Through the years I have discussed the need to raise prices and that setting too low of a price is the No. 1 cause of contactor failure. In tighter economic times, maintaining margins is more important than ever. A slower housing market, less rain and an overall change in consumer buying attitudes can cause contactors to panic and slash prices. Such random cutting of prices can lead to financial suicide. Here’s why:
Many contractors do not fully understand their costs and tend to price jobs based on their competition with unit prices that may not be accurate. When I am trying to help a contractor, I try to find out how they are bidding jobs. Frequently, he or she is using arbitrary per square prices that do not represent true costs. For example, when asked how much per square is included for overhead, most contractors can’t tell you. So cutting your price to match other contractors who do not know what they are doing does not seem very practical. Since contracting has a low cost of entry, there will always be a person with a pickup truck and ladder who is cheaper than you. Using such competition to establish market prices is just plain foolish. You must budget and develop your own cost methods.
Don’t assume that automatically lowering your price will win the job. It is not uncommon for professional contractors to be 30 percent to 50 percent higher than the competition. You will never be able to cut your price low enough to compete with the lowest segment of the market. Customers can also mislead you regarding who won the job and why. For example, have you ever been awarded a job where you were not the lowest price? If you were awarded such a job, what did the customer tell your competitors? I doubt they told them that they were unprofessional and you were a better contractor. They probably simply said they had another price and your competitors assumed it was a lower price.
Understand that it is the customer’s job to tell you that your price is too high. What if a customer told you that your price was perfect? You would probably be lying in bed that night worrying about what you did wrong or left out of your quote. You will never have the perfect price. You will either be high but do good work or be cheap and well, cheap. Finding out what other contractors are charging can be tough to determine. Many new contractors in our roofing networking group are amazed to find out that other roofing contractors are able to sell at higher prices than they are. Such knowledge develops pricing confidence and gives them the courage to charge more.
Crunching the NumbersIn most situations, the pure mathematics of cutting prices does not make sense. This is particularly true in a slower market where there are fewer jobs to go after. To drive this point home, I am going to use a simple mathematical example.
Suppose a company did $500,000 in sales and their overhead to include owner’s salary was $150,000 per year, or 30 percent of sales. (Remember, these are just arbitrary numbers and you must determine your own overhead and profit.) This means a $5,000 job would have $1,500 or 30 percent gross profit and $3,500 in hard or direct costs. One hundred of these jobs would be needed to recover the $150,000 in overhead ($150,000 overhead divided by $1,500 gross profit per job equals 100 jobs). Now suppose this contractor cuts the price of the job 10 percent. The $5,000 job now becomes $4,500, but the hard or direct costs remains $3,500, dropping the gross profit on this job to $1,000. Now it takes 150 jobs or a 50 percent increase in jobs to recover the $150,000 in overhead costs ($150,000 overhead divided by $1,000 gross profit per job equals 150 jobs). It is highly unlikely the contractor will be able to sell another 50 jobs or 50 percent more work in a tighter economy.
So when does it make sense to reduce one’s price? Reducing prices only makes sense when taken as part of a carefully thought out and strategic plan, not as knee-jerk reaction to the market. Reducing prices might make sense when entering a new market or going after work you normally may not do.
Reducing prices may make sense if you have no work and a reduction forces a decision, but this still may not help. Again, you are assuming that price is the reason you do not have any work.
Cutting costs is a much more realistic approach to surviving in a down market. Every dollar gained is a dollar saved. Most contractors do not take this route because it is much more painful. Cutting costs requires you to reduce overhead and make some tough choices, some of which cannot be quickly undertaken. Also, understand that roofers are entrepreneurial by nature. They are risk takers who gamble each and every day whether it will rain, the customer will pay you and the crew will show up and do a good job. Their natural tendency is to think that everything will be all right and that they will sell or grow their way out of the problem.
In summary, business is always risky. Don’t underestimate the impact of price cutting. Reducing your margin can create a no-win situation. If you are going to go broke, it may be smarter to do so while doing nothing. Roofing yourself to death for little or no money is just plain foolish.