How to expand with higher prices

BY RICHARD P. DiTOMA,
contributing writer

A plumbing contractor whose initials are DT emailed the following to me: “Hello Richard, I have been in business for 4½ years now. I started out trying to be the low price but quickly learned to price myself where I feel I should be and have been very successful as a one-man plumbing shop. I work 1,600 hours in the field a year and gross sales are $430,000. I take home $200,000 a year for my family.
“My goal is to run a six-man (mid-sized) shop, but I cannot get any larger customers because they are only interested in the lowest price; I sell quality and service at a mid level price. 60% of my business is remodelers and new home builders, 40% are homeowner calls. Every time I bid with a mid-sized or larger builder (five+ houses a year for new/three — four projects a month for remodel) I find myself going nowhere, because of price. Two years ago, I completely gave up trying to get larger contractors, because I find that, regardless of their status as a high or low end builder/remodeler, they all want the lowest price and don’t care about quality. I have instead focused on the smaller contractors (one — two houses a year/one remodel a month or less). To expand to six employees, I’d need 120 small builders/remodelers (I have 20 now).

“Using your higher price theory (which I somewhat agree with) how does one expand without getting the larger customers?

“Right now, my rate on new homes is $88 per hour (competition is in the $70s) and $104 on remodel (once again, low end is $70 – $80). Typically, on new homes the low bid is what I consider ‘at cost,’ which is typically $1,500 less than mine. Once in a while, I get outbid on new homes by $3,000+. I’ve had some large remodelers complain to me about the high price their plumber charges, then, later, I’ve found out that their plumber is one of the top five lowest-priced guys in town. The pattern of large builders has been repeated 20 times+ over the past 4½ years. I’ve never talked with one large builder who looked for a mid-priced plumber.

“The only reason I lose a customer is typically over price; 50% come back within a year. I completely blame our industry for undercutting to the point of doing jobs under cost, but reality is what it is. How can I expand?”

D.T.

Dear DT,

Business fundamental 101

My theory is not “higher prices for the sake of higher prices.” Putting aside “non-profit” and “not for profit” businesses, the only reason a business exists is to earn a profit. To reach that goal, contractors must utilize a business plan that contains the following steps.

Step 1: Identify, calculate and control tangible and intangible operational costs.
Step 2: Choose a proper profit margin that provides the opportunity to attain the desired profit.
Step 3: Properly blend steps 1 and 2 to arrive at proper profitable selling prices.
Step 4: Develop a client base that wants value for the dollars they spend with contractors and is willing to allow contractors to recover their cost and have an opportunity to earn the reward they deserve for the delivery of excellence.

There is no shortage of ignoramuses who turn our noble industry into one of stupidity, stress, frustration and misery for the following reasons: They guess at their costs. They use profit margins that can never result in a profit, because the margins they choose cannot withstand the unforeseen conditions that arise in any fiscal period. They base their decisions on wrong numbers and blend those faulty numbers to arrive at unprofitable selling prices that do not allow them to afford to deliver excellence to consumers on a constant basis.

You envision my theory as a “higher price theory,” because when contractors embrace proper business protocols and mathematical fundamentals their selling prices are higher than those of contractors who utilize flawed techniques, which can only lead to the stress and frustration about which you have written to me.

About your need for more customers

As to your dilemma about the contractors for whom you provide your service, think about the fact that high priced luxury car manufacturers don’t sell many cars to consumers who just want low priced, no frills vehicles that only get them from point A to point B.

All consumers and contractors for whom you can provide service are not suited to be your clientele. Some are price buyers. The value buyers (which includes the 50% who left and came back) are aware that your prices are higher because the value you deliver is better.

Regarding shop size

Although large shops employing more than six full time plumbing technicians exist, volume does not guarantee that you will make a profit. I believe most plumbing shops in the U.S have fewer than six full time technicians. Expanding to a larger size shop will definitely add to your cost of operation. In turn, your search for more builders to address the higher costs of your larger shop makes your managerial job more difficult. This will lead you to being tempted to lower your prices just to make payroll. When you think about it, the size of your shop is not as important as the profitability of your enterprise. If each technician is not profitable, there is no need for that technician.

Concern over your numbers

I don’t know all your true numbers and have some concern regarding the $430,000 gross sales and $200,000 take home numbers you provided. Some amount must be applied to material and overhead expenses. A one person PHC business in the U.S. such as yours has a minimum labor and overhead cost range of $100 to $250 per hour. It has a minimum overhead burden of $75 per hour for expenses, not including the salary and salary expenses of one person as the business’s administrator.

That $75/hr is related to administrative salary (the amount the one person should be earning for his/her duties as the business’s administrator, which add to your 1,600 hours in the field) and to related salary expenses, vehicular expenses, insurances, office supplies and equipment, utilities related to the business operation, communications, advertising, professional services (accountant, legal, etc.) and additional miscellaneous expenses necessary to run your business.

Figure 1 gives you an idea of hourly costs to that one person contractor example for labor only and for labor and overhead costs combined (using $75 per hour for the overhead burden) based on 1,600 hours in the field. These numbers are conservative and will vary from area to area, but I believe they are close. As you can see, the lowest minimum cost to the contractor, inclusive of the items listed is $106.43 per hour for a $30,000 annual salary. It goes up from there.

When you charge $88 per hour, you are probably losing at least $12 per hour. If you had a six-man shop and charged $88/hr, you would probably minimally lose at least $72 per hour. Your $104 per hour rate is just over my estimated minimum cost of $100 per hour. Therefore, that too may be a losing rate, which, according to Figure 1, it is.

The revenue you can bring in at your remodel rate of $104/hr for 960 hours (60% of 1,600 hours) can only bring in $99,840. The $88/hr. rate would obviously bring in less. Neither gets you to the $200,000 you say you bring home. Therefore, you must be charging more for your homeowner calls, making a great profit margin, have arrived at wrong numbers in your email to me or some combination thereof. With the limited information you sent, it’s impossible for me to pinpoint the reason.

Solution

If your “homeowner calls” are bringing in profitable numbers, while your contractor rates are bringing in losing numbers, the answer to your question is right before your eyes. Concentrate on establishing your homeowner business, where you can earn the reward you deserve for the excellence you deliver. Then, if those builders, contractors and remodelers still want to avail themselves of your superior quality, they will have to pay you a profitable amount for your services. And if they don’t, you will have your homeowner business to expand profitably.

With correct numbers, the right mindset and strong financial ability, PHC businesses can afford to expand the size of a shop in a proper manner, which delivers excellence to consumers rather than resorting to the erroneous thought that volume can make up for flawed numbers.

Contractors only have three choices with regards to their selling prices: They can choose to sell their services below their cost, at their cost or above their cost. It’s each individual’s choice. Don’t blame the industry for your price structure and your business plan. You can help to fix the problem by doing the right things and being a good example. If you don’t start now, you will have the same problems decades from now.

Thanks for your input, DT. If you want my help for your business or want me to show the people in the industry in your area the error of their ways, call me at 845/639-5050. That goes for all my readers. That’s why I have spent a good portion of my life writing articles, conducting seminars for groups of contractors and consulting with contractors who seek my coaching skills on an individual and confidential basis. I’m ready, willing, able, waiting and looking forward to helping all of you. I wish you all good health and much wealth.

Richard P. DiToma is a contracting business consultant and active PHC contractor with over 40 years of experience in the PHC industry.