BENCHMARKING YOUR BUSINESS: A Recipe for Disaster

Another estimating method used in the industry is the single overhead recovery system (SORS). I also call it the gross profit margin (GPM) method because it determines a price by focusing on the gross margin (price minus total direct costs).

SCENARIO. I’ll use two examples to show why the SORS method for pricing your jobs doesn’t work. True, the two are extreme, but they make my point.

The sample company

• General and administrative (G&A)
   overhead costs: $10,000 per month;
   $120,000 per year.
• Entire field labor force with burden:
   $13,000 per month; $156,000 per
   year.
• Adds 30 percent gross profit to all
   of its direct costs for net profit and
   G&A costs.
• Goal for net profit is a 10-percent
   markup on all jobs.

Job A (material-intense, one-month job)
Material costs:  $100,000
Field labor with burden:  $13,000
Equipment costs:  $7,000
Subcontractor costs:  0
Subtotal:  $120,000 
Gross profit markup x 1.3
Price for Job A: $156,000

Job B (labor-intense, four-month job)
Material costs:  $40,000
Field labor with burden:  $52,000
Equipment costs:  $28,000
Subcontractor costs:  0
Subtotal:   $120,000
Gross profit markup x 1.3
Price for Job B: $156,000

WHY SORS DOESN’T WORK.
How Job A should be priced?
Total direct costs: $120,000
1 month of G&A costs: $10,000
Break-even point (BEP): $130,000
10% net profit markup: $13,000
Price for Job A: $143,000 
 
Using SORS, at $156,000, Job A
is over priced by $13,000.
How Job B should be priced?
Total direct costs:  $120,000
4 month’s of G&A costs:  $40,000
Break-even point (BEP):  $160,000
10% net profit markup:  $16,000
Price for Job B =  $176,000 
 
Using SORS, at $156,000, Job B
is under priced by $20,000.
 
If you’re bidding by using SORS in a competitive market, guess which job you get. You get Job B because you underpriced it by $20,000. If I am bidding my direct and G&A costs accurately, guess which job I get. I get Job A because I overpriced it by $13,000.

CONCLUSION. Bidding work using the SORS method is a sure-fire way to lose money. It treats all direct costs the same and doesn’t take into account the project’s duration. You will load up with work that you underprice. And this is a recipe for disaster.

Jim Huston is president of J.R. Huston Enterprises, a Denver-based green industry consulting firm. Reach him at 800/451-5588, benchmarking@gie.net or www.jrhuston.biz.