The price is right

Departments - Travels with Jim

Make sure you’re calculating your gross profit and net profit margins correctly.

Subscribe
June 3, 2021

Travels with Jim follows Jim Huston around the country as he visits with landscapers and helps them understand their numbers to make smarter decisions.

Recently I worked with two landscape installation contractors who installed both residential and commercial projects. Gunther hailed from Utah, and Zane was headquartered in Idaho. They had archaic estimating systems that were a combination of hourly rates, equipment rates and material markups. They wanted to systematize their pricing while making it simpler and more consistent. I identified two KPIs that I thought would help them achieve their objectives that I’d like to share with you.

Understanding margins.

In financial terms, a margin is the difference between the costs to produce a project and its price to the buyer. There are two types of margins — gross profit margin (GPM) and net profit margin (NPM). Let me illustrate with a $10,000 planting job.

$2,500 Material cost

$2,000 Field labor cost

$500 Field labor burden cost

$1,000 Field truck and equipment cost

$6,000 Total direct costs (TDC)

$2,000 General and administrative (G&A) cost

$2,000 Net profit margin

$10,000 Price to the customer

GPM can be calculated two ways. You could add the G&A overhead cost to the NPM to total $4,000, or 40%. Or, you could subtract the TDC from the price and arrive at the same figures.

The break-even point (BEP) is calculated by adding the TDC to the G&A overhead costs or $8,000 (80%) in our example.

Take a look at how you’re estimating, and make sure you’re calculating your gross profit and net profit margins correctly.

NPM is calculated by subtracting the BEP from the price or $2,000 (20%).

Understanding pricing.

Next, we need to understand market pricing and what I refer to as market predisposition. By market predisposition, I mean that there are certain price points that the market favors and rallies around: unit prices for various products such as pavers, zones or heads for irrigation systems, hourly rates for maintenance, and so forth. Once you understand and know these price points, you have a much better idea how your customers will respond to your pricing.

• Retail or list price: This is the price that a homeowner pays a nursery for a plant.

• Re-wholesale price: This is the discounted price that a contractor pays the nursery for the same plant. It is discounted because the contractor gives the supplier multiple jobs, not just one as does a homeowner; and the contractor is the sales person for the product. As such the discount is somewhat of a reverse discount credited to the contractor.

• Wholesale price: This is the amount that the supplier or vendor pays the grower or manufacturer for the materials.

An overly simplistic example might be a plant that the grower sells to the supplier for $5. The supplier multiplies his cost by 2.0 and charges the homeowner a $10 retail price. However, the supplier sells the plant at a re-wholesale discounted price of $7.50 to the contractor.

How it works in the field.

• Residential installation work (the contractor works for the homeowner): In today’s robust market, you should add a minimum of a 20% net profit margin to the BEP when pricing residential work. You should strive for a 40% GPM on such work. You could reduce your NPM by 5% for jobs over $100,000. This would produce a GPM in the range of 35% or so.

• Commercial installation work (the contractor works for the GC, builder, etc.): You’re a sub-contractor when you work for a GC, builder, etc. A subcontractor should provide the GC, builder, etc. a discounted price for his or her work. This discount usually amounts to 10-15%. This allows the GC to add a 10-15% margin to the subcontractor’s work and sell it to the end user at a retail price. Here are some minimum KPIs for commercial installation work:

  • The GPM on such work should generally be 25% +/-5%.
  • You should price negotiated work in the mid to high twenty-percent range — 25 -30%.
  • You should price competitive “low-bid-takes-all” work in the mid to low 20% range.

Conclusion.

These KPIs not only helped to simplify Gunther’s and Zane’s installation pricing, but it also made it more consistent. In today’s market, these residential and commercial KPIs are very accurate.

Break down your bids similar to my illustration above and compare your margins to mine for both your residential and commercial work. I bet they’ll be fairly close.

Of course, if you can, charge more than my KPI benchmarks. The better you understand your own (and the market’s) pricing, the better you’ll reflect market conditions. This should make you a smarter (and richer) estimator.