I’ve been in a hot discussion regarding Markup on another forum and while poking around through some old files on my computer I can accross an archive of a great discusson on markup that ran on for over a year on the old Remodeling Online forums which are now extinct called Markup How Much is Enough. In it Tom Lykos (Sonny’s son and now the brains behind The Lykos Group ) wrote a couple of great posts and thinking they might inspire some worthwhile logical and critical thinking here I thought I post some of them here.
Posted: 10:02 pm, Sunday, Feb. 1, 1998 By: Tom Lykos
I love this subject. Because our jobs are so diverse, I deal with this issue on almost every estimate.
Let me throw this out for you guys to think about:
An exterior finish company called Exteriors Unlimited does siding, painting, stucco, and masonry.
Job #1: Painting the exterior of a house
- 100 man hours @ $25/hour labor burden = $2500
- Paint & caulk cost $1000
- Total direct costs = $3500
- Add 50% mark-up $1750
- Total selling price $5250
Job #2: Install siding on the same house
- 100 man hours @ $25/hour = $2500
- Siding & material $7500
- Total direct costs = $10,000
- Add 50% mark-up $ 5,000
- Total selling price $15,000
In both jobs, the labor invested is 100 man hours, however the siding job produced an extra $3,250 in gross profit.This raises several questions:
#1 Should this company continue doing painting?
#2 Should a different mark-up be used on each type of job?
#3 Should mark-up be a factor of time not costs?
The one problem I have always had with the flat rate mark-up is that the mark-up is noirmally based on historical information i.e., overhead from last year, sales from last year, profit from last year. If this company had a stretch of painting jobs, it may not generate enough income to cover overhead & profit. Or, on the otherhand, if a stretch of siding jobs were used to calculate P & OH, the painting job mark-ups may be way to low. Based on those arguments, a mark-up based on time may be most accurate. Regardless of the mark-up calculations, timely and concise job costing and P & L statements should keep any company on track.
In the case of the companies that use the same mark-up regardless of the duration of the job or the breakdown of the direct costs as a percentage of total costs, you may bidding too low on some jobs you get, and way too high on jobs you don’t get. At the end of the year, all you have is an average P & OH on all the jobs you did.
Obviously, there are other considerations involved in estimating and selecting jobs to bid on.Just my two cents on a complicated, yet interesting issue.
Tom
So what do you folks think? Should this company “Exteriors Unlimited” continue doing painting? Should a different mark-up be used on each type of job? Should mark-up be a factor of time not costs? What do ya’ll think?
Edited 12/15/2005 4:26 pm ET by JerraldHayes
Replies
Should they? Yes. Why? It's profitable. The non-financial perspective is diversity alone may allow them to weather some industry flux that other businesses will not do as well in. At which point, that is a financial consideration, but not one that is easily broken down into nuts, bolts, and numbers. Objective vs. Subjective.
Should a different markup be used? I'm not ready to call that black and white. It's possible. I don't see a fault in it. You of all people are (now thanks to JLC) painfully aware that different people and companies prefer to use different methods to compute their markup and where that markup originates. It can be an argument as simple as one company knowing that their level of attention to detail can net a premium for the same kind of work that another company will do for less. Brand loyalty. Their client list wouldn't even think of calling someone else.
I like the last question most. Time vs costs. Both. I tend to look at it from a perspective of not just what I'm doing, but how long it takes, what I have in materials, and what kind of risk I'm taking on by doing the job. Say door replacement is a chunk of business for you. You can send one guy out and in one day, he can easily replace one front door, get the DW patch work done, paint touchup, and casing on. So there's 8 hours at say $25 an hour. Your labor is $200. Do you charge the same $200 for a steel Thermatru as you do for a custom ordered Mesquite door that cost you $5K? No. And again, the why is, someone who's only comfortable with $200 doors isn't going to take on a job where one snag can screw up a $5K piece of material. They'll walk. But you'll take it, and it matters not that you have people who routinely do the cheaper doors, they're capable of dealing with higher end materials as well without giving your business a black eye. And you charge for that. And not just because "you can", because you have to. Even great employees make mistakes. And you're going to stand behind it, whatever it is, and make it right for the homeowner.
You haven't asked, but I'll spill it. Overhead for me is on labor. Markup and profit is a separate line item, and it fluctuates, a little, depending on the variables I mentioned.
"If you pick up a starving dog and make him prosperous, he will not bite you. This is the principal difference between a dog and a man." - Mark Twain
I think the key to the three questions
is all in the answer to the third question.
#1 Should this company continue doing painting?
#2 Should a different mark-up be used on each type of job?
#3 Should mark-up be a factor of time not costs?
In the scenarios above the contractor "Exteriors Unlimited" is using a Traditional Volume Based markup method.
(Labor Costs + Materials Costs + SubContracting Costs) X Volume Based Markup = Sales Price
Look again at the same jobs at a contractor using a Capacity Based Markup (aka PROOF):
(Labor Cost X Labor Markup) + Materials Cost + SubContractors Cost = Sales Price
Job #1: Painting the exterior of a house
100 man hours @ $25/hour labor burden = $2500
2500 Total Labor Cost X 2.35 Capacity Based Markup = $5875
Paint & caulk cost $1000
Total direct costs = $3500
Total selling price $6875
Gross Profit $3375
Job #2: Install siding on the same house
100 man hours @ $25/hour labor burden = $2500
2500 Total Labor Cost X 2.35 Capacity Based Markup = $5875
Siding & material $7500
Total direct costs = $10,000
Total selling price $13,375
Gross Profit $3375
The Gross Profit on the two jobs which both take up the same amount of the contractors time is now equal.
Additionally job # 1 which was under priced before and was losing money by not generating enough Gross Profit is now priced higher and Job # 2 which might have been priced too high before and the customer might have balked on is now lower priced while still covering the contractors Overhead.
I think the point is you often hear contractors talking about some jobs are more profitable than others. Well I think that all jobs can be equally profitable if they are priced using the correct strategy which in this case is using a Capacity Based Markup instead of a Traditional Volume Base one.
So looking at those three questions again I would say:
#1 Should this company continue doing painting? Yes, if they change to a Capacity Based Markup instead of a Volume based one.
#2 Should a different mark-up be used on each type of job? No, that's not needed if they use a Capacity Based Markup instead of a Volume based one.
#3 Should mark-up be a factor of time not costs? Yes Markup should be a factor of time (Capacity) not Costs!
RW - "You of all people are (now thanks to JLC) painfully aware that different people and companies prefer to use different methods to compute their markup and where that markup originates."
What I have learned from the markup discussions on JLC is that many people don't make rational decisions regarding what Markup strategy to use based on logic or math. They make their decision on emotion, their loyalty to a teacher ( Walt Stoeppelwerth, Michael Stone or Alan Hanbury etc.) or contractor who first taught them how to price their work. I know I was a Walt Stoeppelwerth protégé for a long time until I one day stumbled into an Irv Chasen, seminar on Markup where he taught his system called PROOF which is a Capacity Based Markup methodology. Luckily something clicked and I listened and rethought the way we were doing things. As it turned out in time I discovered there are other "teachers" out there who also advocate a Capacity Based Markup such as Ellen Rohr and David Gerstel.
"You haven't asked, but I'll spill it. Overhead for me is on labor."
Randal, I didn't ask because I didn't write the original post, Sonny's son Tom did. I did however think it was a really great example of a way to look at the question of markup.
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In your first example, your gross profit is 33% for both jobs. In the second, your gross profit is 49% on the paint job.
Job cost are basically labor and material. As a builder who primarily uses subs my view may not apply.
I pay a sub-contractor and do not look at it as labor, but rather a service (the installation of a product). So, the GC is making a 33% gross profit on installed siding and paint. In both cases the GC is selling a finished package and making 33% gross profit.
I realize there is management, insurance, warranties, bookkeeping, etc. that are not touched on in this situation, and for someone who has "in-house" labor this train of thought may not work.
Why should the GC discontinue painting? The gross profit percentage is the same on both projects.
A good sub-contractor will manage his own labor, I am responsible for scheduling and quality control.
To be specific, related to your example and my procedures: Our painter does a turnkey job, furnishing paint and prep material, there is less management required. On the other hand our frame / cornice sub provides labor and fasteners ONLY, so there is more management necessary doing materials take-offs, managing material, paying bills, etc.
I can see and understand your reasoning given in-house labor / hourly employees and material management.
txlandlord - "In your first example, your gross profit is 33% for both jobs. In the second, your gross profit is 49% on the paint job.
Job cost are basically labor and material. As a builder who primarily uses subs my view may not apply."
That is true and that is what all the heated debated and misunderstanding in the JLC discussion on this is mostly about. For a contractor who subs out everything using a Capacity Based Markup isn't essentially since the measure or index of his or her capacity is in how much subcontracted work they can sell. I that particular case Capacity does happen to be equal to Volume so a Volume Based Markup does work. The point I was making over there was that yeah a Volume Based Markup does work under those conditions but so does a Capacity Based Markup too. However if the business model changes for whatever reason, market dictates that a builder needs to get into small jobs or remodeling and hire on personnel etc. then a Capacity Based markup is essential. So what not just use a method that works under any and all conditions rather than one that works only under certain specific conditions?
"Why should the GC discontinue painting? The gross profit percentage is the same on both projects. "
In the examples in my first post where the contractors are using a Total Volume Based Markup strategy while the percentages are the same the resulting dollars over the same time period are not and that is the heart of the problem. Both projects take 100 hours yet one project (Job 1) earns $1750 in Gross Profit where the other one (Job 2) earns $5000 in Gross Profit. That's a difference of $3,250 for two jobs that take up exactly the same amount of a contractors time or capacity.
"I can see and understand your reasoning given in-house labor / hourly employees and material management. "
Thank you, that's really been the heart of my point all along. If your labor in-house unless you are doing projects where the ratio of Labor to Materials to Subcontracting is roughly the same for every job then a Capacity Based Markup is essential. If your a contractor doing projects where the ratio of Labor to Materials to Subcontracting or are doing projects where you sub out everything you can use a Volume Based Markup but you could also still use a Capacity Based one too and be more protected just incase those ratios or your estimated Volume changes.
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I would tend to agree with RW.The "operational" overhead should, IMHO, always be covered by labor rates if you're a smaller remodeling contractor who is likely to do a lot of in house work.The other kind of overhead, the costs that are incurred from the risk of handling expensive materials or increase in GL costs because your annual volume has increased, obviously lends itself to being tied to a markup on materials and labor.Should the fictitious company continue to paint? There are a lot of factors that go into answering this questions. What are the current market conditions? Does the company have a business plan and how does painting work fit into the big picture? How busy is the company now and how do they project their workload in the next 1-5 years? What type of employees does the company have and what does the available labor pool look like?RW's right, if they can profitably paint, why shouldn't they?I believe I've heard someone say (maybe Jerrald) that they have noticed that 20% of their projects produce 80% of the profits. I think this point is one that many business owners should consider.Some jobs can be much more profitable than others, but you may need resources at your disposal to perform that you wouldn't have if you focused only on the lucrative jobs.Another questions is, using an SPC chart, how do you determine the buffer to eliminate all variability? <g>
Jon Blakemore RappahannockINC.com Fredericksburg, VA
JonBlakemore - "I believe I've heard someone say (maybe Jerrald) that they have noticed that 20% of their projects produce 80% of the profits. I think this point is one that many business owners should consider."
That was a reference to Pareto's Rule but I don't think I said "Profits", I think I said "Revenues". 80% of our Revenues come from 20% of the things we do. Because of the Capacity (PROOF) Markup strategy we use all of the labor we perform is equally profitable. However in both the example and the equation above, in order to keep it simple, I didn't markup Materials and Subs for Net Profit which you should also really do too. That makes jobs with high material costs or high sub costs extra profitable. The Capactiy (PROOF) equation should really read:
(Labor Cost X Labor Markup) + (Materials Cost x Net Profit Markup) + (SubContractors Cost x Net Profit Markup) = Sales Price
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Edited 12/15/2005 6:49 pm ET by JerraldHayes
Okay, maybe it wasn't you that I was thinking of, or maybe I'm just remembering incorrectly.My question for you is, don't you make more money fabricating and installing helical volutes than you do installing baseboard?I know for our company some jobs are very profitable and some are marginal. Of course we do what we can to maximize the percentage of very profitable jobs, but making sure our resources are utilized effectively is also a concern. Some of the time you need to take a marginal job to keep busy and cover your overhead.Of course, you never want to work for less than what you need so that is where the PROOF system is valuable.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
JonBlakemore - "My question for you is, don't you make more money fabricating and installing helical volutes than you do installing baseboard?"
Well yeah, and that is a really good point.
But that kind of work is more profitable or should I say extremely profitable because your doing something really special that no one else can do or it's at least hard to find a company or someone who does that particular task. That's what I was getting at a couple of years ago here with my Pricing for ‘perceived value’ topic . Ths past summer we (I) wallpapered a water closet for $5000 becuase no one else would handle this exotic and incredibly fragile Italian paper our client wanted to use. A lot of that price was a surplus just
for the value of skill in being able to handle it. It's great work if you can get those kinds of projects but they don't always come walking in the door.
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Funny thing too Jon I tried to find what I actually did write in that discussion over on JLC but there was soooo much text to wade through I gave up after a few minutes of looking.
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Jon,
when you mentioned " some of the time you need to take a marginal job to keep busy and cover your overhead"
I think you skipped right over one of the most important things ever covered here on breaktime.
glancing back on the 80%/20% rule
Strictly from a business standpoint---taking that "marginal job"---is probably a mistake
Basically---if you are aiming to stay" busy"
80% of your time is possibly wasted on marginal work
My experience is likely not directly applicable to you------------ but I find that avoiding having employees---allows me to eliminate 80% of the possible projects( and their liability)------and concentrate on finding and producing the 20% of the jobs that will create the most money.
i am sorry that I am not phrasing this well--------- but observing the 80/20 rule---and following it to it's logical conclusion----encourages me to "cherry pick" jobs
best wishes,
Stephen
I agree Stephen, but it does'nt really have anything to do with employees.
I've learned over the years to walk away from marginal deals even if I have employees. Sometimes Frank needs to be reminded of that lesson, but I don't find out till I get to the job-lol!
The thing that I keep pressing into his head is that every time I found myself doing work that was marginal, I didn't have time to seek profitable work. Invariably, every time I'm stuck in the middle of a dead pig, trying to finish up, I'd get a call about a job that would be great, but since I wasn't immediately available, it would go to someone else. I swear this happeded at least ten times to me before I acknowledged it. It usually happened every spring when I was at my hungriest after a long winter layoff. Nowadays, I'm a lot more cognizant of the situation and still turn down nasty jobs even if I've been idle for weeks.
The worst thing about the spring scenario is that it starts of the building season with the entire business operation in a hole. I found it was much better to simply lay off the guys if necessary and then when they come back from their "vacation", were all in a better mood. Nothing sucks the life out of a business worse than a three week house that takes six to finish. Also, those types of builders (the kind that offer three weeks pay for six weeks work) tend to drag out the payment schedule. Instead of honoring their agreement to pay promptly, they find ways to drag out the pay schedule for months, thus compounding the already bad situation.
Nowadays, I don't take marginal jobs. I'd opt for unemployment.
blue
You know blue-------- I think the very FIRST thread I ever had the nerve to participate in here on breaktime---way back when---was on that very idea.
In short--- I had realized that things ( jobs)come in cycles-------- so ---no matter howmuch I might need work------ I won't cut the price just to buy a job.
Iwill stay home for weeks or months---even RAISING my prices
Because I know that without fail---one day the phone WILL ring again---and will ring and ring and ring------and in one day 4-5 jobs will come in
and when those 4-5 jobs come in all at once----I want 'em all to be high price quality jobs
I don't want 'em to be low price marginal time wasters.
Since I realized that---in the last 8-9 years I have ALSO learned to start "stockpiling" some jobs about Oct. or November so that Mid March I am ready to HIT THE GROUND RUNNING.
Useing subs more and more now---and it is considerably easier to schedule eager,experienced,qualified people in march---than it is in Oct.,Nov. when everybody is just trying to finish up their backlog for the year
Stephen
I like that idea about stockpiling jobs for spring. I'm going to see if I can arrange that for this year somehow, someway.
blue
I have the same question for you too Blue. Why do some jobs have to be marginal at all or some jobs more profitable than others? With the correct pricing strategy they can all be profitable.
(Although I should add that yeah some projects can still on top of all that be more profitable than others. Such as those special one of a kind jobs that customers can't find anyone else who can do them. You charge a premium surplus on work like that just becuase you are the only ones that can offer them a solution. Pricing for ‘perceived value’)
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Blue,This thread is about logical markup methods. I think your anecdotal evidence is a prime example why a Capacity Based markup is so beneficial.You warn against taking "marginal" jobs and seem to equate marginal with profitable. I see a big distinction between the two.A marginal job may be just enough to make wages and overhead. I would not consider a job to be marginal if it's below what you need to make according to a Capacity Based system.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
I think both you and Jerrald are misunderstanding my term "marginal".
If I look at a print, I'm going to have to make an educated guess as to how much time it will take. I can price some plans out by flipping through the pages, stopping to look at each page for as little as three seconds. After flipping through, I might very well be able to tell you that I can do that house in two weeks, or three weeks, etc.
How do I know? I've probably built that house in some form before. If the house is very similiar to ones that I've done consistently in three weeks, with the same or similiar features, I can safely "bid" the job at three weeks. Those three week houses will be bid at a profit. It's not a "marginal" job, it's a profitable job, unless I dog it, which is my choice. The "profit" is a lock if I pursue it.
Then we get into the "marginal" houses. They are the types of houses with weird features that maybe could be profitable if everything goes well. But, realistically, we all know about Mr Murphy. So, our dilema is: do we bid the thing hoping that Mr Murphy doesn't rear his ugly head, or do we plan for the worst? The usual scenario is that when we are hungry for work, we tend to be optimistic. The "profitable" job doesn't always work out and our worst fears are realized. The "profitable" job slips to being a "marginal" job, but then the trusses don't show up on time. When they do, their slightly different than we envisioned and the "marginal" job turns into a "breakeven" job. Then, when the builder comes around complaining that we are wrecking his schedule and he can't get his draw, the "breakeven" job turns into a loser because the builder won't be in a mood to be reasonable about re-imbursing us for expense occurred because of his incompetence and furthermore we realize that he isn't going to pay promptly because he doesn't have any money either!
Now after all that, we realize that the "profitable" job is nothing more than a "loser".
Oh, by the way, did I mention that the day we found out that the trusses were wrong, another builder or homeowner walked up and wondered if we could jump on a basement immediately? It's a sweet job, a sure money-maker. Oh, can't get to it for another week or two? Well, call me when you're available, if it's still waiting for a framer, we can talk then.
The sweet ones never wait. They always get snapped up.
The moral of the story is to keep walking by those "marginal" houses and keep your eyes peeled for the sweet ones. Unfortunatly, most homeowners want the cut up, story and a halfs that pay the same per foot as a straight up two story box. I know theres a difference in price, but can someone tell the other ten thousand framers in the Detroit area to straighten out their price structures?
blue
It all makes for interesting, if confusing, reading.
Bottom line is, running a business can be every bit as much an Art as it is a Science. Because of that, what works for Jerrald, might or might not work for Stephen, or Jon, or Mike, or Blue, or anyone else, because in many cases our businesses are as individual as each of us. Similar in nature, but at the same time unique.
These discussions generally remind me of people testing their own theories against others opinions.
jimblodgett - "It all makes for interesting, if confusing, reading."
Ya know the thread that that original question I put forth was pulled from was started on Dec. 16, 1996 and Sonny's son Tom Lykos' post above didn't happen until on Feb. of 1998! That was two years of discussing, trading ideas, and learning about Markup that went on there back then. It was pretty cool and many of the people in that discussion back then wrote that they felt that way too.
"Bottom line is, running a business can be every bit as much an Art as it is a Science. Because of that, what works for Jerrald, might or might not work for Stephen, or Jon, or Mike, or Blue, or anyone else, because in many cases our businesses are as individual as each of us. Similar in nature, but at the same time unique."
I like to try and take as much of the Art out of running a business as I can making the operation as Scientific as we can make it. That way if your basic business operation runs like a machine you (plural meaning the company) are really free to creativly explore other areas.
Looking at that old Remodeling Online Discussion and at other discussions that have taken place over the years while there are perhaps infinite numbers of nuances to how businesses approach markup when you really look at what they are doing I think the methods boil down to three or maybe four different core methods.
"These discussions generally remind me of people testing their own theories against others opinions."
that's exactly what these kind of discussions are about. That's part of the scientific method. You have to put theories out to be tested to check their validity.
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"that's exactly what these kind of discussions are about. That's part of the scientific method. You have to put theories out to be tested to check their validity."
Yeah, I think I benefit most from reading opinions that challenge my own, or are dramatically different from mine. It's hard to keep it intellectual sometimes, though. Sometimes it feels like a personal attack. I always admire people who blow up at each other in one thread, then a day or two later, there they are exchanging ideas again.
George Bernard Shaw once wrote:"The test of a man’s or woman’s breeding is how they behave in a quarrel. Anybody can behave well when things are going smoothly."
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that's exactly what these kind of discussions are about.
What I find surprising is that in opening a dialog with a number of carpenters/contractors, how few of them have ANY method to what they are doing.
Bowz
Bowz - "What I find surprising is that in opening a dialog with a number of carpenters/contractors, how few of them have ANY method to what they are doing."
Ya know when I was responding to Jim I and I wrote that I thought there were "three or maybe four different core methods" the three maybe four methods I was thinking of were:
Value Based Top Down Pricing -Where a price is set based on the Value you feel a project delivers and you then work backwards to see if you can produce the project for that price still covering your costs and overhead.(Top-Down)
Botom Up Capacity Based Pricing - (Bottom-Up)
Botom Up Total Volume Based Pricing -
Wing and a Prayer
In one of the JLC discussions around these topic Bob Kovacs alluded to what I called Wing & a Prayer
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Honestly, my pricing is a conbination of 3 of the methods, but "Total Volume Pricing" is not one of them. (Probably still have too much wing and a prayer)
But I have had conversations with builders in the local lumber yard, at state seminars and at the Remodelers Show that shocked me.
One of the last was at a local HBA meeting (within the last year). Another small contractor got talking about mark-up (after a few beers). In the conversation I asked how he figured to recover his overhead costs, and his eyes glazed over. He was charging $25/hr and adding on 10%. This was someone who started back in the early '90s.
Bowz
Have you ever heard "I just take the material costs and double them"???Talk about a prayer!
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"Have you ever heard "I just take the material costs and double them"???
Talk about a prayer!"
I had an old boss that did that one even better:
"Every job is basically 1/3 labor, 1/3 materials, and 1/3 profit- you just do the material takeoff and we'll triple it- that's our sales price". Needless to say, sometimes that worked, sometimes it didn't- kinda like saying "1/2 the time the ball lands on red, and 1/2 the time on black"......
Bob
Have you ever heard "I just take the material costs and double them"???
Talk about a prayer!
Uh..........I'll have to plead the fifth amendment on this one!
Some other methods you may or may not have heard of:
What You need to pay the bills next month
Whatever the clients budget is
Rumors around the lumberyard
What we think is "fair"
Bowz
blueeyeddevil - "I think both you and Jerrald are misunderstanding my term "marginal". "
That may very well be true. It does seem that you are talking about marginal in a different context than what this topic (markup) was about.
"If I look at a print, I'm going to have to make an educated guess as to how much time it will take. I can price some plans out by flipping through the pages, stopping to look at each page for as little as three seconds. After flipping through, I might very well be able to tell you that I can do that house in two weeks, or three weeks, etc."
I can't do that. I can't do that at all for the kind of stuff we do and I doubt I could do that if we were doing framing too. I mean yeah I can look at a job as say I think that a 48 thousand dollar stair but wneh I actually go and perform the estimate and it comes in 52K I can feel good about myself that I was close but I still missed by 4K. I rather take the time to perform an accurate takeoff based estimate using real labor data we built for cetain tasks over the years and hit the right number and put that 4K to better use either investing it in the company or the company's employees.
Do you actully figure out what your costs are going to be on a job and then apply a markup to those costs for overhead and profit or do you just "look at a job" and come up with a price you feel will return you a profit?
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Do you actully figure out what your costs are going to be on a job and then apply a markup to those costs for overhead and profit or do you just "look at a job" and come up with a price you feel will return you a profit?
Yes!
We look at a plan. We know it will take three weeks. We offer a fixed price that will cover our costs and include a markup including profit. They tell us that we are 13k high on a 28k bid. LOL!
Its astounding how low some contractors are.
blue
View ImageDavid Gerstel writes about the potential problem using a Traditonal Volume Based markup in his book Running a Successful Construction Company starting on page 166:
He writes about it using the metric "weeks" for allocating overhead to a job but it could just as easily be "days" or "labor hours" as PROOF, Ellen Rohr, and I use.
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"He writes about it using the metric "weeks" for allocating overhead to a job but it could just as easily be "days" or "labor hours" as PROOF, Ellen Rohr, and I use."
All this talk about capacity and estimating time has actually gotten me thinging lately about the concept of using days or weeks instead of hours- especially for the one-person handyman-type shop that has no intentions of adding employees.
When you think about it, it's pretty difficult to determine with any true certainty the duration of different tasks, especially when there are small quantities to deal with (no productivity due to repetition). Conversely, it seems easier to look at a lot of jobs and say "that'll take 1/2 a day", or "that'll take 2 days", rather than "that's take 14.7 hours"- which equates to 2 days when you consider that you'd be hard pressed to fill the other 1.3 hours of "two days". So given that, why not take your overhead and desired salary, and divide by 50 to get a weekly cost, and then divide that by 10 to get a 1/2 day rate?
The system does break down a bit when you're on projects where you may not be there full time- say a 6-week basement remodel where there's a few days that the drywall sub will be there by himself, the electrician needs a day by himself, etc. At that point, you've got to either charge for the whole 6 weeks of overhead, or go find small projects to fill in on the days during that 6-week period that you won't be there.
Whenever I look at potential business ideas, I always look at the potential income against "how much do I need to make a day/week/month" and see if it's feasible, so it seems to make good sense in the small-shop application.
Thoughts?
Bob
Bob,
I use 'days' when I'm doing my estimates. I think it's just easier to calculate, and track. I don't have a high tech tracking system, I just have a dayplanner that I write what I did, when I did it, and where. I don't have to concern myself with hours, I'll just write 1/2 day demo, 1/2 day hanging cabinets.
I'm just a one man show, so I don't have anyone to chase after. I could see where it would get complicated with more employees.
---------------------
Swimming through the ashes of another life, no real reason to accept the way things have changed. Wrapped in guilt, sealed up tight.
Edited 12/19/2005 9:25 pm ET by dustinf
Jerrald,
We have been talking about Capacity Based from the viewpoints of business planning and estimating.
Most Managerial Accounting Reports assign what we call Billable Labor to the Direct Cost of COGS and Unbillable to OH.
Do you think there are any advantages for us in reporting COGS without including Labor?
Is there any reason for us to include material in COGS or even using COGS at all?
Should we only look at ratio of Goods Sold vs Total Labor?
I guess my question boils down to "Should we use Capacity Based (Computing) in our Managerial Reports?"
Billable Labor is not universally used in all businesses. Construction is very aware of it, as are service businesses, but we have been trained to use 'standard' business reports which generally aren't.
This definition says: In accounting, the cost of goods sold describes the direct expenses incurred in producing a particular good for sale, including the actual cost of materials that comprise the good, and direct labor expense in putting the good in salable condition. Cost of goods sold does not include indirect expenses such as office expenses, accounting, shipping department, advertising, and other expenses that can not be attributed to a particular item for sale.
Subtracting the cost of goods sold from the amount billed when selling the good (sales revenue) produces the gross profit on the good.
The net profit, what most people understand as the business' income or profit, is determined by subtracting the cost of goods sold and the indirect expenses from the sales revenue.
And here is an example. In one forum I briefly looked at a poster stated that if you don't sell a product, you don't have a COGS.
Construction is a bastard business in that we "produce" things, yet we are a service based industry.
I Made this table to see what the results would be looking at different ways of reporting.
I used the assumption that both homes would take the same amount of time using subs to speed up the Expensive Home on the theory that the expensive home is also larger.
all $ in K's
Cheap home
Expensive home
Cheap/Exp
Material
$100
$1,000
10.00
Direct Labor
$100
$100
1.00
Subs
$50
$120
2.40
Overhead
$20
$20
1.00
Total Cost
$270
$1,240
4.59
Sales Price
$350
$1,500
4.29
Net Profit
$80
$260
3.25
COGS/Sales
57.14%
73.33%
1.28
Net Profit/COGS
40.00%
23.64%
0.59
CBM/sales
48.57%
16.00%
0.33
Net Profit/CBM
66.67%
216.67%
3.25
Material/sales
28.57%
66.67%
2.33
Total Cost/Sales
77.14%
82.67%
1.07
Looking at COGS/Sales, it made us 28% more/dollar to sell the small home.With Net Profit/Cogs, we made over twice as much per dollar with the small home!?!?!?
Maybe the use of the traditional accounting practice of reporting COGS is one of the forces driving our industry to lower quality building.
It's only when looking at profit per annum or per CBM (Direct Labor + OH) that we can see that we made 3.25 times as much money in our pocket for the same work for the same time.
I'm betting that COGS/SqFt would also show a benefit from building cheap homes.
Why is there so much error in using COGS? Because every material invoice we generate is paid for directly by the buyer and we still make a profit on each one of those invoices.
SamT
SamT - "Most Managerial Accounting Reports assign what we call Billable Labor to the Direct Cost of COGS and Unbillable to OH."
Well not not necessarily. And I also think that's more true of Financial Accounting than Managerial Accounting too. But looking at it from a Managerial Accounting still it all depends. Looking at me as an example. I spend some of my time working in production which is Billable and some of my time in Overhead doing office management and other stuff which is Non-Billable. Okay that fits and makes sense. But when I'm working in Production there may be time spent there that is unproductive and is therefore Non-Billable. Should that time be part of Overhead or amortized across the productive Billable time I do spend in production? It's a subjective choice. The way my PILAO worksheet is designed you can certainly spread that time across the productive Billable hours by making adjustments on the Labor Cost worksheet.
"Do you think there are any advantages for us in reporting COGS without including Labor?
Is there any reason for us to include material in COGS or even using COGS at all?"
Well you can't do that because Cost Of Goods is defined as "expenses [that] are directly related to a sale. If the sale didn't happen, the expense would not be incurred. Direct costs refers to material, labor costs and permits used at a specific job site. Or, the cost of the item you purchased intending to resell it."
"And here is an example. In one forum I briefly looked at a poster stated that if you don't sell a product, you don't have a COGS."
Well technically that's certainly true from a Financial Accounting viewpoint if you don't actually sell it it's just inventory.
Now looking at your chart one of the problems I see in it is you seem to be making an assumption that the use of materials that are 10 times more expensive than than cheaper home doesn't deliver any intrinsic value in an of itself. (Plus that ten times ratio is way out of line with the real world difference in material costs between the top and the bottom of the market). The net profit earned on a more expensive home would and should be more than that earned on a inexpensive one. Where did your Sales Prices come from in that example? Why is the Sub cost for the inexpensive home $50 whereas the the same relative expensive home has sub costs that are 2.4 times more costly at $120?
"Maybe the use of the traditional accounting practice of reporting COGS is one of the forces driving our industry to lower quality building."
And who say's that happening? Anecdotally from my own experience I would say the quality in our new homes is getting better.
"I'm betting that COGS/SqFt would also show a benefit from building cheap homes."
And if what you were saying was true everyone would be getting into low income housing wouldn't they? And that's certainly not the case.
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Jerrald,
"Do you think there are any advantages for us in reporting COGS without including Labor?
Is there any reason for us to include material in COGS or even using COGS at all?"
Well you can't do that because Cost Of Goods is defined as "expenses [that] are directly related to a sale. If the sale didn't happen, the expense would not be incurred. Direct costs refers to material, labor costs and permits used at a specific job site. Or, the cost of the item you purchased intending to resell it."
Are you saying that we can't think about it because that's not the way it's done?
"Now looking at your chart one of the problems I see in it is you seem to be making an assumption that the use of materials that are 10 times more expensive than than cheaper home doesn't deliver any intrinsic value in an of itself."
Could you restate that? I can't parse it. Sorry.
"(Plus that ten times ratio is way out of line with the real world difference in material costs between the top and the bottom of the market)."
To reiteratemy self again; I Made this table to see what the results would be looking at different ways of reporting. I used the assumption that both homes would take the same amount of time using subs to speed up the Expensive Home on the theory that the expensive home is also larger.
What figures would you use for material and subs for a $350L tract home and a $1.5M custom, assuming that both were scheduled to use the same labor only cost by the GCs.
"Maybe the use of the traditional accounting practice of reporting COGS is one of the forces driving our industry to lower quality building."
"And who say's that happening? Anecdotally from my own experience I would say the quality in our new homes is getting better. "
Did you read the McMansion thread or any of the many similar threads in BT?
"I'm betting that COGS/SqFt would also show a benefit from building cheap homes."
"And if what you were saying was true everyone would be getting into low income housing wouldn't they? And that's certainly not the case."
Now, that's a good debate technique.
I notice that you have no comment on the one and only statement I made in that post beside the brief explanation of the table.
"Because every material invoice we generate is paid for directly by the buyer and we still make a profit on each one of those invoices."
I was confident someone would ask "What about spec's?"
SamT
SamT - "Are you saying that we can't think about it because that's not the way it's done?"
No I'm not saying that but if you take one of things out of COGS that makes up it's definition then you aren't talking about COGS anymore. You need a different word to describe what you are talking about otherwise you are going to confuse people. You're starting to confuse me.
[Jerrald hayes] "Now looking at your chart one of the problems I see in it is you seem to be making an assumption that the use of materials that are 10 times more expensive than than cheaper home doesn't deliver any intrinsic value in an of itself."
[SamT] "Could you restate that? I can't parse it. Sorry."
For the sake of argument lets say granite costs 10 times what a laminate countertop costs. Will people pay 10 times more for granite or will they be willing to pay up to 20 times more because granite has an intrinsic value to it which far exceeds what it's increased cost is.
"To reiteratemy self again; I Made this table to see what the results would be looking at different ways of reporting. I used the assumption that both homes would take the same amount of time using subs to speed up the Expensive Home on the theory that the expensive home is also larger."
I would prefer a comparison where one house is more expensive than the other but they are both the same size.
"What figures would you use for material and subs for a $350L tract home and a $1.5M custom, assuming that both were scheduled to use the same labor only cost by the GCs."
You would have to do a little research to build your model but the data is certainly out there. I would use a RS Means Residential SF Costs book or some data source like that.
"Did you read the McMansion thread or any of the many similar threads in BT?"
Yeah and they were full of a lot of anecdotal opinions that don't jive with mine or what I have read and studied about the quality of American housing.
Regarding why I didn't comment on ""Because every material invoice we generate is paid for directly by the buyer and we still make a profit on each one of those invoices." I really had no idea what you meant by that. How is every material invoice we generate is paid for directly by the buyer? Really I am having a very hard time figuring where you are going with all this. I'm trying to follow you but I'm not really getting what you are talking about or what you are getting at.
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Jerrald,
You and I certainly have different minds when it comers to looking at some things. Perhaps that is why I get so much out of our conversations, even though you sometimes come across as the south end.... never mind, I didn't say that (|:>)
Seriously, I really appreciate these talks.
Quote: I really had no idea what you meant by that. How is every material invoice we generate is paid for directly by the buyer?
Perhaps not "Directly," however, we are actually a "Materials Broker" in that we do not buy any materials until after we have sold them. We order them, pay for them, and as soon as they are delivered, their ownership transfers to the client. In the case of spec homes, their "Ownership" can be thought of as transfering to the home.
My purpose in the post in question was to explore the difference in decision making value between a report that used a strict COGS number and a report that used a Cost Of Something-or-Another, call it Capacity Based Markup Cost, or CBMC.
I realise that there are superfolous things in the table, but, I am not a scientist who takes all the time needed to refine my papers to the essentials, this is, after all a conversation, not a thesis.
The term "CBM" as in "Sales/CBM" means GC Labor+OH assignable to the project. COGS includes GC labor, Materials, and Sub charges, since we either pay the sub or perform the labor ourselves. Sub charges are not part of the CBM equation.
I used to play video games with a buddy. He was always complaining that I spent too much time flying upside down. I think I had the ratios upside down in the original table so I used the reciprocals here.
I did not perform a takeoff and schedule for the two projects. I did assign sales prices and guess that the material of the cheap home would be about 1/3 of the sales price and about 2/3 for the expensive home and that the labor including subs, would be around twice as high for the $1.5M home. I think that these figures are close enough for the exploration of Managerial Reports.
The term "CBM" as in "Sales/CBM" means GC Labor+OH assignable to the project. COGS includes GC labor, Materials, and Sub charges, since we either pay the sub or perform the labor ourselves. Sub charges are not part of the CBM equation.
All Costs include Markup(nn) indicates the Expensive home is the smaller in the ratio.
all $ in K's
Cheap home
Expensive home
Ratio
Material
$100
$1,000
Direct Labor
$100
$100
Subs
$50
$120
Overhead
$20
$20
Total Cost
$270
$1,240
Sales Price
$350
$1,500
Net Profit
$80
$260
3.25
Sales/COGS
1.75
1.36
(1.28)
Net Profit/COGS
.4
.23
(1.74)
Sales/CBM
2.05
6.25
3
Net Profit/CBM
.66
2.16
3.25
Sales/Material
3.5
1.5
(2.33)
Sales/(CBM+Material)
1.3
1.2
(1.07)
Taking the last first, Sales/Material+CBM ignores the cost of Subs. If we add in the cost of subs the ratio will be skewed farther towards making a cheap home more advantageous.
If we viewed our product line (homes) the way a manufacturer or retailer does, we would never build an expensive home.
It is only when using Capacity Based Markup conventions that we can see the true advantages of more expensive products.
This is because our only product restraint is our capacity to provide labor. We buy materials with OP money which is always sufficient for the product sold. In other words, our material costs are paid directly by the client and are mainly irrelevant to our decisions about product lines.
Jerrald, you already know this, albeit in a different framework, but I am just now discovering it.
We are a service industry with a sideline as a materials broker.
SamT
SamT - "You and I certainly have different minds when it comers to looking at some things. Perhaps that is why I get so much out of our conversations, even though you sometimes come across as the south end.... never mind, I didn't say that (|:>)"
Eh,.. don't worry that kind of criticism never really bothers me. I just say what I think.
[JJH] I really had no idea what you meant by that. How is every material invoice we generate is paid for directly by the buyer?
Perhaps not "Directly," however, we are actually a "Materials Broker" in that we do not buy any materials until after we have sold them. We order them, pay for them, and as soon as they are delivered, their ownership transfers to the client. In the case of spec homes, their "Ownership" can be thought of as transfering to the home."
Ok well in that context I see what you are talking about and I agree.
"It is only when using Capacity Based Markup conventions that we can see the true advantages of more expensive products.
This is because our only product restraint is our capacity to provide labor. We buy materials with OP [other peoples] money which is always sufficient for the product sold. In other words, our material costs are paid directly by the client and are mainly irrelevant to our decisions about product lines."
I alluded to just that and Bob Kovacs expanded on it in one of the JLC discussions last week sometime.
"Jerrald, you already know this, albeit in a different framework, but I am just now discovering it.
We are a service industry with a sideline as a materials broker."
This is something that Ellen Rohr also alludes to in her book How Much Should I Charge?: Pricing Basics for Making Money Doing What You Love pg 51:
But she then goes on to write
The point being and the lesson lesson learned that when we have freed ourselves from covering and paying for our overhead through material sales the more expensive the materials (and subcontracting) we sell the more net Profit we can generate.
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Stephen why do some jobs have to be marginal at all?
If you do those jobs using the correct markup strategy (Capacity Based, which it just so happens to be the method that Jon uses) they wont be marginal in terms of achieving your Gross Profit. They may not be pleasant or fun . But if you price them correctly you'll certainly be hitting your Gross Profit targets.
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Jerrald, as I mentioned------ I didn't feel I was phrasing things well
Basically---- if I do a job---it's NOT going to be marginal
Because
I base my system on working 1000 hours a year total---overhead and production time. I also know almost EXACTLY what I am going to net each year---before the year begins--------- so I know EXACTLY what each hour of production better be generating. this means that my basic rate---in combination with the free market will " cherry pick" my jobs for me.
in effect---my rate will have weeded me out of consideration for 80% of the jobs my "competitors" will be scrambling for---while wondering why they aren't making any money.
however----if my goal was to stay busy---that is--to work 2000 hours a year
or worse yet keep several employees working 2000 hours a year
it's entirely likely that the market would slowly force me to cut my basic rate to attract more business in order to keep at those 2000 hour figures.
I think that's counter productive for me
because personally I have no interest in working 2000 hours a year------and I have no interest in making more money than I currently make.
I STILL don't think I phrased my position very well---but there you have it anyway LOL,
Stephen
Stephen - "Jerrald, as I mentioned------ I didn't feel I was phrasing things well
Basically---- if I do a job---it's NOT going to be marginal"
Well I didn't mean YOU singular I meant YOU as in plural meaning generally speaking why does any contractor need to take on marginal work. I didn't mean to imply that you were taking on any marginal work since knowing you online for a while now I have had the exact opposite impression.
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Stephen,You're phrasing is just fine.I completely understand what you're talking about, and it's a conundrum that I deal with on a weekly basis.I started a company about 18 months ago with an equal partner and we're constantly dealing with levels of growth and what our business model should be.Yesterday I met with our excavator looking at an addition job that would be fairly large for our company (>$200k). We have not been able to find any carpentry subcontractors that can perform to our standards. Of course we've not been around too long so maybe the future will be different.Thanks for your input.This job would not be possible for us if we were a two man company. So either we choose to retain our ability to perform larger projects (i.e. keep employees) or target smaller jobs.Your posts have always made me think and I can appreciate the benefits of a business that is structured like yours. Ultimately, my business partner and I have goals of having a company that can continue on is spite of our physical conditions. Or having the right employees that would allow us to take vacations at our leisure.
Jon Blakemore RappahannockINC.com Fredericksburg, VA
Jon,
it certainly takes a lot of different types of people to make the world go 'round.
YOU and your partner want to retain the ability to take larger jobs
but for ME---taking on larger jobs interferes with what I prefer to do---the smaller jobs.
and similar to what blue mentioned--------almost invariably---if I personally get tied up in a longer, bigger project------ a smaller really JUICY job will appear that I have to turn down because I am tied up on the big one.
for ME--- If working them personally------- the bigger jobs are rarely as profitable per day as the smaller jobs--------and the smaller jobs are almost always more interesting------ there will be a problem to be solved, and unusual material to find and use, a new skill to aquire---something to keep me alive
but the big jobs---working at one place more than 3 days----- just drudgery
My solution is to develope a reationship with someone like you that ACTUALLY WANTS the bigger jobs----- and I sub out most of the project to them-------- but I retain for myself the parts of the job I feel require MY touch. Luckily the parts I tend to retain for myself seem to be the parts the subs consider to be a pain in the a$$---flashing chimneys, soffit and fascia, cornice returns, siding repairs, bending metal etc.
that works out pretty well------ in fact doing things that way can be absurdly profitable on a per day basis------ and I tend to use THAT to subsidize my lateral move out of roofing and into ---well let's call it "obscure carpentry"
what would be perfect is if my bigger subs--- would sub out to ME some of the small stuff THEY don't really want----- but it never seems to work out that way LOL
Best wishes, Stephen
Stephen,Believe me, there are times when I want exactly what you have- close working radius, killer referrals, small work that you complete on your timetable, low overhead to be concerned with, etc. I think you have changed my thinking about smaller jobs more than anyone (except maybe Sonny). Keep up the good work."My solution is to develope a reationship with someone like you that ACTUALLY WANTS the bigger jobs----- and I sub out most of the project to them-------- but I retain for myself the parts of the job I feel require MY touch."Great. When are you moving to VA?
Jon Blakemore RappahannockINC.com Fredericksburg, VA
Personally, I'd me more comfortable answering the question of should they paint based on the overall business strategy. While paint goes on siding, the skill sets and equipment needed for the two activities are very different.
If the question is posed as an exercise intended to influence the overall business strategy and the two scenarios are representative of a larger set of jobs, then it's still only a portion of the overall situation that needs to be considered.
If the company is simply producing a commodity-like service with no differentiation other than it's price, then profits are solely dependant on internal efficiency since it's not possible to sell commodity for anything higher than the going rate.
On the other hand, if the company actually is differentiated in the market place based on such things as quality, speed, etc. then the best way to attain higher profits is harder to pin down, and the simple example only scratches the surface.
What are the company's strengths and weaknesses? Do we have the human resources to do both types of jobs? Can we effectively sell both types of jobs? What makes us better than someone else? Etc.
What are the opportunities and threats? <insert long drawn out stereotypical examples of opportunities and threats>
How durable is a competitive advantage? <insert long drawn out stereotypical examples of the facets of competitive advantage>
<insert diagram of the process of strategic business planning>
<insert outline of current business plan>
<insert bs here>
Sorry, ran out of energy--off to kitchen to eat dinner. :-)
Those are all really good points IdahoDon but the example was a hypothetical case to illustrate a problem that comes up using a Uniform Volume Based Markup applied to the sum of all the job costs rather than a markup that is keyed to a company's capacity.
The problem could have been written as a hundred hour exterior trim job with 100 in materials vs. another hundred hour exterior trim job with $7500 in materials but giving credit to the guy who first illustrated this problem I posted it as he wrote it back then.
IdahoDon - "Personally, I'd me more comfortable answering the question of should they paint based on the overall business strategy. While paint goes on siding, the skill sets and equipment needed for the two activities are very different. "
That's actually one of the issues I get into with some of the contractors I consult with who do everything or close to everything in-house. I have no real statistics to qualify what I am saying but anecdotally it seems to me that at anytime 50% to 75% of their capital investment in tools and equipment is sitting around doing nothing to pay for itself. And as for the labor skill sets I do believe that the old adage a jack of all trades excels at nothing generally holds true to a large degree.
However then again I do think a multidisciplinary company such as the hypothetical "Exteriors Unlimited" that does siding, painting, stucco, and masonry is a great business model to have. My own contracting company while woodworking specialists does "Interiors" not just woodworking. Homeowner clients when they contact us just don't want a raw stair and railing they want a stair and railing installation where the stairs are stained or painted and the balustrade varnished or lacquered and the walls have been patched and repainted. They want a complete solution, not a job they then have to go out and contract other companies to finish.
Also in the case of our hypothetical "Exteriors Unlimited" it would seem to me that you could have a crew of a carpenter and a painter where the carpenter was the lead for the siding installation and the painter served as his or her second mate and when the project shifted over to the painting phase the painter shifts to the lead role and the carpenter becomes the second mate working at the lead painters direction.
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That's actually one of the issues I get into with some of the contractors I consult with who do everything or close to everything in-house. I have no real statistics to qualify what I am saying but anecdotally it seems to me that at anytime 50% to 75% of their capital investment in tools and equipment is sitting around doing nothing to pay for itself. And as for the labor skill sets I do believe that the old adage a jack of all trades excels at nothing generally holds true to a large degree.
How right you are and 50%-75% idle time is probably optimistic, especially for the smaller contractors who don't have multiple jobs at varying stages of completion. It is frightening to add up the costs of storage and organization for the many specialized tools that generalists have to have on hand.
I've been successful as a generalist since it goes well with a curious person who likes to constantly learn new things. Likewise, others' unique collection of personality traits and interests makes for some interesting combinations.
They want a complete solution, not a job they then have to go out and contract other companies to finish.
I agree completely. What makes this such a can of worms is that, while the main portion of the job is done well being the core competency the business is built on, other tasks are done poorly and even the non-technical homeowner can see that something is wrong with the picture even if they can't put a finger on it. I see this a lot with other generalists. Perhaps the worst case is not knowing your personal (or company's) strengths and weaknesses. Yesterday I observed a project that was built quit well, yet was being painted in such a way that few would homeowners would view the overall project as anything but average at best.
Also in the case of our hypothetical "Exteriors Unlimited" it would seem to me that you could have a crew of a carpenter and a painter where the carpenter was the lead for the siding installation and the painter served as his or her second mate and when the project shifted over to the painting phase the painter shifts to the lead role and the carpenter becomes the second mate working at the lead painters direction.
With the right chemistry almost any combination would work well, at least until the combination changes then it's hard to maintain the continuity. Those who are good at finding the right people to keep a unique combination going are talented indeed.
Happy holidays,
Don
Jerrald, your second post made some light come on .. you know how I've been struggling with my Estmating because of all the different, one-of jobs I do. I can usually estimate the time pretty well ..Tell me, how would you figure all your own time, considering you ought to be making alot more than your journeymen crew members. I don't pound that many nails anymore but I'm on the job usually 8 hrs too!Do you just figure your own hrs (8-10 hrs/day?) in there along with the other man hours and markitallup by that 2.35%?how did you arrive at that number anyway?Edited 12/16/2005 10:19 pm by JoeWood
Edited 12/16/2005 10:20 pm by JoeWood
JoeWood - "Tell me, how would you figure all your own time, considering you ought to be making alot more than your journeymen crew members. I don't pound that many nails anymore but I'm on the job usually 8 hrs too!"
Joe did you ever look at and use my PILAO spreadsheet? You would set yourself up as one of the field employees to get a rate for your own time working in production.
Capacity Based Markup Spreadsheet
PILAO_Wksht.xls
A Microsoft Excel Spreadsheet (Windows & Macintosh)
There are a couple of little tricks and nuances you have to make sure your looking after such as the time you spend on other non-billable activities but that's what the graph on the Owners Information Worksheet graphically displays for you. Try it out and if you need my help with it feel free to ask. I'll check your work to make sure you're using it correctly.
"Do you just figure your own hrs (8-10 hrs/day?) in there along with the other man hours and markitallup by that 2.35%?
how did you arrive at that number anyway?"
The 2.35 in the example was just an arbitrary number that works for the criteria in those hypothetical examples. Labor markups derived using a Capacity Based Markup methodology will typically fall within a range of 1.9 to 2.35 although I have seen real world cases where a Capacity Based Markup works out to be 1.63 (a sub who works for us at times) and as high as 2.58 (another shop and showroom based specialty contractor we often work with). It really all depends on what your real numbers and costs are. Every contractor really needs to figure out what the correct number is for their specific operation.
But then again regarding " markitallup by that 2.35%?" well that depnds on what you mean by "mark it all up". That 2.35 represented the markup on LABOR ONLY. The other things such as Materials and SubContracting would only be marked up to generate just a Net Profit off of them. See the chart below for typical Net Profit Markups
A 1.07 markup will return a Net Profit of 6.5%
A 1.08 markup will return a Net Profit of 7.4%
A 1.09 markup will return a Net Profit of 8.3%
A 1.10 markup will return a Net Profit of 9.1%
A 1.11 markup will return a Net Profit of 9.9%
A 1.12 markup will return a Net Profit of 10.7%
A 1.13 markup will return a Net Profit of 11.5%
A 1.14 markup will return a Net Profit of 12.3%
A 1.15 markup will return a Net Profit of 13%
A 1.16 markup will return a Net Profit of 13.8%
A 1.17 markup will return a Net Profit of 14.5%
A 1.18 markup will return a Net Profit of 15.3%
A 1.19 markup will return a Net Profit of 16%
A 1.20 markup will return a Net Profit of 16.7%
A 1.21 markup will return a Net Profit of 17.4%
A 1.22 markup will return a Net Profit of 18.%
A 1.23 markup will return a Net Profit of 18.7%
A 1.24 markup will return a Net Profit of 19.4%
A 1.25 markup will return a Net Profit of 20%
What you want to generate in Net Profit subjective and relative to two things. Number one, what you want to make and number two just what the market will bear. I think anyone should at least shoot for the range of 8-12% at a minimum.
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JerraldHayes,
<!----><!----> <!---->
It sure makes scene to me too use some form of labor based method in which to recover overhead.
<!----> <!---->
I have witnessed the problems with traditional volume base mark ups or volume margin based calculations in my business.
<!----> <!---->
While labor may be the most difficult items in which to estimate it remains one of the simplest items in which to track.
<!----> <!---->
My switch to a “labor based mark up†or (overhead recovery strictly based on labor) has worked extremely well for me. (This method has consistently in regards to capturing my overhead cost.) I see no reason it will not work for any and all of the trades contractors and general contractors alike.<!----><!---->
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One of the biggest issues I see with using a suggested generic mark up for builders is whether or not they use subs for their carpentry labor source or if they use in house payroll labor. My overhead for example would be significantly less using subs as opposed to using in house labor for this task. In the case of using subcontract labor for carpentry, it is the subs that carry the burden of overhead and profit associated with operating a specialty trade company. These carpentry specialty contractors conceivably may have overhead profit margins equaling some 100% of their hourly wage and benefit pay structure.
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Joewood suggested there is a significance pay difference between project manager’s salaries and the salaries of senior skilled trade’s persons. How many of us have a large difference in pay for these positions? My salary pay is the same for these positions. Therefor there is no additional cost to my clients for these task. I am sure many small contractors who work by themselves with out employees differentiate the cost of coordinating labor or producing the project.
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Sam T and Rw apparently use some sort of separate line item for risk assessment. Sounds like this method has a lot of merit.
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Tom<!----><!---->Working for nothing is not getting any cheaper.
Maybe we should give it a cute acronym.
A-R-T
Assessment of Risk Technique
Sounds good, eh? (|:>)
Samt
Sam T,
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I clearly just a matter of time before you will be developing your own business consulting business. Traveling the country and speaking of the merits of ART. I will be looking forward to this with anticipation. Please accept this post as pre registration reservation and forward the additional information to me as things develop.
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Good luck,
Tom
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Foxfire Builders Group
E mail [email protected]<!----><!---->Working for nothing is not getting any cheaper.
TomMaynard - "Joewood suggested there is a significance pay difference between project manager’s salaries and the salaries of senior skilled trade’s persons. How many of us have a large difference in pay for these positions? My salary pay is the same for these positions...."
Well I think that's an entirely subjective choice for the business owner to make.
"....My salary pay is the same for these positions. Therefor there is no additional cost to my clients for these task. I am sure many small contractors who work by themselves with out employees differentiate the cost of coordinating labor or producing the project."
Subjective again, some do, some don't. The system still works. It really depends upon just what the "product" is. I know for the spiral iron stair railing balustrade a friend of mine made for one of our jobs the guy supervising and coordinating the labor had the incredibly difficult skill full job whereas the guys finishing off the welds could be low skilled generic employees. The supervisor's job had more Value attached to it so it was worth more.
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Jerrald,
I think your example is too simple to work properly.
Job #1: Painting the exterior of a house
Job #2: Install siding on the same house
Job #3
May I suggest an Invested Risk based mark-up?
There is no one markup scheme that will fit all or even most construction sales.
The Fixed Risk side is your investment. Volume based M/U would be a simple ROI calculation.
I think something like this might work for the OOPS! side:
on top of the normal sales price, add (Cost/Odds) x Fixed OH x mark-up
Job #1 . . . $40+
Job #2 . . . $5+
Job #3 . . . $1017+
In some fields, concrete comes to mind (|:>) the ratio of material to labor varies over a very small range within a companys jobs. In other fields, it can range from one extreme to the other.
Tool costs also vary widely between companies even in the same field. Compare a framing crew with and without a forklift. If the forklift marks up only on labor, he's going broke fast. If he marks up a two story with use of the forklift the same as a single story without it, something is wrong with his model.
Or consider two kitchens about the same size. They're going to get about the same volume of cabinets, the same floor area covered. Same number and kind of fixtures. so they will take about the same labor. Material for one is $15,000, for the other $150,000.
Which mark-up model could fit both those situations?
SamT
SamT - "There is no one markup scheme that will fit all or even most construction sales."
Well I don' know about that at all, that depends upon what you exactly mean by "scheme". Absolutely yes no one markup scheme or schema fits all construction sales. I was alluding to that in my post to JoeWood when he asked me about the 2.35 number. A lot of contractors just want to know what number to use and don't want to do the homework (which is really pretty simple) to figure out their own number specific to their own operation. In that respect no one markup scheme or schema fits all.
However I do believe that one particular markup METHOD (a Capacity Based Markup) works under all circumstances for consistent overhead recovery where the Traditional Volume Based Markup doesn't.
One of my points that I've been making for a while now in all the discussions I get in regarding markup is that the Traditional Volume Based Markup methodology that a lot of contractors pick up from studying Walt Stoeppelwerth, Michael Stone or Alan Hanbury has a set of circumstances where it will fail. Did you read my paper The Potential Problem Using a Traditional Volume Based Markup? The problem as I described it there is a more dramatic and extreme example of just what can happen to a contractor who uses a Traditional Volume Based Markup and works to many jobs like Job #1. The point I am trying to illustrate here is that a contractor using a Capacity Based Markup system (as advocated by Irv Chasen, Ellen Rohr, David Gerstel and I) wont ever experience that problem or crisis since his or her overhead recovery is tied to Capacity, aka the Effort or Time a project takes and not the dollar volume that project generates.
If there is set of circumstances where using a Capacity Based Markup system wont work no one has ever illustrated it to me.
"May I suggest an Invested Risk based mark-up?"
This is a new one to me. What exactly are you saying? What's this formula:
on top of the normal sales price, add (Cost/Odds) x Fixed OH x mark-up
On top of the normal sales price (which you would determine using a Traditional Volume Based Markup?) you would then add the product of Costs divided by Odds times the Fixed Overhead times markup??? What are the odds? Where does that come from? Is it the Odds of things going right or the Odds of things going wrong? How is that determined? And how do you divide the Cost by the Odds? Odds are typically displayed as a ratio. 10:1, 7:5, etc. How do you divide a number by a ratio? Would you would express those odds as fractions? 10:1 being .1, 7:5 being 0.7142857.
Regardless what you seem to be talking about is padding a Cost Estimate and Price to account for the Risk involved. i.e. 8 hours spent installing a $15.000 door a contractor is taking a bigger risk than a contractor spending 100 hours to caulk and paint a house with a $1000 worth of materials. Duh! But padding for Risk management doesn't really have anything to do with Overhead Recovery which is really the issue I'm talking about and looking at here.
And I would submit that there is a much simpler easier way to pad for the Risk in the example you presented than the formula you have. You decide hey what is the Risk worth to me and add that on to the Cost or Price. That Risk Padding like Net Profit is subjective and relative to two things. Number one, what you want to make for the risk you are taking and number two just what the market will bear.
"In some fields, concrete comes to mind (|:>) the ratio of material to labor varies over a very small range within a companys jobs. In other fields, it can range from one extreme to the other. "
Huh? The ratio "varies over a very small range" and yet " it can range from one extreme to the other". That's a pretty confusing contradiction. What are you talking about?
Tool costs also vary widely between companies even in the same field. Compare a framing crew with and without a forklift. If the forklift marks up only on labor, he's going broke fast. If he marks up a two story with use of the forklift the same as a single story without it, something is wrong with his model.
What are you talking about? A forklift is a Capital Expenditure. You figure the cost of recovery of that equipment cost over a particular time period into your overhead. "If the forklift marks up only on labor, he's going broke fast." No he's not. Not at all. In fact if the cost of recovery of that equipment cost is correctly figured into Overhead that equipment is still being paid for even when the Labor is performing tasks the Forklift isn't required for. That doesn't mean or exclude the possibility of adding a surplus charge for whenever the forklift is being used to recover it's cost faster or to help defer it fuel and maintenance but you don't seem to think or understand that a forklift like any major tool expenditure is a capital expense that is generally part of a company's Fixed Overhead. The framing crew with the forklift would of course have higher Fixed Overhead costs. Depending on how many field production people they are spreading that higher cost over their resulting PILAO type Labor markup percentage may be higher or lower than the company without the forklift. What's the problem?
Or consider two kitchens about the same size. They're going to get about the same volume of cabinets, the same floor area covered. Same number and kind of fixtures. so they will take about the same labor. Material for one is $15,000, for the other $150,000.
Which mark-up model could fit both those situations?
In my contracting company we face that situation all the time and it exactly illustrates the dangerous problem with a Traditional Volume Based Markup method which is why don't use it. That's precisely why we use a Capacity Based method. That is exactly the point that Tom Lykos was trying to illustrate in '98 that I posted in my first post. What are you doing arguing or agreeing with me? What's your point? What are you getting at?
Yeah I know risk is a consideration but I've just explained how that handled and I don't believe it should be handled through markup since markup is applied globally to the costs on a job. When we do certain stair railing installations 95% of the job is very routine but something like the fabrication and installation of a helical or serpentine part is incredibly risky. Do you pad the whole job or just pad the risky task with the appropriate amount of cushion for risk? You should pad the particular task not apply padding globally to the whole job.
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Jerrald,
I very carefully read your posts. I try to understand what exactly you are trying to say.
Please give me the same courtesy.
exactly mean by "scheme". markup METHOD Markup Model
Don't all three terms hold the same meaning?
padding for Risk management doesn't really have anything to do with Overhead Recovery which is really the issue I'm talking about and looking at here
You know, you have never emphasised that in all your proseletyzing about PROOF.
The ratio "{In some fields} it varies over a very small range" and yet " {In other fields} it can range from one extreme to the other". That's a pretty confusing contradiction. What are you talking about?
What are the odds? Where does that come from? Is it the Odds of things going right or the Odds of things going wrong
Oh, give me a break, Jerrald, you are being deliberately obtuse.
simpler easier way to pad for the Risk in the example you presented than the formula you have. You decide hey what is the Risk worth to me and add that on to the Cost or Price.
Oh yeah?!?!? What did I just do????? I Proposed a method to do just that. One that you have a simpler easier way.
Do you pad the whole job or just pad the risky task with the appropriate amount of cushion for risk? You should pad the particular task not apply padding globally to the whole job.
To reply in the vein you have repied to me. What do you do? submit two invoices? One for the job and one for the risk?
Now I see why others get so . . .irritated when talking with you. You seem to deliberately misunderstand anything we say, and you arbitrarily reject any new ideas that could be added to your pet theory by the use of specious arguments.
Ok, Jerrald, I just won't bother to discourse with you any more, because I just don't like being told I am a fool when trying to improve myself and maybe share with you my own thoughts about what
we bothI think is a serious matter worth discussing among equals. The fact that I am not as well read on the subject nor am I as good a wordsmith, does not mean you can put me down without consequences.SamT
samT - "I very carefully read your posts. I try to understand what exactly you are trying to say.
Please give me the same courtesy."
I did read your posts very carefully Sam and I think the detail and the questions in my comments certainly show that.
"exactly mean by "scheme".
markup METHOD
Markup Model
Don't all three terms hold the same meaning?"
No they don't necessarily. It would be great if they did and we all were talking the same language all the time but that doesn't always happen. That why I tried to clarify that in the first few paragraphs of my reply to you. That was important to clarify because if you meant it one way I disagree strongly with you if you meant it another way I would be agreeing with you and it wasn't at all clear to me just what you were saying.
"[Jerrald Hayes] Padding for Risk management doesn't really have anything to do with Overhead Recovery which is really the issue I'm talking about and looking at here."
[SamT] You know, you have never emphasised that in all your proseletyzing about PROOF."
No I haven't. That's very correct, but you are to the best of my recollection the first person who has ever inserted a RISK formula into a Markup Formula and I just don't believe that padding for Risk has anything to do with markup which is primarily all about Overhead Recovery. I think RISK should be dealt with in another fashion independent of Markup and Overhead Recovery. I never mentioned it before because it never come up. No one has ever mentioned the price of eggs on Wednesday before either so as I proselytize should I be qualifying what I am saying each time by saying a Capacity Based Markup has nothing to do with the price of eggs on Wednesday?
"Oh, give me a break, Jerrald, you are being deliberately obtuse."
Well Sam I wasn't being deliberately obtuse at all. I just didn't read your statement with a period dividing it into two sentences so I misunderstood what you were saying. When I read that I "heard" you say something to the effect of "the field of concrete the ratio of material to labor varies over a very small range within a company's jobs. It also can range from one extreme to the other" which wasn't what you meant and was why that sounded confusing and contradictory. My apologies. while I do try to carefully read everything that everyone write I very certainly do make mistakes and I was perhaps thinking too hard trying to decipher your equation and lost out on that one. Again my apologies for that. I wouldn't be the first time I made a mistake and it certainly wont be the last.
"[Jerrald Hayes]Do you pad the whole job or just pad the risky task with the appropriate amount of cushion for risk? You should pad the particular task not apply padding globally to the whole job.
[SamT]To reply in the vein you have repied to me. What do you do? submit two invoices? One for the job and one for the risk?"
No what are you talking about? You pad for the particular Risk as a Direct Job Cost on a line item level. I'm very sorry but I think your formula is over complicating something that is handled very simply another way.
"Now I see why others get so . . .irritated when talking with you. You seem to deliberately misunderstand anything we say, and you arbitrarily reject any new ideas that could be added to your pet theory by the use of specious arguments."
Well I do know perfectly well that some people find my style irritating but I never, absolutely never, deliberately misunderstand or reject what other people have to say with out taking a serious hard logical look at what they are saying. Absolutely never. Sam I happen to disagree with you and I am trying to the best of my ability to debate your points and mine on their merits. In fact I happen to think I am more openminded to new thinking and different ways of looking at things than most perhaps even to a fault.
"Ok, Jerrald, I just won't bother to discourse with you any more, because I just don't like being told I am a fool when trying to improve myself and maybe share with you my own thoughts about what we both I think is a serious matter worth discussing among equals. The fact that I am not as well read on the subject nor am I as good a wordsmith, does not mean you can put me down without consequences."
Nothing at all wrong with wanting to improve yourself and wanting to share your ideas but you really need to toughen up a little if you can't take any criticism or desention with what you have to say. I never said you were a fool. Don't put those words in my mouth. I in fact thought you were at the very least presenting a interesting intellectual new look at the subject that I haven't heard before (indeed there been an absolute dearth of discussion regarding Risk in these forums here). I just happened to disagree with what you had to say and I stated my reasons why. If I am wrong and your are right with regard to your applying a formula to risk padding at the markup level then you need to present your case as to why you think that's a better way of doing it.
If you really do follow all my discussion regarding the use of a Capacity Based Markup you will have noticed that one thing I do say and ask for a lot is for someone to present me with a case where they think it doesn't work. I invite the challenge. I know you don't get any smarter about markup or any subject for that matter by having people agree with you all the time. Learning anything means challenging your assumptions and beliefs all the time and trying to respond to those challenges and when you can't respond you learn to make changes. It's part of the scientific process. It's part of learning.
You say "There is no one markup scheme that will fit all or even most construction sales." If by that you meant a Capacity Based Markup doesn't fit all or even most construction sales than I disagree with you very strongly. As I've said I think a Capacity Based Markup functions perfectly well in any service based business model and if it doesn't please present me with a case where you think it doesn't so that I (we) can look at it.
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with markup which is primarily all about Overhead Recovery
Whoa!
Stop right there.
Say what? Please explain that. I thought mark-up was everything between cost of goods sold and sales price.
A few very good business friends of mine explained it that way, but, no, they were no in construction, they are in retail sales.
Samt
Jerrald,
That blew my mind. I had to go look up the definition of "Markup."
http://economics.about.com/library/glossary/bldef-markup.htmDefinition of Markup: In macroeconomics, markup is the ratio of price to marginal cost. Definition: Marginal costs are the costs a company incurs in producing one additional unit of a good.
http://www-personal.umich.edu/~alandear/glossary/m.htmlMarkup 1. The amount (percentage) by which price exceeds marginal cost. Marginal cost The increase in cost that accompanies a unit increase in output;
Now, the way I understand it, marginal costs are labor and material, tools, gas, subs, etc. Overhead is all other costs.
o·ver·head (http://www.answers.com/topic/overhead)n: The operating expenses of a business, including the costs of rent, utilities, interior decoration, and taxes, exclusive of labor and materials.n:Business expenses (as rent or insurance) not chargeable to a particular part of the work or product
Profit (http://www.auburn.edu/~johnspm/gloss/profit) The amount of the excess of total sales revenue over the total costs of production of the good(s) or service(s) produced by a business firm.
Cost: In the widest sense, the measure of the value of what has to be given up in order to achieve a particular objective.
Whew! That auborn.edu link is some serious reading.
There are three things a business MUST get. Marginal Costs, Overhead, and Profit. None of these, or rather all of these are primary.
I believe that your paradigm of "markup [] is primarily all about Overhead Recovery" is not recognised by very many of the people involved and that unrecognised dissonance between our minds has been confusing me throughout this multi-thread, multi-forum discussion.
I think that it is a widely held understanding that markup is everything between cost and the sales price. It must encompass overhead and risk, it better include profit, and in can include the cost of my little princesses new braces.
I include Risk in overhead because we have to be able to cover our donkeys. It is a cost that we all will have and must meet.
SamT
P.S I think you've probably already noticed that I have build a pretty serious Glossary of my own so that when I talk about a term I can always link to it so that if there is any confusion as to what I meant by a term there is a way to clarrify and explain it. I think that was one of the best communication tools I ever accidentally stumbled into using. I add to it all the time. I wish a lot of other people had their own Glossary pages so that I could decipher just what they were talking about (most notably Sphere and Andybuildz).
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jerrrald.. when we gonna do lunch ?
next item: my template has 4 basic divisions :
labor , materials, subs, and equipment.
the Labor subtotal is marked up first for BURDEN
then the template adds the following:
labor
labor burden
materials
subcontracts
equipment
___________________
that SUBTOTAL can be marked up by a factor for CONTINGENCY ( ie: risk )
then the template adds the subtotal plus Contingency for a new subtotal
it then adds a markup factor for OVERHEAD
and then a markup factor for PROFIT
in other words , it takes my fixed ( estimated ) costs and modifys them for labor burden, risk, overhead & profit
mostly , i leave the percentage markups alone for BURDEN & OVERHEAD... and tweak the CONTINGENCY & PROFIT percenatges.
most of the time contingency is entered as zero... but i think about it on every bid.
on an average basis.... our costs run about 1/3 labor, 1/3 materials, & 1/3 subs.... ( average ) i find it to be very convenient to use a level markup for all three instead of allocating all of it to labor..
and the contingency is a fairly common factor in commerical estimating that i have done in the pastMike Smith Rhode Island : Design / Build / Repair / Restore
MikeSmith - "jerrrald.. when we gonna do lunch ?"
It truns out I didn't go on the Boston gig when it came up ( I had other things here I had to do) so I haven't been out your way yet but hey January looks really light for me. I planned it that way since I might get called for jury duty so we'll have to work out something then I guess.
"that SUBTOTAL can be marked up by a factor for CONTINGENCY ( ie: risk )"
Well to tell you the truth we do have standard contingency padding of 3% built into our markup but the "Risk" that that 3% is defined to protect against is no matter how many times we done a particular job or task on certain types of projects despite our best efforts to estimate them (most notable the theatrical ones) will still have Special Causes or Special Cases (Special Cause Variation) pop up that we never clearly anticipated ahead of time. That's what that 3% protects against. Most of the time you really want to anticiapte, plan, and budget for all the cases of Special Cause Variation you might expect on a particualar project but there is almost always something that you miss or that completely surprises you.
However in the case of hanging that painting the other week that 3% certainly wasn't enough to cover the risk in the simple 1/2 hour task. What do you think we figured that at $50 for the half hour that task actually took or $150? We added an extra $100 for the extra risk just that task and it was on a line item so in the context of an job that included several other things too it's not really even noticed by the client but satisfies us. And when you really look at it if anything did happen to that painting that's what insurance is for but just the inconvenience and trouble that would have caused. That's what we feel the risk is there and we made a subjective accessment that it was worth $100.
"it then adds a markup factor for OVERHEAD"
Ah ya know I don't like that. I think you're saying that just to get under my skin. That's a Volume Based Markup applying a markup to the sum of Labor
Material
Subcontract and Equipment Costs. Yeah if your "costs run about 1/3 labor, 1/3 materials, & 1/3 subs" every time then maybe it's okay but are you saying on every single job you get that same mix at the same ratio? No one ever hires you to do just a roof? There are no electricians or plumbing subs on a project like that to fill out that 1/3 ratio you need to make that kind of markup work all the time. Using that strategy you would be subject at time to the problem Tom Lykos was illustrating in that very first post I made that some of your projects will be more profitable than others. Nothing wrong with that if it all averages out but if you were to really use a Capacity Based Markup strategy every project would be more or less equally profitable.
""i find it to be very convenient to use a level markup for all three instead of allocating all of it to labor.."
I've heard that rational before from other contractors but I don't really buy it. I think it's easier and even more convenient to just have to worry about selling our available capacity than to also have to worry about whether I am selling "1/3 materials, & 1/3 subs" that we need to make our markup system really work correctly.
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From my Glossary
Overhead (Fixed Overhead and Variable Overhead)
I don't define Profit and really try to avoid using the word in a singular context becuase so many people confuse Net Profit with the term Gross Profit and when you use the word Profit all by itself who knows what you are talking about.
Two other words that are often confused are Markup and Margin. They are intimatly realted. And in reality the same thing just from different perspectives but understanding that difference is very important. Markup is what you do and Margin is what you get and they are not figured the same way. Margin is is calculated against Sales Price while Markup is is calculated against Cost.
"I believe that your paradigm of "markup [] is primarily all about Overhead Recovery" is not recognised by very many of the people involved and that unrecognised dissonance between our minds has been confusing me throughout this multi-thread, multi-forum discussion."
I would agree that a there a a few people who the concept of "Overhead Recovery" is totally alien to. And that why so much of the discussion over on JLC has been with Bob Kovacs and me trying to isolate and focus on that idea.
"I think that it is a widely held understanding that markup is everything between cost and the sales price. It must encompass overhead and risk, it better include profit, and in can include the cost of my little princesses new braces."
Markup must encompass Overhead yes, Risk no. Like I've said I think that better dealt with on a case by case basis on a Direct Job Jost level since that will lead to better more accurate accessments of Risk. As for should Markup encompass Net Profit well I happen to agree with you and say yes to that but that again is arguable. Allan Edwards over on JLC makes a good point that many times contractors will leave money on the table that could be additional Net Profit by using a formulaic Pricing Methodology. Given that consideration it might be better for many contractors to think of Net Profit separately from Markup.
"I include Risk in overhead because we have to be able to cover our donkeys. It is a cost that we all will have and must meet."
I've never said it doesn't need to be planned for and recovered but I think its better done primarily on a Direct Job Cost level.
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Jerrald,
On my MS IE5.5 machine, I lose the right edge of your pages text. I have the scroll bar, but, the text wont scroll into view.
Net Profit - Is gross profit, less selling costs and administrative overhead. It's the profit remaining in a business after all expenses have been taken out, but before taxation. Net Profit is a subset of a comapany' Gross
Gross Profit - Gross Profit equals Revenue minus Cost of Goods Sold. It identifies the amount available to cover other operating expenses.
Good thing the PROOF driven estimate doesn't have any input to the accounting books.
I've never said it doesn't need to be planned for and recovered but I think its better done primarily on a Direct Job Cost level.
I'm not sure I can agree with that. Some insurance should be a direct Job Cost, but insurance is a prepaid risk alternative.
Direct Cost A cost that can be directly traced to producing specific goods or services.Investopedia Says: For example, the cost of meat in a hamburger can be attributed directly to the cost of manufacturing that product. Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and so are not considered direct costs.
I'm trying to wrap my tiny widdle head around this.Using the example of a $15K door; The odds of breaking the door are . . . say 10:1 against. I definately want to estimate this at the line item level. I definately want to keep this money ($150) in a Self Insuring account because I probably won't break this particular door, but, I will break one 1 out of 10 doors sooner or later.
Ok, I think I've got it. It is a Direct Job Cost assignable to this particular door even though I don't "spend" the money now. I can't credit it to the Biz, because I will spend it on the 10th door along with the other nine $150s I collect. I can't bill it to the 10th, because . . .
I should mark up the $150 because I put that money in the SI account as soon as the door arrives and I should mark up all moneys I spend to earn profit. When that tenth door finally arrives and breaks I will at that point spend $3000 to earn $1500 worth of profit. Hmmm. . . At no or reduced risk . . . Hmmmnnnn. . .The hardest question. . .Ethics. Maybe I shouldn't profit on it. Whadaya think?
Damme, Bud, you give me headaches (|:>)
SamT
More Good Reading:
Job Costing
SamT - "Say what? Please explain that. I thought mark-up was everything between cost of goods sold and sales price."
Well, markup is right in between cost of goods sold and sales price in the equation Cost of Goods Sold + Markup(Margin) = Sales Price. But like I said I think Markup is primarily about Overhead Recovery not Risk protection. Where I said Risk protection should be done on a task level or line item basis before Markup means that I think of Risk protection in the way of padding as falling in the realm of Cost of Goods Sold. I think you really should figure for it as a Direct Job Cost so you are specific about what parts of an estimate are risky and what parts aren't.
"A few very good business friends of mine explained it that way, but, no, they were no in construction, they are in retail sales." While there are some important differences between service businesses and retail I don't think that's one of them. Cost of Goods Sold + Markup(Margin) = Sales Price is the case in any business.
I just a few minutes ago read over in the JLC forums where you did say that "There is no single fits-all mark-up model." so on that I do absolutely disagree. I think a Capacity Based markup will work in any service business. Although that's not exclude that another markup model, Total Volume Based, wont work under certain specific conditions, it will.
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Jerrald,
If we are only talking about recovering overhead, then I wholeheartedly agree with you inre Capacity Based Markup.
As long as we recognise that that is not the total markup. It is merely the amount per billable hour we need to charge to cover labor as a marginal cost and also cover overhead.
The problem is that it is not designed to cover all marginal costs, only the labor portion of them.
Your PILAO worksheet includes Owners Compensation, Owners Salary and Company Profit as parts of the inputs. I am beginning to think that it may be a mistake to include them there, at least for the purpose of Managerial Accounting.
It is not fair to me as an investor to include all profit in billable hours because I deserve more reward when I puchase extraordinarily expensive materials, (higher Marginal Costs.)
I see that I changed my mind within this post.
At least I'm thinking.
Now.
You have been arguing PROOF as a Time Based Income machine. To wit, using PROOF, I can know that If I and 5 employees work 1500 hours I will have $XX at the end of the year. If I hire another employee I will have $7/6XX. No matter how much or how little money I invest in materials.
It's an Employee-at-Hearts' dream.
It is anathema to an entrepreneur because it eliminates the profit of Risk.
A quote of Frank H. Knight, from the preface to "Risk, Uncertainty and Profit", Beard Books:This one "conclusion" may be hazarded, that no one mode of organization is adequate or tolerable for all purposes in all fields.
I (still) like PROOF for recovering that portion of business cost that are fixed no matter what I sell. Billable hours plus nonbillable hours is a constant, the only thing to be determined is what portion are billable. I would include my salary in that fixed cost.
I don't want to include that portion of Marginal Costs that are attributable to material because I want the rewards due my investments. I think I will use the traditional Volume Based Markup on material, Billable Hours, and other Transaction Costs.
Why have a VBM on Billable Hours (at PROOF rates?) Because I am going to take Profit out of PROOF and restrict it to recovering Fixed Costs, even though some of those Fixed Costs are Marginal and some are Overhead.
SamT
SamT - "It is not fair to me as an investor to include all profit in billable hours because I deserve more reward when I puchase extraordinarily expensive materials, (higher Marginal Costs.) "
That's probably very correct but you wouldn't be earning profits on materials as a product of your Billable Hours. You'd be earning a Net Profit on materials by the Net Profit only markup you placed on those materials.
"You have been arguing PROOF as a Time Based Income machine. To wit, using PROOF, I can know that If I and 5 employees work 1500 hours I will have $XX at the end of the year. If I hire another employee I will have $7/6XX. No matter how much or how little money I invest in materials."
True. You'll actually notice that I try not to call it PROOF too. I prefer Capacity Based to PROOF because for one, it's a descriptive name describing what the method is based on where PROOF is not and two if you ever read the PROOF manual you would see that it really very specific to companies that are providing their own labor where the broader term Capacity Based which I may have taken from David Gerstel is a much broader application of the concept. But what the hell, when somebody says PROOF I know exactly what they are referring to so it really doesn't matter. Now that I am thinking of it I should probably really put the terms PROOF, Capacity Based Volume Based Markup in my Glossary too.
"It is anathema to an entrepreneur because it eliminates the profit of Risk."
I don't think so at all because that kind of Risk, the risk of running a business in the first place, is returned as a function of Net Profit. In general we are able to get a higher Net Profit than other contractors because we "generally" take on riskier projects than they do. However Risk such as the specific Risk you take when you hang a painting that's worth $400,000 on a wall is another thing and I think that's that is better and more accurately estimated and accounted for a line item basis.
Re: Frank H. Knight's Risk, Uncertainty and Profit, I haven't read or even heard of that book before Although it looks interesting so I just ordered it. A good one I read awhile back an now listen to on tape from time to time is Against the Gods: The Remarkable Story of Risk.
"I don't want to include that portion of Marginal Costs that are attributable to material because I want the rewards due my investments. I think I will use the traditional Volume Based Markup on material, Billable Hours, and other Transaction Costs."
A Capacity Based (PROOF) methodology will allow you to put any markup for Net Profit you want on materials and/or subcontracting. It becomes entirely subjective and up to the whims of the person or persons pricing the project. In a Capacity Based system any markup you place on materials and/or subcontracting is pure gravy since your Overhead has already been accounted for as a function of the markup you placed on Labor.
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JerraldHayes ,
I think Tom Lykos initial post shows the flaws with traditional volume based mark ups. In his example each project produced 100 hours of production labor. Yet the first project had only 35% the margin the second had.
Using a labor based mark up it seems the following would work for specialty contractors and general contractors alike.
(1)labor based index method of overhead /profit recovery
Specialty contractor Install siding on a house
Same project as no 1., however this project was contracted through a general contractor using all subs
Specialty contractor Install siding on a house
A) 100 man hours @ 25.00/hour = $2,500.00
B) Specialty contractors labor bases overhead/profit recovery 2 X labor =$5,000.00
C) Siding materials = $7,500.00
D) General Contractors cost= $15,000.00
E) General contactors direct management labor = $25.00 an hour X 20 hours =$500.00
F) General contactors labor bases overhead/profit recovery 2 X in house labor = $1,000.00
G) Total sales cost of project = sum lines (H-J) = ($16,500.00 )
Tom
Working for nothing is not getting any cheaper.