Why Ain’t There Any Profit?

Each year, I review the statistics on the HVAC trade in America and each year I see the same basic data.  To be sure, from year to year, the numbers change—but only a little.  (The data from the current recession won’t be out for a good while yet, but I shudder to think what it will look like!)

For decades, the net profit after taxes in this trade has run under 3%.  For all the hard work contractors put in, to only keep 3% of what they bill out doesn’t seem fair, does it? (By the way, that is about the average net profit of health insurance companies (3.3%), too; click here for details; not that I am opposed to reform in the health insurance business– I am– but I am not convinced they are making a bundle off their clients. Probably makes more sense to do tort reform, but that’ s another blog!).

The math is simple—and ruthless.  Profit is what is left after overhead and costs are subtracted from sales.  In my consulting practice, I find that most dealers have pared about as much overhead as they can.  (To be sure, there is some waste here and there, but it is often not enough to make a big difference to the bottom line.)  They have also gotten their costs down about as low as they can (to the grief of many manufacturers).

So why is there so little profit?  One of two reasons—the sales are too small to begin with, or the control of direct labor is a shambles.  For this post, I want to focus on the stunted sales too many contractors put on the books.

When I speak about sales being too small, I am not speaking about the quantity of jobs a contractor does, but rather the size of the contracts on those jobs.  Too many contractors end up selling their work and material too cheaply—way too cheaply.  This can be due to fear of losing a job (this is a huge factor in the current economy).  But it is usually the result of ignorance about job pricing.  I am not being cruel when I speak of ignorance, because ignorance simply means one doesn’t know how.  There is nothing wrong with that, but once you learn how, if you go back to your old habits, then you deserve the moniker– Stupid– because then you aren’t ignorant anymore!

I have taught job pricing in hundreds of workshops to thousands of contractors, and when I toss out a job to bid, only about 4% get it right the first time.  (By the end of the workshop, all of them get it right.)

Here’s a case in point.  Suppose you have a job to bid and that the materials (equipment, piping, wiring, ductwork, and so on) comes to $3,478.  Suppose also that you estimate labor to take 4man-days at a cost of $250 per man-day (that’s about equal to about $21 an hour plus bennies).  You want 10% net profit on this job, and your accountant tells you that  your overhead (which does NOT go on the job estimate as a line item) runs, on average, 24% of sales.  How much should you bid this job (not getting into the messes taxes can cause)?

Some people would solve it this way:

Materials = $3,478.

+ Labor = $1,000.

Total costs = $4,478.

Multiply that by 34% (24% overhead plus 10% net profit) to get $1,523.  Added to the costs, bid the job at $6,001.

Clever, but wrong.  Others would take the $4,478 in costs and multiply by 24% (giving $1,075).  Adding to the costs, they get $5,553.  They would then multiply THAT by 10% (to get $555) and then add it to the subtotal to get a bid of $6,108.

Also clever, but also wrong.  The right answer is $6,784, but it doesn’t matter because the job would probably go for $5,078 because some idiot bid just enough to cover his costs and make $600 “profit.”

By the way, if you did not get $6,784, click here to see how to price any type of job.  You might also find this link to be helpful.

You might also want to  download the sales quip by John Ruskin [click here].  When I was a territory manager, I gave the quote on parchment in a frame to my contractors and they all put it up on their office walls.  It changed how a lot of them priced their jobs and got the customer to agree to it when there were cheaper “idiot” bids.

Finally, this link takes you to software that can make your job a lot easier (and more accurate)!