Pricing & Margins Are Key Elements to Survival
The buying experience is the one area that can be unique to your firm, and you need to evaluate and manage this at every turn.
It’s likely that over the past two or three years, you have seen a pretty drastic change in the markets that your kitchen and bath firm serves. Consumers are shopping harder than we have witnessed in many years as they try to stretch incomes that have, in many cases, actually shrunk in terms of real purchasing power. Obviously a number of potential customers have simply dropped out of the market for remodeling work.
Add to this the fact that new-home construction in most areas of the country is at a virtual standstill, converting every laid-off superintendant and carpenter into a remodeling contractor, and you have more competition than you’ve probably ever seen.
In Econ 101, we learned that when supply exceeds demand, the tendency is to drive prices down. So, you may need to ask yourself what is a reasonable strategy to pursue in light of such circumstances?
This month, we’ll look at several elements of a successful survival strategy. We’ll try to answer questions such as “What is the impact of competing on the basis of price?” “Can your firm’s projects be considered commodities, where price is the only way to differentiate them?” “Are you listening to what your clients want or designing beyond their means?”
Price Competition
In this kind of market, there’s going to be a great deal more emphasis on price than we have experienced in a long time. So, the first thing we need to do is take a hard look at our costs.
You need to start this process by looking at your overhead. It’s likely that in the boom years that preceded the current downturn, a lot of things were added to this category that simply cannot be sustained any longer. Is your firm buying season tickets to the local NFL team? Is the company paying for that luxury car you’re driving? Are your employees receiving perks and benefits that your competitors are no longer absorbing?
Look over your income statement, line by line, and make sure that each and every expense is absolutely necessary to produce the level of service needed for your place in the market. Even if you cannot adjust or eliminate some of these expenses right away, you can make plans to deal with them as soon as practical. You can be sure that at least some of your competitors are performing this kind of analysis.
Next you need to look at your costs of sales. Are you getting the most competitive prices possible from your suppliers and sub-contractors? When you’re bidding a job are you, at least occasionally, getting second quotes on various elements of labor and materials? Your subs may resent having to “compete” for your work, but they need to understand that if you cannot be competitive, they will not get the work anyway.
Now that you have expenses in line to be as competitive as your firm can possibly be, you need to remember that no matter how low your price, someone else can always come in lower. However, this is often because they do not have a firm grasp of what their costs and expenses really are.
So, how do you know how to price the jobs you’re quoting? Here it’s important to understand the relationship between gross profit and overhead. The lower your gross profit margin, the higher your total revenue will have to be to cover a given amount of overhead.
For example, assume that you have a total monthly overhead of $40,000 and you believe you can get projects with a margin of 35%. You will need to sell jobs worth $114,285 to generate the $40,000 of gross profit (40,000/.35). If you think you have to cut your price by 10% to get these jobs, your gross profit will then be 25% and require $160,000 in sales to generate the same $40,000 of gross profit. The lesson here is that the important element is gross profit, not sales volume. It’s important to note that $400,000 in sales at 10% gross profit is no better result than the $114,285 at 35% and probably will require a lot more management effort to perform the jobs!
