Steering the Pricing Ship

Markets are dynamic. Markets are always changing due to the various forces, which influence them. Contractors tend not to realize or be aware of the subtle and not so subtle changing tides and currents beneath the seemingly tranquil surfaces of the markets in which they operate. The ebb and flow of market forces escape them. Profits and margins erode while market opportunities slip by. Like a blind sailor on the ocean, the chances of reaching port safely are slim at best.

Sailors have tools to help them navigate the waters upon which they sail. In like manner, there are objective, quantifiable reference points available for contractors to help them along their way if they know what to look for. But one must be trained in the art of observation.

Seasoned captains of the sea do not get that way by treading water. They get that way by spending a lot of time monitoring and studying the oceans upon which they sail. Before they become masters of the sea, they are first students of the sea and the forces that influence it. Contractors must do the same. They must know how to study their markets and the hidden signs contained therein. Fortunately, there are tools and training available to teach them how to do so. But these tools and methods must be studied and they must be applied. As contractors study their markets and the jobs being bid, they need to continually ask, “Can I play this game and win? Does this job or market adaptation add to my company’s bottom line?”

CHARTING A COURSE. Adapting to the marketplace assumes certain prerequisites. The first prerequisite is that you have a clear vision of what to adapt to. You have a definite “port” in mind, so to speak. This leads to the second prerequisite. The destination must be one worth going to for you and your company. There must be a “payoff” for taking the trip. It might be increased or maintained market share. Or, it might be to realize increased margins due to expansion into a new market. Thirdly, you must have measuring devices and tools to help you stay on course and to navigate the waters safely as you attempt to reach your chosen port of destination.

An irrigation contractor had a market opportunity to add a lawn maintenance division to his company. We ran the numbers. When we finished, I was convinced that this contractor knew clearly where he wanted to go, that there was a quantifiable benefit to his company for doing so and that he would successfully reach his chosen destination. This contractor did his homework. Unfortunately, most don’t because they do not know how.

Markets become predisposed. Even though markets are dynamic, trends can usually be identified within them. One of the objectives of an owner and/or estimator and a good estimating system is to identify these trends. Once identified, they can sharpen your estimating skills. Market predisposition can be seen in certain indicators if observed closely. Unit prices and gross profit margins are two tools that can readily indicate market predisposition.

For instance, let’s assume that the going price for installed brick pavers in the residential market in your part of the country is between $8 to $10 per square foot. If you tell your potential customer that you are going to charge $15 per square foot, you had better have a good reason why or be a terrific salesperson. Otherwise, you might as well not waste your time giving that customer a quote for the job. On the other hand, if you can reduce your costs and make an acceptable profit charging $6 per square foot, why charge $6 when the market will allow you to get $8 or $10. That’s using market predisposition to your advantage.

A commercial landscape installation contractor in New England has tracked his gross profit margins (GPMs – gross profit margin equals net profit margin plus general and administrative overhead costs included in a bid. Put another way, GPM equals sales price minus direct costs) religiously for the last seven years. During the recession of the early 1990s, he knew that if his GPM was more than 18 percent on a job being competitively bid by other contractors that he would have no chance of getting the job. He might as well not waste his time bidding it.

However, he knew that if he was negotiating the job and that it was not being put out to competitive bid, he could put 22 to 25 percent GPM on the job and still get it. Today, this contractor consistently puts 22 to 25 percent GPM on competitively bid jobs and 25 percent to 30 percent on negotiated ones because the market has recovered from the recession of a few years back. This contractor monitors his market by tracking GPM as it reacts to market forces. He then adapts his pricing accordingly.

MAINTENANCE TRENDS. The commercial lawn maintenance market displays some very interesting trends around the country. The primary indicator of its predisposition takes the format of a unit price. It is the man-hour rate. You determine the man-hour rate by dividing the billing price of a job by the total man-hours (including drive, load, unload time, etc.) required to perform it. This number averages $22 to $27 around the country. However, some markets realize $30 to $35 per man-hour. These markets are usually found in industrial parks near major metropolitan areas. Certain cities in New England, California and pockets in the Midwest see these types of prices. However, the Southern California market sees its man-hour rate drop to the mid- to low teens ($13 to $16 per man-hour). In one area, rates of $11 to $12 per man-hour are not uncommon. This is understandable due to intense competition, low labor rates and the ability to spread overhead costs over a 12-month season rather than a nine-month one. GPMs in the lower man-hour markets usually ranges from 20 to 35 percent and from 35 to 45 percent in the higher ones.

Municipal lawn maintenance markets in Southern California have displayed some interesting trends over the last 10 years. At one time, the man-hour rates were consistently hitting the high teens to low 20s. Presently, they are in the low to mid teens. Gross profit margins have fallen as well. This once very lucrative market was realizing 30 to 40 percent GPMs. Now it is lucky to see these margins hit the low to mid 20s.

Margins and rates have dropped partly due to the economic doldrums of the Southern California economy. However, municipalities have become much wiser in overseeing the contractors performing the work in the field. Partly due to budget constraints, quality control inspectors look for areas where contract specifications and standards are not being met. Deductions are then subtracted from the contractor’s monthly billings.

One contractor recently found himself in a “catch-22.” He saved a city more than $100,000 on a rather large contract. To show its appreciation, the city took the $100,000 savings and went out and hired another inspector to help oversee the contract, which upset the contractor. He worked to improve production, reduce margins, be more competitive, save the city money and keep one inspector happy. Now he had to keep two inspectors off his back who were trying to save as much money as possible for the city, at his expense.

These are the types of situations and realities of business reflected in market forces that influence margins and drive prices up and down and to which the contractor must adapt daily.

I consistently see residential landscape installation work realizing 30 to 40 percent GPMs throughout North America. An East Coast contractor had an installation division, which did both commercial and residential work. However, profits were very slim at the end of the year. Upon reviewing several completed jobs, we found that the GPM bid on these jobs was rarely more than 27 percent. This was OK for commercial work but it was too low for residential work.

The designer/estimator admitted that he could have raised the GPM on the residential bids 5 percent to 10 percent and still have won the jobs had he been aware of that market’s predisposition and had he used an estimating system which clearly identified the GPM to him during the bidding process. He underbid his residential jobs and left money on the table because he did not pay attention to market forces and trends.

Moving Prices Up

Business owners facing fierce competition can never predict whether a price increase will send an established client searching for a cheaper rate. Some owners have annual price increases and others base their increases on their costs. Bill Cox, president of Lawn Management Company, Houston, Texas, said he has had a lot of success with timing his price increases to coincide with a federal minimum wage increase or price increases in the oil market. “It’s just accepted then that everyone’s prices are going up,’’ he remarked about the effects of those economic influences. Cox emphasized that he keeps a good relationship with his 125 clients and lets them know of new prices well in advance through contacting them by telephone and by letter. If a particular customer has a problem with the increase, Cox said, he tries to compromise. “They’ll say: ‘The timing is not right for us.’ So we’ll wait six months or so before raising their price,” he explained. “We realize some customers’ budgets can’t go up when we want the prices to go up.” With more than 1,000 clients, Gary Moss, president of Moss Landscaping, Houston, Texas, said he notifies his customers about 30 to 60 days before a scheduled price increase is going to take place. Moss echoed Cox in that he, too, negotiates his prices if a customer objects too strongly to the increase. Each customer has an annual contract for services with the company and yearly price increases are based on that contract, Moss explained. Prices are based on the bottom line, and increases have generally ranged from about 5 to 10 percent each year. They are typically based on the higher workers’ salaries and costs for supplies and equipment his company has to pay, he remarked, adding that he rarely offers customers these explanations for his price increases unless they want to know.

It is imperative that contractors be able to identify direct and indirect costs as well as profit margins in the bidding process. Doing so will help you identify the market trends mentioned above. It will also help you identify what I call a bidding envelope or range (e.g., 25 to 35 percent GPM) within which you can safely bid.

You need to know how high you can go with your GPM and still get the job. You also need to know how low you can go with the GPM and not hurt yourself. Looking at how high you can go is the easy part. If you are too high, the market will tell you to take your price and get lost. How low to bid is much more of a challenge. As a general rule, you want to bid above your break-even point, which is the total of your direct costs plus the general and administrative overhead to be recovered on a job. Rarely do you want to bid below the break-even profit on a job.

CONCLUSION. Adapting to the marketplace requires that you be able to measure it. It is necessary to have the right tools and methods in order to do so. Once you have the right tools and methodology, you can measure and adapt to just about any marketplace. However, the critical question to ask is, “Can you play this game and win? Does this job add to your bottom line and does it fit into your bidding envelope?”

Seasoned captains of the sea are not rudderless victims of the waves. They consistently reach their chosen destinations because they have mastered the tools of their trade and have adapted them to each course they navigate. Contractors who employ similar tactics not only have the ability to adapt more easily to their markets today, but they ensure that they will be able to sail into the markets of tomorrow as seasoned profitable contractors.

The author is president of Smith Huston, Inc. which specializes in construction and services management consulting to the Green Industry. He can be reached at 800/451-5588.

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