It’s one of the most important concepts in running a successful remodeling business, but still trips up many companies. How do you determine (and preserve) the margin and mark-up that you need to be successful. Professional Remodeler’s Jud Motsenbocker talked to remodelers Peter Feinmann and Jeff Hunt about the key info remodelers need to know about this crucial subject.
Jud Motsenbocker: Define the difference between margin and mark-up.
Peter Feinmann: That’s the biggest problem in the industry. The best way to describe margin and mark-up is to talk about it mathematically. If I have a $100 cost on a job and I’m going to mark it up by 30 percent, I would take $100 times 30 percent and sell the job for $130. With that gross profit of $30, I then have a margin of 23 percent because you take that $30 and divide it by $130 and you end up with 23 percent.
The big mistake in the industry is people think their mark-up equals their margin. What you multiply by and what you divide by after you get your final cost are two very, very different numbers and can put a lot of people out of business very quickly if they don’t understand the difference.
Jeff Hunt: We have to understand that margin is what we’re after and we mark up each line item to achieve that margin. I think the example Peter gave is entirely accurate.
It’s a very common misunderstanding when people dig into the numbers, to misunderstand the difference of what you mark something up and the resulting profit margin. A long time ago, when I was trying to get my numbers straight and grasp it, I had a real simple guide, a spreadsheet that showed me for any given markup what the resulting profit margin was.
Feinmann: The simplest way to solve it is something I was taught 20 years ago in a Business Networks meeting, which was get away from mark-up and go to the divide approach. If you want a 33 percent gross margin, divide by 100-33, which is 67. If you divide by .67, you’re always going to end up with a 33 percent margin. You’ll never confuse mark-up with margin.
Motsenbocker: What does the margin consist of?
Feinmann: A margin is to cover your overhead and net profit. So what’s built into your gross margin is the amount of money you need to carry all of those non-direct expenses to run a remodeling company. Expenses such as insurances that are not directly billed to a job, any of your non-billable employees such as office managers, owner’s time, vehicles, legal fees, rent, I can go down a long list. The best way to really think about margin are what expenses are not billable to a job and those are the expenses that you need to cover in your gross margin.
Motsenbocker: Do you change the mark-up depending on the size of the project?
Hunt: There are times when we may adjust up or down the mark-up or the margin we are trying to achieve on a given job. If we know where our break-even point is we may adjust the mark-up on a job to be more aggressive. On a simple project that’s going to last 9 months to a year, we may mark up differently, meaning less, than we may mark up a little three- or four-day bathroom. We can make some adjustments to the mark-up on any given job based on its size or complexity.
Feinmann: On a large job you might argue you should lower your mark-up, but the question is are you having higher or lower risk?
To really answer your question, math never lies. If your goal is to do $1 million in revenue at a 30 percent gross margin, and you take a $1 million job and lower your mark-up because you think it’s good for the company, it’s only good if at the end of the year you have reached your break-even and hopefully created a net profit. It never works at the end of the year if you’ve lost money.
Motsenbocker: Do you ever lower your margin to keep the employees busy?
Hunt: I wouldn’t necessarily lower the margin just to keep an employee busy, per se, but for the right job with the right complexity or lack thereof, for a repetitive job that we’ve done over and over and had really tight numbers on and good plans and specs and so forth, I might consider taking the margin up or down.
Feinmann: After the bottom dropped out in 2008, 2009, we both lowered our overhead and lowered our projected growth margin to be more competitive. Not by a lot, but we probably knocked it down 5 to 10 percent. Since that point, we might adjust down a percentage point. It’s not to get the job, but we’ve set an expectation the job is going to be a certain price point and when we get our final pricing, we feel its difficult to a new set of expectations. To me, math doesn’t lie, so to lower margin to get a job is the kiss of death.
Motsenbocker: If our goal for the year is $1 million and we want to keep our 35 percent margin … but if our volume drops to $900,000, then where did that throw our margin? You’ve still got $350,000 to cover, so what did that do to your numbers?
Feinmann: Your margin has gone up. If you have a $250,000 overhead on $1 million revenue, that’s 25 percent. If you do only $900,000 of work, then your overhead has gone up to 28 percent. That means your break-even has gone from 25 to 28 percent.
Motsenbocker: I just want to bring that up because in today’s market, we need to help the readers understand you may need to raise your mark-up to make ends meet at the end.
Feinmann: But I think the problem is more profound than that, because in this economy, you’re probably not looking at a 10 percent net. You’re probably looking at a much tighter net, and if your revenue decreases by 15 or 20 percent, it’s quite likely you’re not losing net profit, you’re starting to lose money against your overhead.
Most of us have sat in the position the last three or four years where we’re struggling with how much of this overhead we can afford to keep, because our break even gross margin has gone higher than we projected and we’re not able to sell the revenue.
Motsenbocker: Do you mark up materials and subcontractors the same?
Feinmann: Again, it’s math. You’ve got an overhead you’ve got to cover and a profit you want to achieve. The way we do it is by doing an even mark-up on all labor, on all subcontractors and all materials.
Hunt: I think it makes no difference if you mark up labor and materials differently, but everything that goes into the job, the bottom line has to come out to the target gross profit margin that covers our overhead and net profit goal. Whether you mark up each individual line item the same amount or not is sort of immaterial. It’s easier, certainly, to come up with a certain mark-up. In my world, I just find it easier to add that mark-up to every single line item and to be consistent about it on every item.
Motsenbocker: Do you mark jobs up differently when they’re time and materials jobs compared to a contract job?
Feinmann: We don’t do a lot of time and materials jobs, but we communicate a different mark-up on time and materials jobs than we do on fixed-price jobs. What we do is we burden our labor and lower our mark-up.
Motsenbocker: When you do a contract price and you have an additional work authorization, do you do a different mark-up on that than you do on your regular contract?
Hunt: The going-in position on that on change orders is that everything has a standard mark-up. Whatever the mark-up that was set for the job … the change order’s going to be the same. The caveat to that is, I will watch job costs during the job to see how we’re tracking, and if we get through a certain percentage, and we come out that we beat the numbers, then I know I’ve got a little leeway to do something nice for the homeowner or give them a little break on the change order. I may adjust mark-up in that scenario up or down depending on how we’re doing.
Motsenbocker: How far do you go with showing the client your margin?
Feinmann: Since the recession, we pretty consistently put together a client budget to show the client in 10 or 15 categories our projected costs with a mark-up. In that particular client budget, we are burdening the labor so the mark-up is perceived to be lower. It’s no different to the bottom line; it’s how we are showing it to the client.
Hunt: Someone once gave the example of someone buying an automobile, they don’t ask what the price of the lug nuts were … it’s how much is the car? If you ask me to build a project of a certain scope, to certain specifications, and according to a certain set of plans, there’s a price for that that’s inclusive of everything that it takes to build that.
I will show a high-level budget, a high-level aggregation of major cost categories. When I show that number, that number would be inclusive of the mark-up on that item. I won’t ever show a line item estimate that shows the overhead and profit down at the bottom.