to give yourself a cushy landing.
Just before the turn of the century, NASA sent a climate probe to Mars. After traveling millions of miles across space, the margin of error for atmospheric entry was as slim as a knife's edge - not much more than 50 miles. The project turned into a multimillion dollar fireworks display due to a small glitch in the way the Martian orbit trajectory was calculated. Fortunately, math has been better in subsequent missions.
The NASA scientists couldn't do much about the distance between Earth and Mars. It is what it is. But in the plumbing/indoor comfort business world, a major part of management involves adjusting trajectories on the fly. The trick is to know which numbers are “soft” and which ones can turn you into space dust.
Soft NumbersPart of my mission is to help contractors navigate their switch to up-front pricing. Probably the most frequent question I field is the one about keeping up with erratic material costs. If we lock in a flat rate price today, then what happens next week when copper prices take another leap? Will we have to reprint that section? No doubt, if you were selling boatloads of copper parts at a 1 percent margin, you might have to adjust prices almost hourly. Thankfully, PHC contractors aren't (or at least shouldn't be) in the commodities business, so we have a bit more fudge factor. We can “soften” these material costs by thinking in terms of materials budgets rather than materials costs.
For example, we know that connecting a circulator may require a couple of male adapters, a union and a bit of piping. If we were charging time and materials, we'd want to itemize every inch of pipe as well as each fitting. With up-front pricing, we can soften the numbers with a materials budget that includes parts to cover the job description, plus a fudge factor to allow for variations in job conditions, material costs and the loss of one of those adapters when it falls into the sump pit. Using a soft materials budget this way helps to smooth out the pricing bumps, stabilizing our pricing for longer periods of time.
Another number which can be softened is our labor cost. Labor is a significant and growing budget item; to keep it from burning up profits, let's add some cushion to the budget. Start by determining what sort of compensation you need to offer in order to attract the top tier professionals you seek. (Notice that I don't ask about the “going labor rate.”)
Let's say a base rate of $60,000 per year would be attractive in your market. Workers' compensation, health insurance, withholding and retirement programs, uniforms and training can quickly boost the cost of that employee to $75,000 before you ever even think about padding. If you build in a reasonable cushion of, say 5 percent, this tech's budgeted cost would still be below $80,000. But now you know you're insured against some of the surprises that can come along. (Note: Use your own numbers for these calculations.)
Hard NumbersIn our previous technician example, we only dealt with the overall base cost of that employee. We haven't yet calculated what that tech's cost would be on any given job. This is where we need a hard number. The number I'm referring to is a production budget. Production, simply stated, is the amount of work that can be performed in a given time period.
There are several ways to calculate a production budget, usually involving the amount of productive hours a technician is capable of performing. For example, in a 2,080-hour standard work year, a tech might be budgeted for 1,000 “billable hours” in service or maybe 1,500 “billable hours” in construction-type work. You can pick any production unit to build your budget on (as long as it makes some sort of sense), but once you decide upon a production budget unit, it needs to be cast in stone.
Using your production budget as a guide, determine what quantity of production should be assigned to each job you do. Keep in mind that a normal technician in a normal day's work should be able to produce enough production units to achieve the annual production budget you created. The dollar amount doesn't matter. The cost of a production unit can vary as your business changes but the production budget should be constant. Calculating the selling price of any given service is a matter of adding the costs - which include the parts, labor and overhead - then calculating your selling price to achieve the profit you desire.
Why is production such a hard number? As we've already mentioned, costs can change on a whim. If production standards aren't constant, then it becomes very difficult to ever know where you are with your pricing, profits or efficiency. Here's an example: We've seen gasoline pricing go all over the map. If you measured fuel efficiency in miles per gallon last year but decided to use kilometers per gallon as this year's standard, it becomes very difficult to compare last year's and this year's performance side by side.
The Performance CushionOnce you've established your production unit, you may find that your crew is more efficient than you first expected. What if you base your budget on 1,000 annual production units per truck, but your data shows that you're averaging more like 1,200 per truck? Congratulations! You've just uncovered the key to supercharging your profits!
On the other hand, what if your crew is having a hard time meeting the production budget? Below-budget efficiency is the same as selling your services below cost because your overhead is not being covered. Make sure that each service you perform includes a reasonable portion of your overall production goal. When you add more production labor to a particular job, you are increasing the amount of operating cost that the job will cover and you're improving the production efficiency for that service. Remember, efficiency is the profit “supercharger.”
The Cushioned Landing Mind-SetThe price of parts and the cost of labor is only part of your pricing equation. You're not selling commodities, you're delivering benefits. An auto dealer may have a hundred identical cars for sale. Some days, the plant may be running at 75 cars per hour while other days it's humming along at 100 cars per hour. Yet, in spite of obvious man hour differences, all the cars carry pretty much the same price, differentiated only by the price of the option packages. Cars built on average production days are profitable. Cars built on above-average days are even more profitable.
Customers don't buy the cars because of how much they cost to build but for the benefits they receive. Looks, color, power, accessories - these are the qualities the customer desires. Why would this be any different for a toilet or indoor air comfort system? Wouldn't it be nice to choose between profitable and more profitable jobs instead of settling for profitable and unprofitable? That's what your cushion is all about.
Is it possible to build in too much cushion? After figuring in a cushion for labor costs, material costs and production efficiency, it is quite likely that your selling prices will be higher than they were before. How much cushion is too much? Before answering this question, think about the alternative. The slimmer your margin for error, the more likely you are to have a hard landing. If you have a 10 percent margin of error and miss the target by 5 percent, then at least you're still in the black. If you have 5 percent margin of error and miss by 5 percent, you don't earn any profits at all. Where's the fun in that?
Will some customers complain about your pricing? Absolutely. What you have to decide is whether or not you want to please everyone in order to survive on the knife edge between profit and loss, or whether you want to serve customers who will allow you to have a bit softer ride.
If you ask me, cushy is better.