Common Home Improvement Error: Improper Pricing Formulas
Revenue is up. Your marketing costs are down. Employee morale is at an all time high. Despite all this, your business is barely staying afloat. How is this possible?
Frequently, it has to do with a miscalculation in the pricing formula.
From our experience, many business owners set their prices based upon arbitrary formulas, what the competition is pricing, or frequently they simply arrive at a number in their head that they believe will yield a strong profit. None of these methods are effective, and frequently they can have a disastrous effect on your bottom line.
Over our 45+ years of industry experience, many things have changed about the way businesses should be run; however, one thing that remains the same is the pricing formula.
With the right system in place, specialty home improvement companies can earn 10-15 (and sometimes) 20% pre-tax net profit. Full-line home improvers (including design and build) can earn 5-8% pre-tax net. It’s all in the formula and the control(s).
In most cases, direct costs are not clearly defined, and fully loaded marketing costs are not defined, allocated or managed. Because of this, a company’s profitability may appear to be in better shape than it actually is. The first step is to make sure you are classifying all of your costs properly; for example, even if you are the only individual who sells business in your company you still need to separate all of the costs that are attributed to the selling process.
Once this is accomplished there is a formula to assist you in calculating your selling price (all of the numbers are estimates based on an average home improvement company that sells replacement windows):
Sales Costs (fully loaded)Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 13%
Marketing Costs (fully loaded)Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 15%
G & A Operating Expenses (overhead)Â Â Â Â Â Â 20%
Anticipated Net Profit                                  10%
TOTALÂ Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 58%
As you can see, the goal is to achieve a 10% net profit. Once you have performed this calculation, the total percentage (in this case 58%) is subtracted from 100% to arrive at your direct cost calculation.
Direct (L&M) Costs   = 42%
The final step is to apply this percentage to the cost of your product/service (again all costs are estimates):
Cost of window (incl. shipping)Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â $150.00
Trim and Miscellaneous                            $ 15.00
Labor to install (incl. re-measure)Â Â Â Â Â Â Â Â Â Â Â $Â 70.00
(Direct Cost) Total labor & material =    $235.00 = (42%)
Next, divide 42% into $235 = $560.00
The $560 represents the minimum selling price of your product/service that is necessary to achieve a 10% anticipated net profit.
A couple things to keep in mind:
- There are always unanticipated factors that come into play that will affect your bottom line (we call them G.O.K. – God Only Knows).
- Depending upon what business/market you are in there may be a slight variation that is necessary; however, the basic calculation will remain the same
By using this formula to arrive at a selling price you are taking all of the guess work out of the equation and assuring that high revenue will equal high profitability in your business.
We developed a package that delves into this formula further along with all of the other elements you need to know to run a profitable business. As you may guess, the package is called: How to Run a More Profitable Business. If you have any questions about how to implement this in your organization, call me directly at (703) 591-2490 or e-mail me at dave@daveyoho.com.
