Note: If you are unsure of the difference between margin and markup, stop reading and call your accountant.
When the remodeling world learned the difference between margin and markup, it was like a child learning about the fourth dimension for the first time. The 1.67 revolution was groundbreaking. Remodelers stopped losing money as fast. Debate over the best number to use (1.45, 1.55, 1.60) still takes place, but little more. It’s ridiculous that in an industry that uses math daily, when it comes to accounting, we act like 12th-century neophytes.
Ban across-the-board markup: Marking up a project across the board is sloppy. It’s a fast way to guess wildly at what you haven’t taken the time to figure out. It places a gross margin on all materials and services without consideration for the risks or challenges associated with them. Imagine running a grocery store where you put the same markup on milk, rice, ice cream, and meat. Your loss ratio on meat is much higher than on rice, so your markup should reflect that.
Skate to where the puck will be: Plenty in our industry whine and complain: Customers are too picky. There’s too much regulation. I’ll never be transparent. Free market! Free market!
Yeah, this piece isn’t for you either. The marketplace has changed significantly over the last decade. Companies promote their humanity, their commitment to the environment, and display a degree of transparency. In 2002, green was a rumor; today it’s a requirement. Transparency (to a point) is what the market wants. Will you be ready?
Get PHAT: Here is my crack at a solution (after two years of use at our firm). PHAT (profits, honesty, accuracy, and transparency) pricing. Throw out the 1.67 markup and replace it with six categories for markup:
1. Material management
2. Material procurement
3. Subcontractor management
4. Labor management
5. General administration
6. Contractor’s profit
Make your markup have meaning. Don’t just slap numbers on top of other numbers. How much admin will the project require? How much client hand-holding? How many site visits? How many man-hours to run the job? How much time ordering and chasing materials? Are they high-risk materials? Is the assembly high-risk? What is the expected warranty and service work?
Those are all real costs of the project. If you put them into your estimate, you can manage them, track them, review them. And if your client needs some transparency, you can share your numbers without either showing what looks like massive profit at the end, or having ridiculously overpriced line-item costs.
There is a better way to do this. It’s time for us to take that next step and evolve our profit models to fit a changing marketplace.