Suppose that your analysis of your client indicates that the proper Labor Burdened Rate is not being used and the Overhead Recovery Rate is too low. Normally, this would require an increase in your pricing. What is your strategy when a client says he can’t raise his prices above the competition? His resistance may be the result of the client not knowing his exact operating costs. His previous pricing may have been determined by trying to be at or very near his competitors. However, this may result in not covering his overhead and thus leading to diminished profits and putting the Company at risk.
If the client is reluctant to raise prices for fear of it making him uncompetitive; this may call for a deeper look at the Company structure and organization. Some basic questions may need to be asked and the resulting answers analyzed to see if raising the prices would really be a problem.
1. What is the Company Mantra?
Do we consider ourselves a Company that provides quality services and on-time performance or have we considered ourselves the low-cost provider in the field? We probably cannot be both. If we are considered a quality provider it will be very difficult to be a low-cost leader. There is just too much expense involved in hiring and keeping quality people to always be the low-cost provider. We may be trying to compete on price when the expenses really require a price increase or in the alternative, cost-cutting. Another factor to consider here is whether we are firmly established in doing business for this customer and what is his real perception of our work. Are our employees highly knowledgeable and experienced? Do we provide extra value by doing the work correctly the first time and on time? These qualities, if presented properly, should support price increases when appropriate. If we have been sloppy in our workmanship or missing timelines, then not so much.
2. What is our bid/ hit ratio?
One possible sign that we may be bidding too low is that we are winning many more bids then we normally would for this industry. In other words, what percentage of the work that we bid are we being awarded? If it is a high percentage or we are getting a lot of work from a limited number of customers we could be bidding too low. We may be winning this work because we are leaving money on the table. If we are consistently the low bidder we may be in fact too low and we may have been able to get the work even if our bid was higher. This requires a closer examination. Whenever possible find out where your bid was in relation to the other bidders. How much higher were they than us?
3. Job Cost Analysis
The next step is to examine the numbers for the completed jobs. Are those jobs that we are winning profitable for us? In other words, we should always be examining the completed jobs and comparing them to the original bid. Take into account any subsequent change orders, but determine if those awarded jobs were actually bid properly. Did we make the expected profit? If not, why not? Was it completed on time? Did we exceed the cost of labor or materials? How much profit did we truly make? This analysis may give us an indication of the accuracy of our bidding and help us determine if we are too low in some of our pricing; thus resulting in lots of work but little profitability.
4. Are we “Lean and Mean”?
Do we have too many unproductive assets or are making payments for too many unproductive assets? These could be eating up our cash and causing us to have Cash Flow problems? Do we need to periodically add cash to the business to pay our bills? In the bid, are we including the costs of equipment to do the work? Therefore, collecting enough money to make the payments? Can any of these assets be disposed of?
5. Are the Overhead Expenses in line with our volume?
Overhead is representing our fixed expenses that need to be paid whether we open the door or not, like rent. Do we have too many personnel? Do they have productive roles in the operations? Can we get by with less? Are they doing the right jobs? In other words, where can we cut costs without disrupting the operations of the Company?
6. Have we used Break Even pricing to formulate our bids?
By this we mean have we updated the Labor Burden Rate and made sure it is accurate. Then, have we calculated and applied the Overhead Recovery rate to arrive at our Break Even price? If we then add our desired profit (by dividing by the reciprocal of that number) we can determine the proper selling price. One alternative may be to lower the price by reducing our profit. Once we have determined the Break Even price we may not need that 30% we are “adding for Overhead and Profit.” A calculation for ” pure profit” is more likely to be in the 5%-20% range.
7. Cost of Materials
Most times the Overhead Recovery Rate needs to be applied to all materials and labor associated with the job. However, in some cases where every bidder is going to price the materials almost the same because they are all using the same suppliers; we may want to recover our Overhead strictly on the basis of the Labor involved in the job. Particularly, in a job with a greater portion of materials than labor in the bid.
SUMMARY
Once all of these areas have been examined, the choices should be presented to the client. It may involve cost cutting, price increases or a little bit of both. However, all choices should be presented with a recommendation as to the preferred course of action. Maybe, we can increase the equipment pricing without having to increase our labor rates. Or, as suggested, if we can reduce our Overhead we then will be able to reduce The Overhead Recovery rate and avoid a price increase. Either way, a convincing case needs to be developed and the options presented as well as the consequences of not doing what the numbers are.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
