Volume 36, Issue 9, September 2001
The Profit Formula
-by Bob Lawrence
I cannot help but be puzzled that a homeowner can buy a high-performance, technically advanced low-E insulating unit for a price that is cheaper per square foot than the wallpaper in his house!
Ever wonder where the Clown University is that graduated the estimators who work for your worst competitors? Agreeing to discount prices up to 25 percent to compromise on a clown's price is not a pleasant way to secure a contract. This phenomenon is accommodated too frequently because so many of our industry estimators haven't a clue what margin they must get when they sell a job. Let me share with you something I worked on years ago. "The Profit Formula" is a simple plan that helps owners develop consistency and confidence in what they are trying to accomplish. It will work for you too, and maybe even a few clowns will learn something.
First, from your company's profit and loss statement, consolidate the information into four categories: sales, net profit, overhead and material or labor. Get your bookkeeper to help you do this.
Remember an important rule: sales must equal the total of profit + overhead + material/labor.
Second, determine your historical mark-up, which is sales divided by actual material/labor. This answer will surprise you. Assuming you are satisfied with the profit, this result gives the minimum mark-up that should be used on actual costs when you decide to go after a job you really want.
Before going further, we must draw attention to an industry practice (see if this sounds familiar). If you actually pay $2.50 per square foot for glass on jobs, then $2.50 per square foot is what will be reported in materials cost—not a $3 "fudge" cost many estimators use and mark-up when everyday jobs are quoted. For this reason, you will probably show a much higher historical mark-up than you think is realistic when calculated. For example, using $3 as a budget number for something that really costs $2.50 is overstating actual cost by 20 percent. Using a 40 percent mark-up on a 20 percent overstated cost is the same as a 68 percent mark-up on actual costs.
"Fudge" costs for estimating works okay. You've probably settled on a mark-up that works well over the years with those numbers. Where estimators get in trouble is when they want a particular job badly enough that they abandon those higher fudge costs for actual cost figures. Deciding to reduce the mark-up from 40 percent to, say 35 percent on the actual cost of glass, means they are reducing the traditional mark-up by 33 percent—not 5 percent as they might think. The profit can be salvaged only if the product and installation go absolutely perfect and under budget.
A Case History Example
Sam owns a company that averages $40,000 a month in sales and he generates a 7-percent net profit on sales. His overhead includes operating expenses that includes insurance, rent, vehicle expenses, office supplies, etc., plus any employee or expense costs that are not included in job costing normally.
First step: Using the monthly averages, Sam's four categories look like this:
• $40,000 sales;
• $2,800 net profit;
• $11,226 overhead;
• $25,974 material/labor.
Next step: Identify the historical mark-up on actual materials and labor costs. $40,000 in sales divided by $25,974 material/labor equals 1.54. This represents a 54-percent actual historical mark-up used to produce the profit and loss statement results.
Sam has been working pretty hard over the years and would like to give himself a raise. Sam also needs to give a devoted office assistant a $400-per- month raise for taking on new responsibilities. He knows the bank wants to see consistent profit to keep funding his loans for vehicles and equipment and for working capital. To give himself a raise and maintain 7-percent net profit for the company, he has few options: generate more sales, get a higher mark-up or cut expenses.
Other Relevant Facts
The market is pretty competitive so raising prices is not an option. However, Sam does feel he could soon increase business by $10,000 a month without causing his competitors to respond negatively. To do this he would have to add another vehicle and use one of his existing employees for the new truck. The new vehicle will add $1,500 a month in interest payments, fuel, depreciation and insurance expenses to his overhead.
To remain competitive, Sam's historical mark-up must be the same for additional business. He can calculate how much material/labor he will have in the revised sales figure of $50,000 by dividing sales by 1.54, which equals $32,468 (this could also be calculated by using a historical percentage of sales). He needs to add $1,500 to his monthly overhead cost for the vehicle and $400 for his assistant's raise. His profit must remain at 7 percent.
Consolidating the Information
Remember the rule: overhead + material/labor + profit must equal sales. So what Sam is able to give himself as a raise equals the sales less all the new adjusted numbers:
• $50,000 sales/month
• $3,500 profit/month (7 percent)
• $11,226 overhead/month
• $1,500 additional new truck costs
• $400 additional salary for assistant
- $32,468 material/labor
= $906 available for additional salary, or for other expenses/profit per month.
The Profit Formula
Sales - desired profit - established overhead = money available for material/labor. Sales divided by material/labor equals mark-up needed.
The best part of the profit formula plan is that it's easy to implement for any business. With common sense input, the profit formula will evolve and grow with you. The plan also works by inputting relevant information when you are facing an extended downturn of business or need to improve your profit.
It is important to remember that this plan identifies what your business must average over an extended time in material/labor mark-ups to achieve your desired results. Realize that many products you sell over the counter and pain-in-the-neck jobs should have a much greater margin of profit than others. This will help to offset prices for products that are necessary to carry, but for competitive or perceived value reasons, you cannot get the margin you need.
Any responsible customer wants a quality company to do his work. You represent credibility, service, a warranty and peace of mind that he is going to get a quality installation.
Remember, very often customers will tell you what the clown is offering simply to test your resolve that your price is the best you are willing to offer. Of course he wants your quality and service at the clown’s price just like I would want a BMW at a Chevrolet price! Using this profit formula, you know your price is right. With knowledge, lowering your price, lowering your standards or compromising the customer's job is not an option. Customers admire that kind of confidence.
I know some of you are thinking of forwarding a copy of this article in a blank envelope to a clown with the message, "Here's a no-brainer profit plan that will get your prices back on this planet!" Let's hope he's a subscriber to this magazine and studying this article with interest. Maybe in the future, those ridiculous prices will become scarce!
By the way … BMW, Baccarat, Jaguar, Rolex, Titliest, PGA, IBM, Peterbilt … and many more companies representing other industries overflow with confidence. It's time members of the glass industry step up and start acting like they are part of a respectable occupation.
Personally, I can't see how wallpaper is worth near what a high-performance insulating unit is worth.
See you on down the fairway.
Bob Lawrence is president of Glass Wholesalers Inc. in Houston. His column appears quarterly. Contact him at firstname.lastname@example.org
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