A lot of contractors don’t believe they need to use their full markup on subcontractor quotes. Let me explain why that can be a mistake.
A long-time reader sent a question recently:
“I am about to take on what will be the largest project I have done as a GC and I am having no small amount of heartburn over the markup on subcontractors for this project, yet I am determined that I need to really understand where I am on this one. I will be using more Subs on this project than before and for higher dollar amounts. One sub alone doing the boiler and driveway heat will be at least $110,000 Last night I carefully evaluated my last year’s overhead and based on the way you present calculating markup is indicating that I need to markup job costs at 1.45. Obviously this sub is a job cost but for some reason I am struggling with putting nearly $50k mark on this. Am I applying your method to this sub correctly?”
I understand the temptation to cut your markup when dealing with a large subcontractor quote, but let’s look at the big picture.
Your 1.45 markup is already lower than the average for a remodeling company, which means you don’t have any room for error. Of course, with a $110,000 mechanical quote, this is obviously a very large job, and if you build exceptionally large jobs, it’s possible your overhead costs are lower than average, resulting in a lower markup.
When you calculated your markup, you estimated your overhead expenses and profit needs, and you estimated the dollar volume you’d sell this year. You used those figures to calculate your job costs, and that means all your job costs, including this mechanical quote.
Will you have a lower overhead expense on this job because of the size of the mechanical work involved? I doubt it; you’ll still be paying rent, supervising the project, traveling to and from the job site, marketing future projects, etc. For that reason, I don’t think you can reduce your markup on this subcontractor quote without hurting your bottom line.
Let me give you a quick example of what happens when you cut your markup on your subs’ work.
Let’s say you have a kitchen remodel and your total costs are $40,000, of which $32,000 are direct quotes from your subs and the remaining $8,000 is in-house labor, materials and a few other expenses. Using a markup of 1.50, the sales price is $60.000.
You decide to cut your markup on your subcontractor quotes to 1.20. So you multiply $32,000 by 1.20 and get $38,400. You multiply $8,000 x 1.50 and get $12,000. The new sales price of the kitchen remodel is now $50,400.
This is what it does to your P&L:
|Using the correct markup||With lower markup|
|Gross Margin (overhead and profit)||$20,000||$10,400|
|Expected Funds Available for Overhead||$15,200||$10,400|
|Projected Profit @ 8%||$ 4,800||$0|
When you cut your markup on the subs to 1.20, you gave away $9,600, which was all your profit and an additional $4,800 of the money you will need to pay overhead. Down the road, if you don’t have enough funds to pay your overhead expenses, where will the money come from? That’s correct: it will come right out of your own pocket.
The problem is that unless you do the math, you won’t see that you’re shorting your company the money it needs over the long term. The result of cutting your markup won’t show up right away. It may take four, five or six months, maybe even longer, for the cash flow shortages to become noticeable, and by then how many job will you have sold short? We get anywhere from three to five new calls into our office each week from contractors who are in debt and can’t pay their bills. Cutting the markup on jobs is often a major cause.
Of course, there’s another option. You could tell the sub to sharpen his pencil and get the quote down to some reasonable amount. This isn’t an option I recommend; leaning on them to lower their price is only going to alienate them and probably make them wary of quoting future work for you. I wouldn’t dream of telling a sub to cut their price unless I knew for a fact they were overpricing their work. Your sub has to cover his job costs the same as you do. They have the same overhead that you do. Their families have to eat the same as your family does.
If you lean on them to lower their quote, you might regret it a year later when the owner calls to tell you about the problem they’re having with the work you and that sub did on their home. You still have to guarantee your work, and that often includes the subs you brought in. The sub is out of business because they made the same mistake of cutting their price for other general contractors.
Job costs times markup equals your sales price. Quit fussing about whether the price is too high; if the numbers are right, the numbers are right. Use the markup that was been correctly calculated for your particular business needs, and go sell the job. If you don’t know how to calculate your markup, we cover that in depth in our book, Markup and Profit Revisited. Using the right markup and learning how to sell your work, not your price, will help you take care of your families and sleep better at night.
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