Contractor costs are similar but their prices might not be

By Richard P. DiToma, L.M.P.

You can shop around for the best price for any of the items you need to run your business. The value you receive for the dollars you spend will probably be commensurate with the price you pay.

All things being the same, the operating costs of your PHC competition in your geographic area are mostly similar to yours. Vehicular costs such as vehicle purchase prices, insurance, fuel, repairs, maintenance, inspections and registrations for the same type of vehicle are about the same. Shop/office rental costs for the same type and size of property are also similar. Insurances, supplies, equipment, advertising, professional services, miscellaneous costs for items of equivalent value are probably comparable.

You may choose to spend the same, more or less money than your competition for any given item, but the gap for the same type of purchase will probably not be that great. One item that may be much more or less than your competition is the salaries you pay to yourself and your employees. But even with this item, both you and your competition must consider salaries that compensate yourselves and your employees at a level that gives rewarding reason as to why your workforce should remain with your business. If you do not properly compensate your workforce, you will probably have a problem maintaining good help.

Keeping good help means paying employees for a full year, including the slow times. If you cut hours or lay off good personnel every time your business experiences a slow down, you will have difficulty keeping them employed. After all, they have to feed, clothe and shelter themselves and their families regardless of the quantity of work you have. In a fiscal year based on 40 hours per 52 week year there are 2,080 hours paid out for each full time employee. If you give technicians two weeks for vacation or personal time, six holidays, and you incur 244 unproductive hours per technician year to prepare each morning and finish up each afternoon [based on one hour per technician per day per five day workweek], you only have at most 1,708 hours to recover your costs and earn the reward you deserve for the value you deliver and the risks you incur in the delivery.

In the service portion of the industry, each phc service vehicle with one technician probably gives you a labor/overhead cost between $100.00 to $250.00 per hour dependent upon the area in which you operate, the salaries you pay to your employees and the sale of all 1,708 annual hours. You only have three choices when choosing your selling prices: sell above your cost, below your cost or at your cost.

The following examples are based on three types of contractors. I’ll refer to them as A, B and C. I’ll base their similar labor/overhead costs at $150.00 per hour if all annual potential hours are sold. Remember, this number is arbitrary and is lower than the average between $100.00 and $250.00. Your costs may be more or less.

The first set of examples compare the amount of money a contracting firm can bring in from the exact replacement of a gas fired water heater [40- or 50-gal. capacity]. In this example, the cost of the water heater to the contractors is $375.00. The additional potential material they may use for items such as nipples, dielectric couplings, copper tubing and fittings, lengths of vent pipe and fittings, black malleable fittings, solder, flux, grit cloth, acetylene, sealant, etc. costs $120.00. In areas where sales tax is not charged to consumers for water heater replacements, these numbers should include the sales tax contractors pay for the material since the tax now becomes part of the cost of the material.

In this set of examples the technician (and if your technician is not doing all these steps, he/she should):

1. Travels to the client to check out the situation, the remedy and the material needed to rectify the problem.
2. Introduces himself/herself to the client.
3. Explains company policies.
4. Discusses the client’s request and/or problem.
5. Checks out the circumstances.
6. Makes a list of the material needed to perform the task at hand.
7. Calculates and quotes a price to the client for the replacement water heater installation.
8. Asks the client if he/she would like the technician to perform the task.
9. Writes up a contract/invoice describing the task and the price to perform the task.
10. Obtains the client’s written authorization to perform the task at the agreed price, terms and conditions.
11. Travels to supplier (or shop) to pick up the material for task.
12. Travels back to client.
13. Removes existing water heater.
14. Installs and inspects new water heater installation.
15. Tests water temperature after heater reaches temperature setting to be certain temperature is within the parameters of safety.
16. Cleans up the work area.
17. Asks the client if they are satisfied and obtains client’s written acknowledgement of satisfaction.
18. Gets paid for the task performed.
19. Goes to service vehicle and calls to inform shop of completion and get information about next call.

According to information found in my Readily Available Pricing Information Digest 2008 for the plumbing heating cooling contractor, the task described will take on average four hours plus initial travel time to client. For the example, I’ll use an average initial travel time of 30 minutes to give the task a total time of 4-1/2 hours.

Contractor A sells above his/her cost at a 50% profit margin in anticipation of slow times and an intention of receiving a return on his/her investment in the business. He/she sells the task for $2,340.00 earning a profit [reward for excellence delivered and risks taken] of $1,170.00. In this example, the contractor also has room to discount the price in a financially prudent manner for those clients who help keep his/her business going through their faithful and frequent patronage.

Contractor B sells at $30.00 an hour below his/her cost. I chose the $30.00 amount because in the 18 years I have been consulting with and helping my fellow contractors I have noticed that most contractors sell their services minimally at $30.00 per hour below their cost. That’s called calculating on the stupid curve. This enigma, “the stupid curve,” is caused by contractors following the lead of other contractors who haven’t got a clue as to the real costs of operating a contracting business. They use an erroneous, flawed and absurd number called “the going rate.”

In this example, Contractor B sells (or should I say “buys”) the job for $1,035.00. It costs this contractor $1,170.00 for labor, overhead and material to do the job. But for some reason which can only be described as extreme stupidity, this mastermind of absurdity adds $130.00 of cost to his/her miserable existence. He/she would be better off sending the consumer a check for $130.00 because then he/she could go out of business and would not have the cost of labor, overhead and materials to pay, and would achieve the same result.

The contractors who install water heaters for themselves or for the big box retailers for less than their costs fall squarely into this category. They are their own enemies because they can never get where they want to go. They are the disease of the industry because their ridiculous behavior decimates our noble industry. They deliver mediocrity or worse to consumers because their flawed prices will not allow them to deliver excellence.

Many ignorant contractors assume that volume brings in profit dollars. Here’s a question for you: How many water heaters will Contractor B have to install at a selling price of $1,035.00 to make as much profit as Contractor A who sells the task at $2,340.00? Answer: He/she will never make any profit! He/she will only lose more money with each water heater sold below cost!

Contractor C sells at his/her cost. He/she sells the job for $1,170.00. The same amount it costs him/her. He/she makes no money and misses the only reason business (other than non-profit business) exists. That is, to make a profit. Although not as extremely stupid as contractor B, contractor C is still stupid.

Every time contractor A sells this task he/she makes $1,170.00 above costs for the business. That means every 10 water heater tasks of the same sort will give the business $11,170.00 above cost.

For every 10 water heater replacements contractor B sells below cost the company loses $13,050.00. Is there any wonder why I call this example extremely stupid?

For every 10 water heater replacements contractor C sells at his cost the business brings in the same amount as it must pay out.

On the other hand, there is one thing contractors A, B and C share equally besides their real costs: the opportunity to place equipment in a home or business that not only delivers hot water, but also, presents the risk of harming, maiming, or killing the client through scalding with extremely hot water, poisoning with carbon monoxide, explosion of equipment or fire. Taking these risks into consideration, calling contractors B and C idiots would be an insult to idiots.

Another way to look at this subject is annual hours sold. Again using Contractors A, B and C, figures 4, 5 and 6 show the different amounts of annual revenue each business has the opportunity to realize dependent upon which choice the contractors have made.

As you can see it doesn’t make much sense (or cents) to sell at or below your cost. Since more contractors than you think choose the path of Contractors B and C, and it makes no sense (or cents) to sell services at, or below, real costs, or at the “going rate,” I do declare, contractors B and C to be “Morons in Perpetuity.”

Regarding your profit margin, I am not suggesting that you use 50%. First you must correctly calculate your operating costs and then choose the profit margin that will allow you to reach your goals.

If you need assistance, give me a call at 845/639-5050.                   

       

Richard P. DiToma is a business consultant and contractor with 36 years of experience in the P-H-C industry. He conducts seminars, evaluates business operations, publishes customized price guides for contractors and offers continuing support.

His book -- “Solutions Management Theories & Methods for the Contracting Business” -- deals with solving pr-oblems contractors face; identifying & calculating costs; developing proper profitable prices; addressing consumer questions; hiring and evaluating technicians; and logical management procedures

It’s also available as a “Workshop On Demand” for individual businesses (from one person to multi-person businesses); contractor groups  (organized or informal); trade associations; and wholesalers to the trade.

Date: Arranged according to your schedule

Location: Wherever you wish. Richard P. DiToma will come to you -- or you can come to him. Contact Richard to find out if there is a workshop coming to your area.

His other book -- “Readily Available Pricing Information Digest 2006” -- for the plumbing-heating-cooling contractor service price reference book is available with plumbing &/or heating &/or cooling section(s). To receive more info about his services, to order his books or to contact Richard at 845-639-5050, by fax at 845-639-6791 or via email at richardditoma@verizon.net