More than three years ago, REMODELING set the benchmark for produced gross profit margin (GP) at 40% (November 1998). While that percentage is certainly achievable for mature companies, it is on the high side for companies who are successful by most other measures. A look at current remodeling baseline numbers indicates that a more representative GP is 35%.
The fact is, the gross profit benchmark changes as sales volume increases. Baseline companies with annual sales under $250,000 average a respectable 28% GP. Size does matter, however, and companies with twice the sales volume -- up to $500,000 -- have an average GP closer to 33%.
Many factors contribute to the increase. To begin with, companies of this size are typically managed by a single owner who performs nearly all essential business functions, including sales, design, estimating, project management, bookkeeping, and production management. Up to a certain point, such a sole proprietor can take on additional jobs and actually become more efficient. Size and type of project also play a role. Larger, more complex jobs using high-end materials increase margin at little increased cost to overhead.
Another factor is an increased close ratio. As a company's client base expands, referrals and repeat work lead to an improved close ratio. Companies at $500,000 in sales have a close ratio of 75% compared with 65% for the average company doing half that volume.
Is bigger better? Growth in annual revenue does not, however, guarantee proportionate increases in gross profit. While average GP increases to just over 34% for companies with sales between $500,000 and $750,000, it drops back to about 30% for companies with sales between $750,000 and $1 million.
This suggests that the "never never land," defined by Walt Stoeppelwerth in 1985 as beginning at a volume of $400,000 to $500,000, has moved in the past 17 years and is now closer to the $750,000 mark. The lower gross profit and deteriorating close ratio are symptoms of a company owner who is overextended, unable to delegate sufficiently to keep up with increased demand. With an increased amount of new work coming from referrals, plus an expanding base of past customers to service, owners of remodeling businesses of this size are often unable to stop slippage between estimated GP and produced GP. Owners neglect production efficiency to concentrate on sales and marketing, compromise estimating accuracy in favor of managing actual construction, or fail to recover the cost of change orders. Another contributing factor to the decline in GP is the fact that companies of this size typically make their first hire -- an office manager, bookkeeper, or production manager -- allocated entirely to overhead.
Why worry about a few percentage points? For smaller companies, a few points could mean the difference between winning and losing the job. Even when pricing is not an issue, as is the case for many mature companies, slippage in produced gross profit directly affects the bottom line and ultimately reduces net profit. That leaves less money available for cash reserves, capital investment, and employee benefits designed to retain key personnel.