Markups, Profits, and Customer Perceptions

You shouldn't show customers your numbers ó but you sure better understand them yourself. May 20, 2006

I am an independent contractor and I do remodeling. I've built several pieces of furniture and some cabinets for clients and have decided I really like it. I have a few questions. Are most of you upfront about material mark-up, or do you build it in to the labor price? I was not upfront about my mark-up of 20%, which barely pays me for pickup and disposal of scraps. When I gave my client the final invoice he asked to see copies of material receipts. I gave him the receipts and then had to explain the mark-up. The customer seemed okay with this but it was really an uncomfortable situation. I am thinking about building this cost into my labor. How do most of you do this?

I am a small, one man shop and the shop size is 25í x 20í. Is it possible to make a profit with this set-up for awhile? My prices for cabinetry seem really high. I've based an hourly rate on a target salary, and fixed expenses, but when I give a price it seems high for what it is. My long time customers don't bat an eye at the price but new potentials have told me that it is more than they expected. Maybe I'm slower at this than most but I have to charge for my time, right?

Forum Responses
(Business and Management Forum)
From contributor A:
When you buy lunch, try asking the guy at the counter for a breakdown of his labor, materials, etc. Granted, McDonaldís and others know it down to 4 decimal points, but they aren't going to share it with you. It is absolutely none of their business what your markups are. Will they reimburse you if you miscut, or for unusable lumber waste? Get your tax numbers, set up a business, and buy wholesale. Do not quote or sell at labor and material - just give them one price complete. If they demand more, start walking. They are too cheap to afford your services and skills, and you can leave with your spirit intact.
It sounds as if you need to search out the right market. It is hard to know if your costs are too high -you have to do the best you can to control them. The nouveau riche will try to cut you down fast if you let them.

From contributor B:
Your comparison to the restaurant business is perfect. Even when you think you know, you donít know. Ask your waiter to justify this. If an order of toast is 90 cents, and the difference between a regular burger and a cheeseburger is 25 cents, then why is a grilled cheese sandwich $2.20? Determine your price and make the quote. If you need to break it down or justify in any way to your customer, your pricing might be higher than everyone elseís. Thatís not always a bad thing, but should be further explored.

From contributor C:

In almost all cases it's more than what they expected - that's a given. You can give them more than a cheap price which they can get from any shade tree type. But will they get dependability, quality, timeliness, or satisfaction in knowing that the job will be completed to their expectations? In other words, sell the job on something other than price alone.

From contributor D:
I believe you are talking about time and materials. As the others have said, this is a bad thing when making cabinets. Give them a price, and if they say it's more than they expected then it sounds like you've got the price about right

From contributor E:
The only time I give a materials and time breakdown is on a commercial work, and only then if it is not a "here are the blueprints, how much to build". Once they start blowing the budget with trim, laminate panels, extra tables, etc. I always give them a breakdown because I am usually working on time and materials cost on anything over the original estimate work.

The only way to know if you are charging too little is to know your costs. If you are still getting work on 40% of your estimates, you are close to what the market will pay in your area. You want to have just enough estimates accepted so your shop keeps busy.

From contributor F:
My pricing has very little to do with labor and materials (or any costs, for that matter). I make sure my costs are covered, of course, but my pricing is based on what the finished product is worth on the market, not what it costs me to build it. My contracts have line-item quantities in linear feet of cabinets at a specific price for a particular run. 35 LF of kitchen bases cost this, 15 LF of laundry uppers cost that, etc. The price per foot covers all my associated costs (materials, labor, overhead, insurance, utilities, supplies, hardware, etc.) but each line is not broken out for the customer, it's just a single price point. At the same time, I do include a profit line item in my contracts. It's straight up profit with no costs associated to it, and it generally floats around 10% of the contract price. I tell customers right up front that this is what I'll get to put in the bank. The rest of the profit margins built into the LF pricing fluctuate - maybe I'll have more waste or less finishing, whatever, but the profit line is free and clear.

If a customer ever asked me for my material receipts (and they never have) I'd ask them for their tax returns. After all, they're trying to figure out if they could have paid less. It's only fair for me to be able to determine if they could have paid more. Are your prices too high? Only you know. Is your product worth it? If it is, stand by your prices. Of course it's more than the customer expected, what else are they going say? Don't fall into the trap of letting your pricing sell your product for you - it's a bottomless pit from which there is little hope of escape. Sell the benefits of your product backed up by the features you included and charge for it.

From contributor G:
There are two ways of selling in this world. When I say selling, I mean the way that you fix the project - and yourself - in the customer's mind.

The first is based on price. This is a game that the one-man shop cannot win - as well I know, as I'm also a one-man shop. We simply cannot compete with the economies of scale that the import furniture manufacturers have. And if you do try to sell based on price (been there... done that...) you're working essentially for free. You can't do that for long and expect to survive.

Selling based on quality and the value added to someone's life by purchasing your product is a more winning strategy in my experience. In this case the customer, as has been eloquently pointed out, has no business knowing where the nickels and dimes went. Here you're not selling a price point - you're selling your fine craftsmanship and the added value and serenity, etc. brought to the customer's home within a single, bundled price point for the given item.

Time and Materials is a good start to coming up with what to charge the customer, and works out if you know what all of your overhead costs are and if you're really good at estimating the amount of time the project will take. Sounds like you've got this part figured out. But the price communicated to the customer is a non-negotiable bundled cost for the item. Don't forget to include things like delivery, whether you need to hire an extra set of hands (friends, family, etc.) for the delivery/installation day and any other incidentals. Don't forget to also up-charge if you need to rent a box truck to carry the finished goods to the customer. This up-charge accounts for your time to wrangle the thing and return it again, plus fuel, etc. Again - a bundled, non-negotiable price for delivery and installation is the key.

Ultimately I think your difficulties are fixed with clear-set expectations that you define at the outset of the project, done as you're hooking and booking the job. Set the customer's expectations for these bundled costs right at the beginning and your life gets less complicated.

From the original questioner:
Thanks for all of the advice I usually on my invoices and proposals give a price for the labor, materials and total. I think I'll just give a total from now on. Thanks for the different points of view. I have figured an hourly rate that includes my expenses and overhead plus the annual salary I need to make and it seems to work when I do electrical work and remodeling as long as I estimate how long it will take accurately. I have a good source at wholesale for solid wood like mahogany, maple, etc. It does have to be planed, but a good price.

From contributor H:
There's been some great advice here. Now, when you do your estimate (for your eyes only), be sure to account for all of your costs (it sounds like you already are), then add profit. Contributor F mentioned this already. There is no need to add this as a line item for the client, but please add it to your price. If you ever plan on retiring, and being able to have money then, you need to put that extra money away. Or, you can use it to reinvest in your business (buy more efficient equipment, etc.). But if you are not adding profit, you essentially have a job, not a business. Besides, profit is not a four letter word.

From the original questioner:
How much of a percentage should I add for profit? And this may sound stupid, but what should I do with it? Invest in more tools? Start an IRA? Other?

From contributor I:
If you're making a good profit, yes - re-invest it or pay taxes on it. If you're paying taxes on about $30K/yr, it's time to file articles of organization. We markup every item that goes into a project, including the labor and pro-rated operating costs then add a profit margin. Since our hourly rate includes operating costs, the labor really has a double mark up. But, that's all just cushion that (hopefully) covers the unforeseen things that periodically pop up. As previously said, if they think you're too high you're probably on target!

From contributor E:
I mark up material between 30 and 100%, depending on what it is. I have a spreadsheet on my PC where I track costs. Expensive items usually get the 30%. For lumber, I usually add a buck a board foot, sometimes a little more, sometimes a little less. Little things like hinges, catches, etc. get 100%. I also add about 1% of the total estimate into the cost for glue, screws, brads, etc.

For the shop rate I know what the minimum is to meet payroll for one person plus all overhead (burden, taxes, etc.). Then I double it. That is my shop rate. For only one person working, that is not much money. However, with at least two employees working, the first person covers all overhead for the shop and their salary. All additional people still make the same shop rate, but no overhead comes out. Here is where I get to make money.

It takes a lot of self reflecting into your business and the costs associated with it. No one else can give you any sort of formula or % or anything else that will work for you. I believe all owners should know all costs involved in running your business. How much did you spend in labor sanding on your last job? How about in cutting, CAD, selling the job, assembling, etc.? Once you have some data on this you can begin to look at time savings. Where do you need to spend money to get a ROI the fastest? Will that new oscillating 108 inch sander be worth it to you?

I know that seems a little off track but being new to this you really need to know all the little details. Some disagree with me. Watch the dollars not the pennies. I watch pennies. If I watch them closely, I know what my dollars are doing. Now, starting my 3rd year doing this full time, I know my percentages are in line of what I want them to be. I turned a profit in year 2 and had a 65% growth from year one. I owe no one. Iíve always used cash to buy equipment or did without until I saved the cash. I have no credit other than a small line at Home Depot in case the shop needs something while I'm out.

The point is, do the best you can at first. Develop cost tracking sheets and learn your costs. Then adjust your shop rate to match the costs. One more thing - all this shop rate and mark-up stuff is a minimum. If the market will bear it, charge more.

From the original questioner:
Thanks, I feel like I got a lot of great advice. I also think I need some time to keep even better records and then review, change if needed, and keep doing the same.

I agree with sweating the small stuff. For instance, when I do electrical, I figured out awhile back that if for any reason I lose and hour of billable time a day, for, say, 250 days a year, I lose $12,875.00. That's just an hour. A trip back to the supply house, could take an hour. This changed the way I thought about being organized.

From contributor J:
This statement..."My pricing has very little to do with labor and materials (or any costs, for that matter). I make sure my costs are covered, of course, but my pricing is based on what the finished product is worth on the market, not what it costs me to build it", is a statement you need to take to heart. Think about it for a good long while.

Remember these 3 things:
1) Quality
2) Speed
3) Price

Pick two of the three, because you canít have all three. In other words, you canít sell the best product for the cheapest price, and faster than anyone else. Your customers want quality and timeliness. If they say itís expensive, it because you haven't sold them hard enough on your quality and timeliness. You can do it 500 sq ft, just be very organized. You will soon want another 500 sq ft, but by then you will have a better feel for what youíre doing.