BENCHMARKING YOUR BUSINESS: Factoring Material Costs

Factoring is one of six estimating methods – including Market-Driven Unit Pricing, the Single Overhead Recovery System (SORS), the Dual Overhead Recovery System (DORS), the Multiple Overhead Recovery System (MORS) and the Overhead and Profit Per Hour (OPPH) –  used within the green industry.

The prices these methods calculate  often vary dramatically for the same job or service. In fact, they can vary so much that a critical look at each method is not only useful, but also imperative for contractors who want to understand costs and pricing structures. Understanding these methods is important when a contractor needs to take his best shot at the bid table.
 
Factoring is another word for multiplication. Simply put, its formula is: Factor 1 multiplied by Factor 2 = The Product. Applying numerics to the formula looks like this: 2 x 3 = 6. The 2 and 3 are factors of the product 6.
 
Using the factoring method, also called the multiplier method, we simply multiply estimated material costs by a “factor.” The factor may be based on past Profit & Loss statements, or may be a number “arrived” at as a result of monitoring past competitive bidding situations.
 
The rationale is if you ended a previous calendar or fiscal year with a sufficient net profit, and if material costs were 33 percent of your gross sales for that year, then all you have to do is multiply material costs for the new year by a factor of 3.0. Supposedly, this will produce prices that will cover all costs and insure sufficient net profit.
 
The flaws in this method are too numerous to mention, but it’s surprising how many contractors bid their work using this “material-times-two” approach. Job costing the most critical component of your bids – field labor – is impossible and many contractors use this method until they learn a better way to price their services.
 
The only variables addressed in this method are the amount of materials and the factor (2.0, 2.5, 3.0, etc.). Unfortunately, factoring doesn’t address the multitude of other variables  –  general conditions, net profit markup, site conditions, etc. – that apply to your bids.
 
Turn your attention to the two sample jobs (above). Assume both jobs take a three-person crew one month to complete. Job A may have more expensive materials than job B. Or Job B may have a lot of demolition involved. The 3.0 factor calculates a price on these jobs of $60,000 and $30,000, respectively. The additional $40,000 and $20,000 is intended to cover general and administrative (G&A) overhead costs, net profit margin, field labor,  labor burden and equipment costs. If the net profit margin is 20 percent for both, that equates to $12,000 on Job A and $6,000 on Job B. That leaves $38,000 on Job A and $14,000 for Job B to cover these costs (without net profit). That’s ridiculous. The G&A overhead costs, labor and labor burden costs should be the same for both jobs as they both require the same amount of time to complete.

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