The Impact Of A Price Increase
Unfortunately, the first thought that enters the average contractor’s mind for generating more sales and profits, is to go after more business by adding more men, buying or leasing additional trucks, purchasing more tools, etc. Sometimes such expansion makes sense but more often it simply betrays a lack of imagination and courage.
The problem with business expansion per se is that it usually results in increased sales but decreased profits or even losses. There is some very detailed numbers crunching that needs to be done to determine whether purchasing more equipment and additional labor will make profits rise or fall. For now, let’s look at some cheaper alternatives.
There are three fundamental ways to increase revenues and profits without incurring extra costs. One is to cut expenses without impacting sales and profit margins. Another is to increase productivity. Both are highly desirable but in truth not so much a matter of business strategy as something every business person should be striving for day after day. We all want to cut costs and increase productivity, but exactly how to do that is a big question that puzzles everyone.
The final way to increase sales and profits without spending more money is to increase prices. For most of you it is the best way of all. Unfortunately, also for most of you, it is absolutely the last one you consider. Too many of you have the belief that “my customers won’t allow it.” I’ve never heard a more ridiculous bunch of b.s. in my entire life. Yet this is the mentality of far too many contractors, which is why so many of them have a guaranteed ticket to the poor house.
Make A Business Plan: The arithmetic of a price increase can have a dramatic impact on owner compensation and company profits. The case at hand stems from an actual experience with a young contractor client of mine.
He felt his compensation, almost $75,000, was not adequate for his investment and the amount of business activity that had taken place during the past fiscal year. Although many people would think they had gone to heaven if they earned $75,000 for a year’s work, I agree with my friend that he was substantially underpaid. He was looking to make around $125,000, along with increased profitability, and I like his way of thinking! (The average compensation for PHC contractors in his area was around $49,000. The vast majority earned between $30,000–$45,000.)
He expressed to me that it was difficult for him to move forward aggressively to grow his business in other markets. He was looking for greener pastures by developing a larger service, replacement and remodeling business, but so were many others. Sometimes no matter how good you are, and how hard or smart you work, competitive realities will only allow a certain amount of new business to come your way.
But there are alternate ways to make more money on the same amount of business. I asked him if he thought he could have sold all of the work performed last year at a higher price than he did, say 5 percent more. He said yes. Then I asked the most important question of all — “Do you know your cost of doing business per hour?” The answer was a resounding no.
This business, like so many others, did not operate with a budget or a business plan last year or for any other year of its existence. That’s no longer the situation. Now this company has a plan in place and will always have one. If you don’t know where you’re going, how are you going to get there?
After all the important questions were resolved, I proceeded to show this contractor how simple it is to “make money” if one understands some basic principles of “numbers crunching.”
A Price Increase: Below is a reconstructed profit and loss statement based on the figures actually given to me by my client. The first two columns of numbers represent a breakdown of his actual dollar and percentage figures for direct costs in the last fiscal year. The final two columns show the hypothetical results had he done the same amount of business at prices 5 percent higher.
(For the sake of simplicity and to save space, we skip the overhead itemizations. As shown near the bottom of the statement, his overhead amounted in total to $351,368 or just short of 21 percent of sales. This is a relatively low overhead percentage reflecting the fact that my client gets more than 60 percent of his work from new construction.)
The most important thing to notice about this reconstructed statement is that the dollar cost of sales in the reconstructed version is exactly the same as the actual costs line for line. Both columns total $1.233 million.
However, whereas that cost actually represented 73.5 percent of sales, it would be reduced 5 percentage points to 68.5 percent with the hypothetical price increase in effect. This contractor would have generated $1.8 million in sales rather than $1.678 million. Gross profit dollars likewise would have risen from $445,125 to $567,001, a whopping increase without having to add additional employees, trucks, etc.
With overhead of $351,368 remaining constant, we observe net profits jumping from $93,757 to $215,640, an additional $121,884 earned that could go to boost owner compensation, retained earnings, investment capital and so on. I recommended that he spend $50,000 of it to employ the “right-hand” man that he, like so many of you, desperately needs. It would take at least that much to employ an experienced pro who can become part of a management team and enable him to remove some of the 15 hats the boss is wearing!
Like a lot of you, my client is going slightly crazy wearing all those hats. He’s become a slave to his business but could go a long way toward buying himself out of slavery with the extra profits stemming from a five percent increase.
No doubt many of you would challenge my reasoning assuming the same amount of sales despite a 5 percent price increase. Obviously, the example is vastly oversimplified but I don’t think most of you would lose very much business if you boosted your prices 5 percent. The problem is not that most of you charge too much, but too little. Besides, most of the business you would lose, you’d be better off without. People who are so price-conscious that they’d stop patronizing you over a piddling 5 percent are not going to allow you to make any decent money anyway. These are the people who cause you endless grief job after job and most of you end up losing money servicing these kinds of accounts.
The simple cure for unprofitably and inadequate owner compensation is to change one’s mindset. You need to learn to sell benefits and value rather than price, and understand that there must always be three winners in any business transaction — the customer, employees and the owner. Unfortunately, in our industry, far too many business owners have not been winners. They keep shooting themselves in the foot, then ultimately take one between the eyes.
Until next time, good luck, think prosperity and God bless!