I got annoyed reading an article a few months ago by a management consultant writing for another industry magazine. He was discussing contractor compensation and stated as a guideline that most small shop owners withdraw about 10 percent of revenues as their own compensation. He used the example of a $500,000 company resulting in $50,000 "withdrawal" by the owner, and explicitly defined withdrawal to include not only base salary, but insurance premiums, vehicle expenses and all other perks and bonuses. By the time you take out all those expenses, the owner's income probably wouldn't be much more than $30,000.
By this reasoning, smaller contractors that only generate $300,000 or $400,000 in sales would be limited to merely $30,000 or $40,000 a year in total compensation. Smaller than that and you're better off going on welfare.
This is precisely the type of thinking that drives me up a wall. It epitomizes everything that's wrong with this industry.
The 10 percent guideline might work with a larger company doing millions of dollars a year in volume, but it would be pointless for a one-person operator to limit himself to $50,000 or less in total compensation. You could make more than that working for a good plumbing company while avoiding all the headaches and putting in fewer hours.
As I pointed out in last month's column, there's nothing wrong with remaining small. Mom-'n-pop shops are the
backbone of this industry, and staying small eliminates a lot of headaches that come with larger businesses. But I hate
the suggestion that you have to take a vow of poverty to stay small. If anything, I think a guideline should be that the
smaller the business, the larger the percentage of revenues the owner should take out for himself.
Better Living Through ConsultancyTo illustrate, I've constructed an imaginary P&L statement for a contracting firm I'll call "Expert Plumbing & Heating." Let's examine some of the pertinent details.
For our purposes, I've eliminated material sales from consideration. That's because material sales are unpredictable. More important, I've structured this business as a plumbing-heating consulting firm.
Think about it. Consultants have no trouble making money. I bet that any independent consultant who generates $300,000 in annual revenues takes more than half of it in owner "withdrawals." And if he or she doesn't earn that kind of money, is this someone you want to be taking advice from about running your business?
Every garage shop operator in the country identifies himself as a plumber. What if you were to come up with a marketing persona that led people to believe that you were strictly a plumbing-heating consultant? You would come to the house to diagnose problems, make repairs and even install goods purchased from Home Depot or other suppliers. But mainly you would earn your living as a plumbing expert.
This consultant's hypothetical P&L statement shown here is based on the following assumptions.
- You, as a sole proprietor, work 3,000 hours a year, of which 1,500 are billable as labor - 1,200 via jobs sold, 300 as diagnostic fees. This is pretty close to what you could expect in the real world. Only about half of the time you spend working would be billed to a customer. The rest would be devoted to marketing and other administrative duties, along with professional advancement through association activities and educational programs. Time spent on these tasks should be built into overhead.
- The line item labeled "Diagnostic fee only" pertains to those jobs in which you are called out to diagnose the
work, but the home owner decides not to use you to perform the job, perhaps feeling you are too expensive. No
expert consultant gives away his time, so you charge a $79 diagnostic fee for this service. The home owner
may wish to hire a $50-an-hour plumber to do the work that you determined needs to be done.
This is OK with you. You have plenty of business and don't mind losing a job once in awhile. The home owner still benefits from your professional advice. Odds are he or she will end up calling a slug who wouldn't be able to figure out the problem.
- As a highly trained and skilled mechanic/consultant, you value your labor at $55 an hour. This is what you pay yourself, and it is built into the hourly labor rate that you charge your customers. When you factor in overhead, that amounts to $275 an hour. Do that as a plumber and everyone would call you a rip-off. But once you position yourself as a consultant, the more you charge, the more people will respect you as an expert in your field.
- With 1,500 hours charged to either labor or diagnostic work, this generates a direct labor expense of $82,500, with another $1,000 expended in permit fees. The $82,500 (pre-tax) goes in your pocket as compensation for your hands-on work as a top-notch plumber/consultant.
- However, as stated, you don't just work those 1,500 hours. You put in another 1,500 hours in unbillable time. But that doesn't mean you give it away for free. As owner and CEO of this company, you ought to draw a salary for all the administrative work you put in, along with the risk and headaches you endure. I'd say $75,000 a year sounds about right for this one-man owner's salary.
- By the way, your wife does the bookkeeping for your plumbing/consulting business. She's darned good at it and could make $40,000 a year performing a similar job for an outside company. So that's what you should pay her.
- After you add up these and all other expenses, you end up with a reasonable operating profit of $69,300, representing 19.6 percent of revenues. Some of this will be chewed up by taxes, which you, as a responsible citizen of this great country, don't complain about paying. An even greater chunk, $29,625, or 8.4 percent of revenues, would be set aside into a retirement account for you and your wife.
What's left on the bottom line is a 7 percent net profit of $24,675, also known as retained earnings. Depending on
your needs, you can pay this money to you and your wife as bonuses, use it to finance company growth or capital
improvements, or some combination thereof.
The Real WorldAdd it all up and you have a portrait of a company that generates $353,700 in annual revenues, of which the owner and his wife get compensated to the tune of $197,500, perhaps with some year-end bonus money on top of it. A little bit more than 10 percent, huh? Plus they put aside money for a well-deserved comfortable retirement after many years of working 60-hour weeks.
Is this hypothetical scenario realistic? Well, I bet if you looked at the P&L statements of many self-employed consultants, lawyers, accountants and other white collar professionals, you'd find numbers that resemble these. In relation to your profession, are you any less talented? Are your services worth any less to your customers?
So why shouldn't a plumbing contractor enjoy the same degree of prosperity by putting in 60-hour weeks almost all year long, and contributing valuable services to his customers?
Granted, it wouldn't be easy. You couldn't pull this off doing business like most of the one-man shops in this country. You'd have to market yourself as a consultant or specialist of some kind with advanced expertise. Maybe it would be as a specialist who knows everything there is to know about backflow prevention, radiant heating, indoor air quality or something else. Or, maybe you could offer the same plumbing services like everyone else, but become known as the person to call when nobody else can figure out what's wrong or how to make it right. Or, maybe you're so confident in your abilities that you attach a lifetime guarantee to all your workmanship. The trick is to get people to view you not as a plumber, but as an expert consultant.
Can it be done? You bet! It's been done by scores of contractors around the country who have made the transition from slugs to respected professionals, with corresponding financial rewards. One of them recently called to chat and thank me for the direction his life had taken ever since the day more than a decade ago when he went from a $30-an-hour plumber to a $170-an-hour "consultant" - though not after first telling me for many months that "it can't be done - not in my market."
I hear these stories over and over. So have many of you, although too often you don't want to believe it. All you see are the "rip-offs" who charge too much, and the occasional customer who complains about them after you inform them that you would do the job for half their price or less.
Maybe it's time to stop and ask yourself why the rest of their customers don't complain, and keep coming back to do business with them over and over. It's time to stop criticizing success and start acting like a professional plumbing expert.