land more work for you. If a 1.5MV wins you 70% of bids you might try a 1.8MV factor to see where the up limit is. If you continue to get 60% to 65% of the jobs you bid I would suggest you are still leaving money on the table and should raise your MV to 1.9, maybe even 2.1, just to test the up limit. Now, if you want a lot of work at a particular price range and you're getting 60% to 70% of the jobs you bid then leave well enough alone. Just remember, if your winning percentage is high (greater than 60%) chances are just as high that you are pricing work too cheap.

Setting your Mark-Up Value is both science and art. Don't be price foolish, but determine what your historical Mark-Up Values have been, what your market will accept, and then price accordingly.

Brad Humphrey is president of Pinnacle Development Group, a management consulting firm to the construction industry. Brad has written several books for business owners and leaders and has begun to put many of his writings onto CDs. For more information about Brad and his available resources visit www.pinnacledg.com.