Hopeful Thinking Can Ruin Your Company

In my meetings with contractors, I often encounter what Shawn McCadden calls “relentless hope” as well as self-delusion. It comes in many forms, but here I’ll focus on four biggies.

1. Not understanding the true cost of labor:
This affects jobs that are sold as time and materials (T&M) or contract price work. With T&M, typically the labor component is sold at an hourly rate. The hourly rate, more often than not, is based on what the contractor thinks will be acceptable to the customers in his geographical region, and is frequently set to match or undercut the competition. With contract price, the costs for the job are estimated and a markup applied in some way.

If the labor portion of the costs isn’t fully understood, then obviously when a markup is applied it will probably be inadequate to generate the desired gross profit.

I had conducted several meetings with both the owner and the bookkeeper of a remodeling company when I introduced the owner to my labor burden calculator (see "Getting Labor Burden Right," JLC, Jun/2022 ) and briefed him on how to use it and what should be included. On our next call, the usually quiet owner nearly blew my eardrum off by shouting “Do you know what it costs me for an hour of labor?!? I have to start charging more!”

Mission accomplished.

2. Disregarding overhead:
I can't even count the number of times that a contractor has said to me, “Yeah, that job was a mess, but at least I didn’t lose money on it.” What he meant was that his costs for the job were covered by what the customer paid for the work. But let’s say that the job lasted six weeks. Let’s further say that even a very modest construction or remodeling company probably has at least $52,000 in overhead per year. So that’s $1,000 per week in overhead. If the job lasted six weeks and he didn’t cover his overhead, then he just lost $6,000 on the job, to say nothing of the profit that the job should have contributed.

3. Making it up on the next job:
Many contractors and remodelers are embarrassed by profit. Yes, they want it, but all too often they’re more driven by a desire to create beautiful, imaginative, and enduring quality work and leave behind a delighted customer who feels like a good friend. To this end, they will give away what should be charged as change orders and solve every customer disappointment by “making it right” no matter what the cost.

As a result, they drive themselves and their crew into the ground.

Too often, this kind of thinking and behavior promotes a company-wide culture that takes “The customer is always right” to nonsensical and unprofitable lengths. The rationalization is that the next job will somehow run perfectly (it never will), will be sold at a price big enough to make up for the past less-profitable jobs (unlikely), and will produce sufficient profit to cover what the earlier jobs failed to yield.

Let’s look at the numbers in the table below. To keep things simple, assume that you produce four jobs that each sell for $100,000. Your production costs fluctuate between $72,500 and $75,500. When you’re done with the four jobs, you have $400,000 in sales and have an achieved gross margin of 26%. You’ve read, or heard, that your margin should be more like 30%, so that’s your target. Now you need to “make up for” the lost margin in your next job. Assuming a similar job with similar costs, you’d have to sell it for $130,000. That’s nearly a third more than the price you’re used to selling. Can you really do that?

4. Thinking that one big job will cover anything that went wrong in the little jobs:
This is an interesting blend of No.2 and No.3 above. Remodelers who do very well with jobs in the $50,000 to $80,000 range may find that a sudden “windfall” of a $1.1 million job changes all the rules. One of my clients claimed that because the anticipated profit on the big job was so enormous (this assumes, of course, that the job will be brought in at or under budget), he could afford to price it lower than his margin by calculation needed to be, and that it would also make up for the margin shortfalls that the jobs to date had displayed.

There are a couple of problems with this thinking. First, if you’re used to wrapping up a job in three to four months, production inefficiencies such as scheduling issues, material delays, or poor field-office communication practices may show up, but the job is mercifully too short to lead to catastrophe.

My rule of thumb is: Whatever inefficiencies or poor practices exist in the company will be magnified by the job’s size and degree of difference.

I measure “size” of the job by number of employees and subs involved and the length of the job. I consider "degree of difference" to be a subjective assessment of how much the job will stretch you and your crew beyond what you’re comfortable doing on a regular basis. For example, if you’re a remodeler specializing in producing 5-by-8-foot bathrooms and you take on the construction of a new 15,000-square-foot home, that would be a big difference. (See my "Disaster-Potential Calculator" below.)

Disaster Potential Calculator

Second, as soon as a job is different, a learning curve is introduced, whether it’s learning how to work with new materials, how to handle a particularly challenging framing problem, how to get materials delivered at the right time, or how to coordinate multiple warm bodies over a prolonged period of time. It can also involve knowing how to collect money over a longer period of time so you’re not providing interest-free financing to your customer.