Setting Your Margin Part 2: Finding the Right Markup

Shoot for 40 percent to 50 percent on remodeling jobs, and don't provide breakdowns.

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 the variable costs, undocumented expenses, consumables and material estimates and all the other costs.

A remodeler should aim for a markup of between 40 percent and 50 percent, says 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'll lose work. Others think they're getting that much but in fact are getting significantly less. And some misunderstand the difference between margin and markup, 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 it's actually the percentage of the total bill that's profit, and that's entirely different. On a project that costs the remodeler $100,000, a 50 percent ($50,000) markup means the project will be billed at $150,000. The project has a margin of 33 percent, because a third of the total amount billed ($50,000) is profit.

Too many contractors mark up their cost by their expected margin (33 percent in this case, to $133,000) and then can't figure out why they aren't making as much as they should. In this case they undercalculated and left $17,000 on the table. Thinking they were receiving a 33 percent margin, 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 Web providing easy access to discounted pricing on everything 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 think 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," Shiner says. "You're not selling products; you're providing a service. Don't provide breakdowns, even if you do use different markups 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 aren’t labor-intensive and thus don't cover their own costs.

"You have to understand where your profit comes from in each component if you're going to mark up different activities or materials differently," Shiner says. 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 enough to cover his costs, as his sub costs had always covered him.

"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," Shiner says. "You have to know exactly what you spent and what you made and why. Until you know those variables, you're flying blind."

When to raise your rates Raising rates as a remodeler can be an easy accomplishment, since customers don't recur on a regular basis as they do for gas stations and grocery stores and therefore aren't aware when charges have gone up. But it can also be difficult; a miscalculation about when to raise rates can result in lost business that brings in no profit at all.

Surveying customers whose jobs weren't contracted can help pinpoint whether pricing is too high, and a job analysis can reveal whether prices are too low. After that, the best time to try to raise a price is during the busy season, Shiner says.

"If you don't get that job because you're too high, it doesn't hurt that much, and you can learn that you've reached your limit," Shiner says. On the other hand, if you do land the job, you know you're still in the ballpark.

Over time, remodelers can essentially raise their rates by doing their jobs faster—which also satisfies customers more, she notes. "You get better at what you do and can do it faster, which makes you cheaper because you can do more jobs in the same time."

Creating efficiencies in the office and creating more accurate estimates also can help bring in more profit without raising prices. Reducing costs can provide the same benefit as raising prices.

As the saying goes, it's not what you make that matters — it's how much you keep.

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