We received this question recently from a young contractor:
“I figured what my markup needs to be (1.4) but had a question that may seem silly.
I have assumed the markup I came up with is added to the cost of the project and not just materials? But as I search more it seems contractors “markup” materials more than the whole project.
I don’t understand why someone would markup materials only? I believe I am doing it correctly based on your book by adding my 1.4 markup at the end of an estimate and that is the price to sell the job. As I don’t see it in black and white I just wanted to make sure this was the correct way of adding markup.”
Before I address his question, I want to say that this contractor is doing exactly what should be done when you have a problem. He asked for help. We’re honored that he asked us, and we’re pleased that he followed Cardinal Rule # 4: You shall keep your ego in your pocket. When you need help, get it.
I think it helps to understand why you’re using the numbers you’re using.
When you calculated your markup, you projected your job costs, overhead expenses, and profit. (This is all covered in detail in Chapter 3 of Markup & Profit Revisited.) Your projected job costs were used to calculate your markup, so your markup needs to be applied to job cost.
In a perfect world, estimated costs will match actual job costs. At the end of a perfect year, total job costs will equal projected job costs. If you applied your markup consistently, you’ll have the funds needed to pay all projected overhead expenses and meet your projected profit goals. It’s not a perfect world – that’s why you need to review and recalculate your markup over time – but that’s how it’s designed to work.
So, when you aren’t sure how to apply your markup, think about how it was calculated. Since it was calculated against job cost, it needs to be used against job cost.
Taking it a step further, if you aren’t sure whether or not something should be included when estimating a job, would it have been considered a job cost when you calculated your markup? Then it should be in the estimated job costs. If it was considered an overhead expense, keep it out of job cost because it will be covered by your markup.
If your P&L is laid out correctly, your expenses are categorized to match your markup calculation: Job costs (Cost of Goods Sold), Overhead expenses, and Profit. You can glance at it and with a few quick calculations know if your markup is adequate or if something needs to change.
That’s why we believe that using one markup is smart. It’s simple and quick, and keeps you focused on what you’re supposed to be doing, which is promoting your business so you can sell and build more jobs.
When you see a quote that shows a markup only on materials, rest assured, the labor rate has been marked up as well. They’ll call it the “going rate”, and it’s marked up. An example would be an electrician giving a quote and telling the owner that the labor rate for electricians is $65 an hour, “what with the union demands and all.”
They use the “going rate”, then reduce the markup on materials so it looks good to the client. They hope that the extra $30 to $45 an hour over what they are paying their workers is enough to cover all their overhead. Maybe it is, maybe it isn’t. (If it isn’t enough, we both know who will make up the difference. Their family.)
It’s important to calculate your markup based on your business needs. It needs to be adequate to cover your overhead expenses and your profit needs. Anyone using a “going rate” on labor and guessing at the markup on materials is gambling.
What this young contractor is seeing is a problem that too many contractors introduce into the mix, and that’s telling clients their rate per hour or what materials cost. The only thing a contractor should tell a potential client is the lump sum or fixed price for the job (unless they are doing service work, we’ll cover that another time). The issue of price for a given job is almost always with the contractor. As soon as they start talking about the rates per hour and the cost of materials, it becomes an issue with the client.
Every survey I’ve seen that asks building owners what their criteria was for picking their contractor never lists price as the top priority. They instinctively know that what Ben Franklin said is even more true when it comes to their home. “The bitterness of poor quality remains long after the sweetness of a low price is forgotten.” With most clients, the price of a job only becomes an issue when the contractor makes it an issue. If you’re dealing with a client whose number one focus is price, find another client, because this one will just cost you money.
Let me share a discovery that I had back in 1969 when I first started selling remodeling. You can continue fussing about price, and continue to have knots in your stomach every time the subject comes up with a potential client. Or you can get busy, polish up your sales skills, use one markup, and go sell your work. It’s your choice. In my opinion, it’s much easier to polish your sales skills. I’d suggest starting with our book, Profitable Sales; A Contractor’s Guide.