Should You Ever Cut Margin?

Seminars, classes, conferences, peer groups — indeed, even remodeling publications — devote themselves to teaching the importance of understanding overhead and net profit, margin and markup. As a whole, the industry doesn't charge enough to make the margin required to cover overhead, pay the owner a good salary, invest back into the business and provide a retirement plan.

August 31, 2005

Jud Motsenbocker
Contributing Editor

Seminars, classes, conferences, peer groups — indeed, even remodeling publications — devote themselves to teaching the importance of understanding overhead and net profit, margin and markup. As a whole, the industry doesn't charge enough to make the margin required to cover overhead, pay the owner a good salary, invest back into the business and provide a retirement plan. Increase markup, we hear. Improve estimating accuracy. Qualify prospects. Write an explicit scope of work to ensure you and your client share expectations. These things will make the business, and in turn you, more profitable. Is there ever a time when a remodeler should willingly, knowingly, sacrifice gross profit? This month, Jud Motsenbocker asks Mike Nagel and Mark Brick just that question.

Jud: Is there ever a time when a remodeler should be willing to sacrifice profit margins on a job?

Mark Brick

Mark: If it's to make a client happy, if it's something that's not going to take too much time but will give results. Compromise is better than not getting paid.

 Mike Nagel

Mike: I can think of two times when I would be willing to sacrifice profit. One of the toughest commodities to come by is good labor and good leadership out in the field. And sometimes, although we don't like to admit it, we do have slow periods in our construction. There are times when I'm willing to sacrifice profit to keep a good employee on board and take a job at a little bit lower margin in order to have work for him to do.

The other time is when I see a marketing opportunity. There are some jobs that are just run of the mill, and we do them because we know we can make a good profit at them. There are other jobs where we walk in the door and everything is right: The client is an outstanding client; they have their house decorated to the nines; it's always super clean. It becomes a showplace for us. Sometimes I'm willing to drop profit a little bit to make sure I get that job, because down the road I can get a lot of jobs just by taking people to see that one.

Mark: That is about the only other time I would do it — if I could use that home for a tour, or I see it as an award-winning project. I don't know if I would really sacrifice profit on that, but make them feel like they're getting more for their dollar.

We're in business to be able to wake up healthy the next day. It's the remodelers that end up sacrificing consistently that have the problems.

Jud: Are you willing to drop margin when you have made an error in the project?

Mike: If we made a mistake, we have to make it right, and if that eats into our overhead or our profit, I would say absolutely, positively. I've never walked away from a job in my life, even if it costs me money to make it right.

Mark: I would say exactly the same thing. It's even less profitable if it affects your name in the industry and if attorneys get involved. It affects everything, and it takes away from the profitability of other projects going on because you have to manage that situation.

Mike: I've never had a project with a major problem that would be threatening to the overall well-being of the company. Any problem we've ever had is something we've always fixed in-house. We did whatever it took to make it work.

Jud: As a general contractor it doesn't make any difference if a sub made the mistake or you made it, it still should be taken care of. Would that be a fair statement?

Mark: That would be a very fair statement.

Mike: Even though it would be the responsibility of the subcontractor to resolve the issue, it's still going to take more time for my lead carpenter or project manager to make sure that it gets done correctly. That's going to eat into his time, which definitely goes into the overhead side of the equation.

Jud: Is there any time you would sacrifice margin to keep a promise or a deadline?

Mike: We have never had a contract where we put a finish date and were penalized if we didn't complete it by that time. But if somebody's having a wedding party at their house and I promised I'd have the project done, would I bring in a higher-priced subcontractor to get the project complete so they could have their wedding party? Yeah, I would do that, because that was the whole point of the remodeling project. There's nothing worse than having a bad name out in the marketplace. In a situation where it was really critical, I would do what it took to get the job done.

Mark: We're not unrealistic in our time frames, which are generally padded pretty good. The only times that things have changed is when a client hasn't made a decision in time. We tell them we won't even start a job in general unless certain products are ordered ahead of time, so we don't get into that problem.

Mike: Good remodelers do that for the most part, but we all know that product comes damaged and product comes in later than they say sometimes.

Jud: That's a good point, especially if the damaged product is a special product that takes two or three weeks to get.

Mark: The brands of products we use have been about 95 percent a comfort level versus a problem. We did have a sink that came in all scratched, and we're doing countertops next week. I was able to find it to get it UPS'd to us so we could continue the project.

Jud: That's a good point, though. You had additional expense that you didn't have in your estimate to start with. You were willing to give up some profit because you were going to meet that deadline.

Mark: That $35 really didn't amount to too much in a quarter-million dollar project.

Mike: It could have been two hours of somebody's time on the phone or the Internet trying to locate it.

Mark: You're right. There is the overhead cost of your management team. I happened to handle it because I knew where to go and knew what questions to ask. But you have to depend on your staff to be as efficient as you.

Jud: You made the comment, "I took care of that because I know where to go and where to find the answer." On the other hand, you're talking about your time, and your time has got to be factored into this overhead and profit situation. You were willing to solve the problem one way or another, and you were willing to take the time, and your time is money. We don't think of that as money, but realistically, gang, it is, because if you weren't solving that problem you'd have the opportunity to go out and sell another job, right Mark?

Mark: Well, I would have had an opportunity to get on my motorcycle a little bit earlier.

Jud: Is there a time when a referral is worth sacrificing overhead and/or profit? Mike?

Mike: I don't look at it that way. I like to think that we satisfy our customers and 99 percent of our customers are going to give us referrals. I think that becomes automatically part of our overhead in that we may reward that person for giving us that referral. So we could say that if we gave them a $50 gift certificate we could consider that part of overhead. Are we willing to sacrifice that $50 gift certificate? I'm going to say no.

Jud: Mark, any comment?

Mark: Well, I feel that it's very important for us — and a lot of cases in the work that we do — to have built up some good will in our overhead. So I feel that when we send out a gift certificate, we do that as a thank you for working with us for the project that we did and hopefully in a continued relationship. We also have a rewards program that we set up through our company that we give out to clients that do refer us. In nine out of 10 cases, getting a referral is almost guaranteed work. And it's a very inexpensive advertisement.

Jud: Which situations with the customers are worth confronting and which are not? If there's a disagreement over a price or a change order, is there a point there where you're going to give up margin?

Mark: Not really, because before we'll make a change, they're signing a change order and understanding the cost involved. A lot of remodelers get themselves in trouble by agreeing to do it without having that discussion and signature up front.

Mike: We don't typically get into too many battles because we do change orders the way you're supposed to do them. There are guys out there that just go ahead and do it and give customers $10,000 worth of change orders at the end, and they had no idea it was coming.

Jud: Let's look at it from this standpoint: You take the change order to the client and the client says, "Wait a minute. That one cabinet is going to cost this kind of money?" Is that a time when you're going to sacrifice overhead or profit?

Mike: No. It's spelled out plain and simple in the contract. We state a specific markup, and we state a specific labor rate. We always show them our material at our cost on that kind of stuff and add our markup that's already in our contract. If you educate them right, you have less conflict in the end.

Jud: What about when you get trapped in that "he said, she said" situation where your lead has said one thing and the customer has said another?

Mike: I hate to say it but, as much as we talk about them not doing that, my lead guy sometimes does promise things that may not get back to me. If he promises them something, and he gives them a specific price, and for some reason that number did not get back to the office or wasn't discussed, I give it to them at that. I'm not one to back charge my employees. That's just my policy not to do that. So I would lose margin. I'm not going to call the homeowner a liar.

Mark: I stand by my people, too. Some decisions have to be made on the fly. If we don't empower our responsible field people to make certain decisions, that's making a big mistake. If I have to answer every question, I don't have enough hours in a day to do it.

Jud: We agree then that part of this whole program to prevent losing margin is to educate our employees on what that is. So many companies, I think, hesitate to explain to their employees what overhead and profit is. We sit down with all our employees twice a year and go over nothing but overhead and profit.

Are allowances a bad idea because they cause us to lose margin even when we don't mean to?

Mike: We use allowances all the time. It is stated in my contract that if they go over the allowance, it gets marked up our stated markup. If there is extra time involved because they went from a standard tub deck mount faucet to a deck mount faucet with remote personal hand held unit, which takes about another four hours to install, they are going to pay for that time. I don't know how we could exist without allowances because some people just can't make decisions.

Mark: I totally agree. Let's say that somebody, for example, wants a shower system, and we put in $300. Then they pick out one with body sprays or whatever that costs $1,000. It's stated in our contract that that is not only additional cost but also labor.

Jud: What you're saying is when we write that agreement up, we've got to have in there that when they go over an allowance, that you will, in fact, include your overhead and profit in that number. If you have an allowance of $1,000 and the folks only spend $800, so you have $200 to give them back, do you take the overhead and profit off of that also?

Mark: No.

Mike: We do. We do because most of the clients that we deal with seem to be pretty savvy in that kind of stuff. They know that if they go over $1,000 that I'm going to mark up whatever they go over. They're going to expect to get that off on the backside. How do you explain that if somebody questions you, Mark?

Mark: We still have overhead and profit on the products. Our overhead that we put over and above that is in general on everything.

Jud: Do either one of you charge a fee for change orders?

Mark: Yes, we do. We have it built into our price.

Mike: No, we don't do that. We consider it part of the overhead in the markup. I don't consider going under your allowance or over your allowance a change order.

Jud: If you are low on work, are you going to cut the margin in order to keep work on the table?

Mike: I don't have a guy working for me that's been with me less than five years right now. We've been very fortunate in our 20-year history not to have too many layoffs or slow times, but we had a really bad one last January. It's a long story, but we ended up with no work for about 2½ months, which was a killer. We did whatever we could do to keep those guys busy even if it meant breaking even. For the size of our company, we do a very healthy dollar volume, but we don't have a huge office staff and my office is in my house. Our overhead is pretty low as companies go.

Mark: When work is slow, it's time to remodel my kitchen or bathroom. I put together a business plan a long time ago that helped me diversify. I own properties and I own land. If you diversify and have other avenues, you can still keep your margins.

Mike: What does that do for your employees?

Mark: What I do, I have permits set for projects that I have going on — building a duplex, let's say. By owning the land and having approvals, if I'm not getting it from the client, I make myself the client. I've got 17 carpenters and 12 of them have been with me over 15 years. Making sure that you keep good people is important. I wasn't joking when I said it's time to do a kitchen or a bathroom or whatever.

Jud: Both of you are in areas, as well as I am, where weather plays a factor. You are in a serious winter situation, you are low on inside work, you can't work outside — are you going to sacrifice profit or overhead in order to get work on the table?

Mark: Creating projects at the right time goes with experience. Will everybody get a 40-hour week? No, they might get 37 hours if roads are bad or whatever.

Jud: Mike, are you going to take a job and sacrifice any overhead or profit in the winter?

Mike: You know, the winters we've had here in Chicago of late haven't been a real issue. We've pretty much been able to work outside a lot. I really haven't been forced into that situation in the last five or six years but again, my employees mean a lot to me, and I wouldn't have a livelihood if it wasn't for them. I try to take care of them in any way I possibly can because I don't want to lose them. If we got into a real cold spell, I'd do something. If it got so bad that I had to tell them they would have to take off two weeks or a month, and they went on unemployment, I would still pay their health insurance.

In a company of my size, overhead is not as easy to get rid of as somebody with a larger company who could say, "You know, we're slow. Maybe I need to get rid of somebody in the office or maybe I'm going to get rid of a couple of laborers in the field that are not as difficult to replace."

Jud: Administration costs, which none of us like, but certainly if we don't have it, we're not going to be in business very long.

Mike: Right.

Jud: Either one of you have any further comments to make?

Mark: A lot of times we're offered opportunities like kids with candy. You really have to have a comfortable feeling working with your clients, because all it takes is one bad apple or one deal that you hear, "Let's do a trade on something." In most cases when you make that trade it costs you somewhere because you're using emotion versus business. It's better to walk away from any type of trade opportunities in 99 percent of cases.

I really feel that people getting started in this industry can't afford to give anything away. Opportunities might come down the road where they can do some bargaining, but in the beginning, they need to build a sound business. We've learned through experience that when you do deals it haunts you.

Jud: Yeah, that's for sure. I just had an incident remodeling a bathroom for folks we worked for forever. He owns and operates a car dealership, and we put in a comfort height stool. And it came as an oval shape. The height was fine, but the lady just didn't like the way it set. She wanted it changed. And she selected it, she saw it — the whole 9 yards. It wasn't a question of us putting in the wrong thing or selling her something she hadn't seen.

So I called the guy up and I said, "I got a question for you. If I order a car, and I ask you to put a CD player in and you do, and I don't like the CD player, I want a tape player, will you charge me to change that?" He said, "Absolutely, without a heartbeat." I said, "Thank you very much. That's all I needed to hear." I took the bill over to them this morning, and they were happy as a lark, so no big deal.

Mark: Well that's good, because it would have been a small headache.

Mike: I think that the key to this industry is picking your client, because once you run into one bad client, you never want to run into another one again.


Mark Brick, CR, CGR, President

B&E General Contractors Located in Glendale, Wis., 20-year-old B&E General Contractors employs 13 field and seven office employees. Currently a $5 million company, B&E has an average annual growth of 12 percent. They are a full service design/remodel/build company.

Mike Nagel, CGR, CAPS, President

RemodelOne Design/Build Construction
RemodelOne, a $1.8 million company located in Roselle, Ill., has been in business for 20 years. Nagel and partner Terry Debartolo employ four field and three office employees doing residential and commercial remodeling in the Chicago area.

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