Another recent email:
I own a design build firm. I was completing a continuing education class today, the subject matter was knowing if you are making a profit or not. The instructor had mentioned that the bigger the job the less the mark up should be.
These are my examples, I do not recall his numbers. For example for a job with the job costs of $50,000, with a 1.5 markup the job should be sold for $75,000. For a job with a job costs of $150,000 the job should be sold for $195,000, a 1.3 markup.
I am working on designing a few jobs with the job costs starting around $125,000 and up. What is your opinion on markup when the job costs are getting bigger? I want to make sure I am staying competitive with my competition.
This is a myth in construction, the belief that as the job gets larger, you can cut your markup because your overhead isn’t as high. Obviously this instructor believes it and is misleading contractors who are taking his class for continuing education.
I address this in my classes by presenting a chart that shows fixed and total overhead over the course of a year. I’m going to approach it differently here.
There are two kinds of overhead: fixed and variable. Fixed overhead doesn’t change from month to month. In a construction-related business, fixed overhead examples would be like rent, office and management salaries, and certain insurance policies like health insurance. Variable overhead is the overhead generated by the actual job. Variable overhead examples would be vehicle expenses, sales commission, maybe job supervision, and possibly other insurance policies such as liability. Fixed overhead is steady, the same amount month after month. Variable overhead varies with volume.
Can a project with job costs of $150,000 be built in the same amount of time as a project with job costs of $50,000? Probably not. So the larger job will incur more fixed overhead because it takes more time. Variable overhead increases as the job size increases. So of course, variable overhead as dollar amount will be higher on the larger job than on the smaller job.
If you pay a sales commission, do you pay a lower commission on bigger jobs? Not too many salespeople would agree to that. Many insurance policies are based on your dollar volume; is it a smaller percent if it’s a large job?
One of your risks is warranty issues after the job. Will a larger job have a lower risk of warranty problems? No, it could easily have a higher risk.
So can you cut your markup and still make enough to cover all overhead expenses and make a reasonable profit? I don’t think you can.
Using the numbers in the example, a job with job costs of $50,000 would generate $25,000 to cover all overhead expenses and make a reasonable profit. A job that’s three times bigger with job costs of $150,000 would generate $45,000 to cover all overhead expenses and make a reasonable profit. Given that the larger project will likely take more time and require proportionally more supervision, is that reasonable?
Misunderstanding overhead is why you hear instructors or other contractors tell you that as jobs get larger, you can cut your markup because your overhead isn’t as high. That’s not true.
If the markup you need is 1.5, then that’s the markup you need regardless of job size. You can certainly raise your markup for smaller jobs to account for the fuss and trouble a smaller job can have, but I wouldn’t drop it for a larger job unless I could honestly point to the lower overhead and/or profit needs for that job.
One last thought. If you’re fussing and worrying about how to get your prices down, you’re thinking wrong. Think about this. There are more people in the country today than there were in December 2008 and January 2009, which was the lowest point in our economy in a very long time. There’s more demand for both remodeling and new buildings. There are also fewer contractors in business today than there were in 2008-09. That includes both those working on residential structures and those working in the commercial sector.
It’s all about supply and demand. If there is more demand and fewer contractors, doesn’t it make sense that you can charge the price you need? This isn’t rocket science, it’s cold, hard economics. The problem is that too many contractors haven’t figured this out yet and they are still busy trying to be competitive.
You have a choice of being competitive, but you don’t have a choice of being profitable. You’ll either be profitable or you’ll go out of business. That applies to both commercial and residential work. Think about it, and may the profits be with you.