What do you consider to be a “fair” profit for the goods and services you offer? Judging by the way many contractors do business, I get the impression that they feel guilty accepting any money at all!
I’m all for charity and philanthropy, and am proud to say that I share some of my good fortune with various worthy causes. But if I had not run my business with sound financial and pricing policies over several decades, I might be receiving charity rather than giving it.
It’s puzzling why so many of my colleagues around the country refuse to charge a reasonable price for the work they do and merchandise they sell. Consider the following.
According to Standard & Poor’s statistics, the McDonald’s hamburger chain earns 22¢ before taxes for every dollar passed over the counter. Masco Corp., the parent of Delta Faucet and several other leading plumbing manufacturers, earns about 23.3¢ before taxes on every dollar of revenue. IBM reports a net profit of 23.2¢ before taxes. Merck & Co., the pharmaceutical company, reported net profit of 24.2¢ for a year, according to the statistics as well.
I could go on for pages with a litany of successful businesses and industries that boast double-digit net profit percentages. I can assure you that none of them feel guilty about earning all that money. In fact, as soon as their profit margins fall a few percentage points, their shareholders begin screaming for management’s scalp, and company executives scramble like crazy to shore up performance.
Compare this tale with our PHC contracting business. According to Robert Morris Associates, a statistical reporting firm with many clients in the banking industry, the PHC industry at the contracting level earned an average of 2.7¢ for every dollar of revenue before taxes. The firm reviewed 584 PHC firms, with sales volume ranging from$500,000 to 10 million.
Net profit of 2.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. There must be an error, you say? Can’t be! Sorry guys and gals, it’s the truth. What’s more, it represents an improvement from the prior four years, when average net profits for PHC contractors ranged from 1.3{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} to 2.4{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}.
Granted, some businesses are structured8 as high-volume, low-profit enterprises. The average supermarket for instance, would be doing well to achieve even 1{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} net profit on sales. PHC wholesalers consider 4{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} a terrific year. Generally, low margins are common to businesses which move a lot of product in routine, highly automated transactions, and where labor and capital costs are relatively small.
Does that describe PHC contracting? Not on this planet! We are a labor-intensive business, and our transactions are by no stretch of the imagination “routine.” Considering the risks we take and the value we give, our profit margins should be closer to those of the Mascos and IBMs of the world, not that of a supermarket chain.
Of course, not everyone in their fields perform as well as Masco and IBM. Robert Morris reports, for instance, that plumbing manufacturers overall realize on 5.3{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} net profit before taxes on the average. That’s not very dazzling, but it’s almost twice as much as the PHC contracting industry, and remember that each 1{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} increase in net profit translates into, depending on the size of your firm, tens or hundreds of thousands of extra dollars. In any case, I am going to draw attention to high-profit firms as models of what all of us should strive to imitate.
The real tragedy in contracting is that low profitability has existed for at least four and a half generations that I am aware of, during good and bad times. There is a very simple reason for this, namely the failure to understand basic mathematics and markup procedure.
The Blind Lead the Way: I quote from an industry article published by Robert Denham, chief engineer of the Denham Cost Finding Co., Cleveland, Ohio.
“Selling price, the base, is always represented by 100{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. Profit must be calculated as a percentage of the selling price, not the direct cost or purchase price. The more intelligent and advanced businessmen are doing this at present, but their number is less than 10{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of the whole.”
Seventy years have passed since that article appeared, with the same error being prevalent today. I know this from my experience as a business consultant conducting seminars and advising clients on a variety of management fundamentals.
There is a standard exercise I use in which I ask an audience of contractors what $1,000 of direct cost should sell for if 25{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} of gross margin is desired. If there are 100 people present, I’m lucky to get 10 correct answers. This basic error, together with unenlightened understanding of the words “profit” and “return on investment,” produce the results we witness throughout our industry.
The real tragedy is that the 90{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} who do not understand basic markup are precisely the people who establish the market price for goods and services in our industry. This is simply because they are such a vast majority. Blind men and women lead the way, and they muddy the path for all the rest of us.
I am positive that this is the basic reason why the PHC contracting industry averages only 2.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} net profit before taxes. This poor profit performance in turn is the root cause of many other industry problems.
Desperate contractors who get into a financial jam are apt to take shortcuts which diminish the quality of work. the worst among them cheat and gouge their customers at every opportunity. Financially pressed contractors find it difficult to invest in proper training. The much belabored notion of contractors being “poor merchandisers” is due in part to the fact that the average contractor budgets a pitiful amount of money for advertising and promotion. Our industry as a whole has little money left over to promote ourselves via institutions like the Plumbing-Heating-Cooling Information Bureau and its “PHC Month” and “Super Value Days” efforts.
Let’s Argue! I know what you’re thinking. The party line goes: “This industry is extremely competitive, and there is no way we can achieve a better profit. Besides, I’m drawing a decent salary.”
B.S.! You can quote me on that.
The fact is, there are many contractors who are not fairly compensated for the hours and effort they put into their business. A lot of you think earning $50,000 a year is a dream come true.
I got news for you, that’s how much your top employee should be earning – even more. For your risk and investment, you should be earning twice, three times, four times that amount – the sky’s the limit! There should be money available for you and your people to enjoy the benefits of profit sharing plans and bonuses; for business expansion and improvements; for advertising campaigns that compete with those of the home centers; etc., etc., etc.
Still not convinced? Do I hear some of you saying that I’ve got my head in the clouds? Okay, at the risk of sounding like a bragger, let me advise you that my company’s overall net profit for the last fiscal year was 11.6{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}. That’s not very good for us. We’ve done better. Our profit percentage was lower than normal because we realized a huge volume growth of 47{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, and when you grow that fast there’s usually a lot of loose ends that result in inefficiency. We’ll tighten those up over time.
In case you’re wondering, the reason for our growth is that a bathroom and kitchen showroom we opened in began paying off in a big way. The money for that investment came primarily from previous profits earned in our regular service business, the largest in the Milwaukee area and, incidentally, a union operation. This serves to illustrate one of the opportunities that comes from making money.
Another is to reward your employees for their work in making the company successful. This year, as always, some of our profits will go to them via the maximum contribution allowable to a profit-sharing plan. It’s one of the reasons why we have very little turnover in our company, and I wouldn’t trade our group of people for any other in the industry. I feel that it is better to give money back to your employees than to Uncle Sam, although he certainly gets his fair share as well.
Still Skeptical? You’re saying, “Okay Frank, you’re good, but the real world of contracting is so dog-eat-dog that all of us can’t achieve double-digit profitability.”
Maybe not, but we sure can do better than 2.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} on the average. Why is it that, again according to Robert Morris Associates, concrete contractors earn an average of 4.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} net profit, electricians 3.1{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, excavating & foundation contractors 6.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, floorwork contractors 3.7{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, home builders 3.9{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, painters and paperhangers 4.1{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}, highway contractors 4.2{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f}? Why is it that the PHC field ranks as one of the lowest in the contracting world, even though our work is among the most complicated and important in construction?
Maybe an even better question is, how can the legal profession make 23{938cd9e8dae860e800efc538277d4f7684e6f6981618ba70d1c34357a53c2e1f} net profit before taxes on the average, even though there are 650,000 lawyers competing for business in the United States, more than half of all lawyers in the world?
Perception Problems: The ultimate and saddest irony is that while we’ve been selling ourselves short, the general public believes we’re way overpriced. Yet the problem is not the price, but of perception.
The average consumer will pay $100 to a doctor or lawyer for absolutely nothing, and go away feeling like he got a bargain. The same person will pay $100 to a plumber for an emergency repair, and gripe to high heaven that he got ripped off. And if you drop your price in half, I bet he’ll still complain.
This situation is not right, but I don’t blame the consumers for it. They’ve been conditioned for a long time to believe that plumbing comes cheap, and they don’t know the difference between good plumbing and bad plumbing – or the consequences to their health. They don’t realize that we are professionals just like doctors and lawyers, and we have trained and studied just as long. We’ve failed to educate them, because we haven’t been educated ourselves to know how much we are really worth.
All of the companies named early in this article are in highly competitive fields – computers, pharmaceuticals, etc. but there is one thing that separates them from poorer performers in their respective industries.
They have a positive attitude about “fair profits” and stockholder demands for a “fair return on investment.” Happy will be the day when we begin to think in the same positive, mental terms – instead of cringing every time a customer complains that we charge too much.
Compare the value you add to society with McDonald’s, IBM, Masco, etc. These entities create jobs for many people, young and old, for construction workers who build their plants. They pay property taxes and corporate federal and state income taxes, all of which help our society pay for the government services we demand. They innovate and come out with new products and services which make our lives easier, and produce innumerable other residual benefits. For all that they feel entitled to earn double-digit net profits.
As a group, PHC contractors are equally valuable or more so. Collectively, we create many jobs. We provide the means to bring safe, potable water to homes, factories, hotels, hospitals, schools, etc. We provide for the safe and healthy elimination of a multitude of waste materials from these establishments. We provide society with the expertise to heat and cool those facilities for maximum comfort. And we do all of these things with a great deal of financial and often physical risk. We also pay taxes.
Yet we earn less than 3¢ on the dollar. Are our contributions really worth only about an eighth of McDonald’s? For some reason, I believe that safe and convenient plumbing is more valuable than a quick and convenient hamburger.
Call To Action: It is long past due that PHC contractors take a different view of their worth and price their services accordingly. Correcting a problem that has festered for the better part of a century won’t happen overnight, but the process can and must begin right away.
Trade associations must assume some of the burden, and I suggest they do so by making business management education their number one priority, with salesmanship and marketing close behind. What’s at stake is not only the financial health of PHC contractors, but also our professional image in the eyes of our employees, the entire industry, and the public at-large.