Episode 25 Podcast Transcript
Speaker 1 (00:00):
You’re here to make money in your business and if you don’t price correctly, you’re not going to make money. Hi everyone. Rob Kropp here and welcome back to another episode of The Trade Den, good to have you back. Dan. How’s things?
Speaker 2 (00:18):
Hey Rob, very, very well excited about a third part of this series. It’s been an absolute blast talking about this stuff.
Speaker 1 (00:28):
How many golden nuggets do you reckon we’ve dropped over the last two episodes?
Speaker 2 (00:32):
I remember we were talking after the second one, we talked around how much actual coaching that we usually cover off. We cover off in one episode, like so many little lessons and nuggets and just little pointers that we’ve done so many times all in one episode. It was pretty cool.
Speaker 1 (00:46):
Yeah, there’s so much here and it’s what you do with this knowledge, which is the most important thing I think, and it pricing’s one of those things where if you get this right, it just sets you up for such long-term success and if you get your pricing wrong, you’re just destined to fail and that’s why we’ve gone to depth on this. This is part three by the way, of our three part series around pricing and if you haven’t done so, make sure you go back and listen to the previous episodes. The first one was all around the principles and how often you should review your pricing and all those types of things. The second episode was all around the cost base and the pricing pyramid, two cracking episodes and today we’re going to be talking about knowing your margin and what’s an appropriate margin you should be charging, but getting this right, it’s the difference between making profit and losing money. It’s just huge isn’t it?
Speaker 2 (01:44):
Is they’re little things that we’ve covered off. Nothing by itself is big and nothing will probably see earth shattering on the surface, but if you do these steps like you said, and actually use this information, the gap from where you are now to where you will be as a result of really knowing your pricing and how to price is going to be just a world apart. It’s a world of difference in so many aspects of your business if you really take the time to learn this.
Speaker 1 (02:09):
When I think about clients who’ve gone on to achieve some amazing things, one of the biggest underlining things has been getting their pricing right through coaching, and this is why we focus on it so much in our launch programme, which is all just good foundational strategies of what it takes to set you up for long-term success. Pricing is just one of those things that when you get it right, it does set you up for success. And when I think about the clients who’ve gone on to achieve amazing things at one stage in their journey, they’ve had the penny drop moment where it’s like, oh, I finally understand these principles. I finally understand how to accurately get my cost base, and then they finally understand what margin is and the different types of margin and what is markup versus margin and all these things we’re going to talk about today where it’s like, I get it. No one’s taught me this stuff. I understand my numbers and their confidence to be able to win work just goes through the roof, doesn’t it?
Speaker 2 (03:15):
Yeah, it is and that’s the best thing to watch is just the confidence in themselves to go off and really stand in the market and say, here we are. This is what we do, this is how we do it. And the first time that they knock back a job happens when they understand their pricing that real geez, I did it. I went and actually turned down some work and I took this on instead, and we’ve got this job that we never thought we were going to win at this price, but we went in with the price we knew we needed those sort of conversations that we get to have so often we’re privileged to have, but it’s this work that we’ve done over these last couple of episodes and today that really set those moments up, which we love.
Speaker 1 (03:53):
Yeah, no doubt that we’re in a pretty tough market at the moment and there’s a lot of trades businesses out there bleeding and really struggling and we just did our last quarter and review across the board with our clients just recently in our different levels of coaching and one thing that really stood out to me is Seth, one of our sparkies in launch, he nailed this pricing stuff strategy that we spoke around in coaching and he’s just had a record quarter in his business because he took on the principles around in week one that we spoke around this where he was trying to have the same pricing models across the board service versus project. He split that did tiered pricing. I really understand his cost base and because he had different pricing models for the different types of work, you all of a sudden started converting better and then because he got his costings, he was able to operationally deliver them way better and he was a charging appropriate margin. He just had a record quarter in what is a hard time out there for a lot of businesses and I’m so proud of him, but it’s just coming back to this whole topic, so that’s why I love this so much.
Speaker 2 (05:08):
Yeah, for sure. Absolutely. Well, should we bring it home part three?
Speaker 1 (05:13):
Yeah, this one’s a big one, this whole margin conversation, and we’ve got a lot to cover today and we’re probably going to challenge a little bit of thinking out there in the marketplace that a lot of tradies do get taught around how to price from a margin point of view. We’re going to talk what is margin, where does it come from? We’re going to talk a little bit about the different types of margin that you’ve got to understand markup versus margin, and then we’re going to go on to talk a bit about why you might be winning work or losing work. So we’ve got a lot to cover today.
Speaker 2 (05:48):
We absolutely do. We absolutely do. So let’s kick off then at the very beginning. What is margin when we use this word margin? Let’s go really, we’re going to go slowly, but we’re going to keep moving through this. So I think if you’re listening to this today and you’re wondering what it is that we covered, go back and listen again to a little bit, stop it, pause it, go back. Really understand each part of this as we layer it on and you’ll be that much better for it. But let’s start at the beginning. What is margin and where does it come from?
Speaker 1 (06:18):
Yeah, margin is the amount of gross profit made on each sale after you’ve subtracted the costs. So it’s the gross profit margin that you make on the sale after you’ve subtracted the costs. So for example, you might have a job that’s 10 grand XGST for a sales price. You’ve got seven grand in terms of your cost base, which includes labour, materials, equipment hire and incidentals like we spoke around on last week’s episode, which gives you a $3,000 gross profit margin or a 30% margin on that job. So it’s the $3,000 which is 10 grand minus seven, and it’s the $3,000 margin left over or 30%, which is on the sales price.
Speaker 2 (07:19):
Great. Alright, so there’s our starting point now already question. You’re talking about gross margin, so margin being the concept of profit, that’s what margin is, but there’s two types of margin and let’s just talk quickly through the two different types of margin because people will hear gross profit margin and net profit margin. What’s the difference?
Speaker 1 (07:39):
Yeah, so gross profit margin is if you think about a formula from your profit loss revenue minus cost of goods sold, which is your cost base equals gross profit. Gross profit margin minus your overheads gives you your net profit. So there’s two different types of margin that you need to understand your business, gross profit margin or gross margin and net margin gross is before you factor in your overheads or the running costs of your business that are ultimately the fixed costs that associated with running the business. And net is your net profit or loss that you’ve made before you pay company tax and debt reduction like payment lease vehicles and all those types of things. So it’s net of what’s left over in the end of the day.
Speaker 2 (08:30):
Fantastic. So just remember that when you talk about margin, we’re talking either gross or net. We’ll try and keep that really clear as we go through this conversation, but that’s the first thing to understand are those two types. Now last episode Rob, we talked about the price to profit pyramid. Where does margin now come into that last time we laid it on cost base as our base sort of structure. Let’s now sort of keep using that pyramid as an example. Our building blocks of cost base. We should know if you haven’t go back and listen to it, but after we do that, what comes next in our pyramid? How does this now start to relate when we bring margin into it?
Speaker 1 (09:07):
Yeah, so when you are pricing using the pricing pyramid, the most important margin that you’ve got to understand is your gross profit margin. That percentage, that GP margin percent is one of the most important numbers that you can know in your business. And so when we are talking through that pricing pyramid, you’ve got your cost place, your margin gives you your sales price because what you’re doing is building up to get to a sales price. Where a lot of guys go wrong is they go, oh, this is my sales price and I’ll work it out down the line, but you’re better off getting your cost base really accurately getting your cost base like we spoke around in last week’s episode, and then knowing for your business what is the different level of service and sector that you operate in and understand what’s an appropriate margin that you need to be able to generate to have a long-term sustainable business. And then that’s the margin that you add on top. And as long as in the end of the day you can operate and generate that amount of margin going into winning a job, then you’re halfway there because at least you know that you’ve won the job at the right margin with the right cost base, then it’s now about delivering and executing that job profitably at the back end, but really understanding that gross profit margin is what we talk about when it comes to pricing.
Speaker 2 (10:34):
Great. And is that margin then a single margin? Is it derived from just one area or am I using my cost base and doing little bits of margin along the way? How do I come up with how to apply or derive margin when we talk about profit, how do we derive that profit based out of our cost base?
Speaker 1 (10:53):
Yeah, margins derived from a couple of different areas. So when we think about, for example, our labour, we spoke last episode around our on costed labour rate. Now this is before you even worry about overhead recoveries and all that kind of stuff. We’ll talk about that later down the line. Let’s assume that you pay someone $45 an hour for example, and then your on costed rate for example is $70 for example, I’m just throwing out numbers. Let’s say you charge out that labour at a hundred dollars and please don’t crucify me that saying a hundred bucks is too cheap, let’s just come along for the journey. You’ve got $70 cost base, a hundred dollars charge out, you are making $30 margin on that one hour, which is a 30% margin on labour so you can generate it from labour. The other area you can generate it for is your materials.
(11:55):
So you might buy something for $5,000, sell it for $7,000, you make $2,000 margin on that, which might be say 28% margin, so 2000 over seven. So you can get it from labour, you can get it from materials, you can get it from equipment hire, you can get it from your incidentals for example. And you can also get it from the use of contractors where you bring in a contractor, whether a single person or a company to do it. Maybe if you’re a builder or you subby some workout, add a margin on top and then that’s where you generate margin from. So there’s different areas within your business within that price that you can gross something up to derive a margin to be able to get a sales price from.
Speaker 2 (12:44):
Excellent. Alright, I like that. So that’s easy to understand. So it’s different building blocks that we put in place last time. We can apply a margin rate to that and build up as we continue this visual of a pyramid, we can continue to build up this sales price, which is really cool. Alright, let’s move on then to our second part of this, which is we already talked about the two types of margin, but let’s sort of start to talk in general terms and let’s sort of get the 800 pound gorilla out of the room, which is what is sort of a margin that I should be aiming for and let’s sort of have a little bit of a conversation around, well what are the specific types of margins or what would be a standard type of margin that people could start to entertain in their own head as we do this?
Speaker 1 (13:30):
Yeah, good question. This is where we get asked all the time going, what margin should I be driving for? And remember we spoke around in episode one of this series around pricing is that there’s no one size fits all. We use general broad brush terms in the earlier phases with coaching, the more that we move clients through to leverage and lifestyle, we get much deeper in terms of financial modelling and really picking apart their pricing. But what’s really important to remember, we also spoke around in week one is that you’ve got to have different pricing models for the different service offerings that you do have. And so in general terms, when you’ve got more maintenance or service work, generally that drives a higher margin, so say 45%, 50% margin that you generate from that work. If you’re doing more building renovation work as a tradie for example, you’re generally looking at 30% to 40% and if you’re doing more larger projects and commercial work, you’re doing 20% to 30% margin and so they’re the different scales roughly if you’re in the building space, you should be targeting anywhere from 18% to 25% margin on residential construction work.
Speaker 2 (15:03):
And this is gross profit margin, right? This is not net, this is gross we’re talking about correct.
Speaker 1 (15:08):
Gross profit margin after you’ve got your sales price, subtract at all your costs from the different four elements we spoke around your gross profit margin at the end of the day.
Speaker 2 (15:19):
Fantastic. And what about then net profit, do we need to care about that or is there a target for net profit that we should have in mind?
Speaker 1 (15:25):
Yeah, definitely. I think it’s for most trades businesses the range is from 10% to 20% net profit if you’re in single digits. To be honest, it’s way too low because you’re only just above inflation and for all the risk that you carry, you want to be beating inflation from the return that you’re getting. And so for a business to be viable and have some level of profitability and sustainability to it, most trades businesses range from 10% to 20% and they’re the general norms that we’ve seen.
Speaker 2 (16:05):
Yeah, for sure. Now we’ve thrown some numbers out here. Let’s be really clear and let’s disclaimer this right, go back to our very first principle. There is no one size fits all. There’s different targets and you can’t have a blanket margin model that applies to all types of work and or all business models. So please don’t take this the wrong way or take it as well. Now that we’ve said that that’s exactly what it needs to be. I don’t need to do the work. People still have to do the work to figure out, well what is it going to be that’s relevant and where am I deriving that margin from my cost base?
Speaker 1 (16:38):
Yeah, correct. And this is why in episode one we spoke around, there is no one size pricing model fits all because let’s use for example in our client base we’ve got two roofers. We’ve got Zach who is in high-end residential roofing, domestic roofing in Sydney, and then we’ve got Luke who is in commercial roofing in Sydney. Even though they’re both roofers based in Sydney, they’re different type of sectors, different type of margin that they can drive from that. We use the example of Sam, the Sparky at a gold coast. He was trying to adopt a pricing model and generate margin on service work and trying to transfer that into the construction space. He kept losing work, he was too expensive. It’s because he had one size model across the board and it wasn’t until in coaching that we really helped him generate the right pricing model for the different services within the one business. That’s when he started winning the game. So you’re right, there’s some targets that you can work towards, but there’s definitely no one size fits all. You’ve got to understand your numbers and a margin that works for you and your business to be viable as per your break even point based on the numbers in your business.
Speaker 2 (17:54):
For sure. And this is where you end up, you’re either too cheap or you’re not going to win any work because you priced yourself out of it if you fail to adopt that principle that we set up so early in this series.
Speaker 1 (18:05):
Correct.
Speaker 2 (18:07):
Alright, let’s now tackle the next sort of question. We’ve gone through the usual one, which is what should I have? Let’s now have a look at the difference between markup versus margin as a concept.
Speaker 1 (18:21):
I love this conversation.
Speaker 2 (18:23):
All right, do you want to have a first bite at it so you have a first bite perhaps, and then maybe I’ll come in and I’ll provide a bit of a rundown between the two from an example point of view?
Speaker 1 (18:34):
Yeah, this is a game changer. So many guys use markup and margin incorrectly and they interchangeably use markup and margin wrong. And markup is your ability to be able to generate a, it takes your cost base and you mark it up to generate a sales price. Your margin is your sales price, less your cost based and what’s left over is your margin. It’s a derivative of sales, less cost. And so guys use markup and margin that the terminology interchangeably and even job management systems do and they use it wrong and then they wonder why they get their pricing wrong and why they either price themselves out or leave money on the table. It’s because they just purely don’t understand this concept that is markup versus margin.
Speaker 2 (19:39):
For sure. And I think that’s the secret, right? The first step is to understand that they’re not the same thing. That to me is sort of the starting point when we start to coach on this stuff. So I’m going to walk through this and sort of see how we go. I’m going to give an example, and again this is one of those ones. Go back and listen to the subtle differences as we talk through it. Once you understand this, it does change your perspective and the rules of the game are then set and then you’ve come so much further than where you might’ve been when we started. So let’s start with markup, as you said markup’s about the extra amount that you add to your cost base and that can be usually in a percentage term. So you’ll apply a percentage to your cost base to determine a sales price. So imagine for a minute you’ve got a service that you want to sell the cost of that service, it costs you $10 to deliver the service your selling price, you decide you’re going to sell that for $20. The markup is the extra $10 you added to the cost to decide the selling price.
(20:42):
So the $10 that you added to the $10 it cost you, that’s going to be your selling price. That’s the markup. Okay, so that’s $10 markup or in this instance in terms of percentages, a hundred percent markup. Alright, now if you’re with me on that, let’s go to margin Now, margin is at the profit portion, it’s the profit, it’s what’s left over and often expressed in percentage terms like Rob just outlined, it’s often in percentage terms of your selling price. So again, imagine you’ve got the same service, it still costs you $10 to get that service. The selling price is $20, okay? But if we’re going to focus on margin, what we’re going to do is split that $20, you sold it into two $10 parts. The first $10 part covers your cost and the other part, the other $10 that’s left over is your profit.
(21:38):
That profit, that $10 profit is your margin. Now if we work out the percentages there, the percentage margin is 50%, that’s what we need to remember. The percentage margin’s 50%, the percentage markup in the same example is a hundred percent, but we have to understand this concept that the profit element of it, what we get to keep as profit, that $10 that expressed as a percentage is our margin, whereas the additional thing we added to the cost price is our markup. So that’s our basic way of looking at the two of them. And again, go back and listen to that as many times as you need to for the penny to drop because it will just takes time to hear that over and over again.
Speaker 1 (22:25):
I think the thing that helps me wrap my head around it is that markup is a cost multiplier to determine your sales price. Your margin is a derivative of what’s left over your sales price and you’ve got to remember that your markup is always going to be a higher percentage than your margin. And where guys get caught is that they go, I’ll ask them the question on a strategy call. I’ll be like, okay, great, tell me how you price. Okay, I’ll price this, price that, do this, do that, and I’ll go, great. And then I’ll go, right, what margin are you adding to your materials? For example? And they’ll go, I’m adding 30%, let’s use round numbers, 25% margin to my materials. And I’ll go, okay cool. And then I’ll go, is that 25% markup on material or margin? And then they’ll go, what’s the difference between the two?
(23:22):
And then I drill out for them on our strategy call and then I’ll go, it’s 25% markup, which is 20% margin and they’re like, fuck, the penny just dropped. And I’m like, mate, you are calling it margin, but you are calling it markup but you’ve been doing margin other way around. You’ve been using the interchangeably wrong and you’re leaving that percentage on the table. You think you’re marking it up, but really it’s incorrect and that’s where guys go, oh my god, it makes sense now. And when you understand the difference between the two, that markup is always a greater number than the margin and that they work in different rates, then if you can really wrap your head around that, then this is what helps you price correctly. You use the right terminology for the right thing.
Speaker 2 (24:16):
Alright, very good. So those are our basic blocks or our differentiation between the two. If you give us feedback on this and you need this explained or you think it’d be worthwhile, we might explain this on a special trade den live event, we might just draw this out like you said, Rob, alternatively people can book in for their discovery call and they’d be able to hear and watch you do this in relation to their own business and have that exact same conversation.
Speaker 1 (24:44):
Yeah, absolutely. I think it’s one of those things you kind of need to see it to wrap your head around it and even in when we’re doing it in live coaching, it takes time for guys to go, oh, I get it, and they’ve just got to go away and let it sink in. So I think you’re right, we got to do a whole episode on it worthy of a whole episode and we can also do a live Q&A or I can do it personally for your business.
Speaker 2 (25:09):
Yeah, absolutely. No, I love that. Now I’m going to completely contradict what I just said and say, have you got an example or one that you can walk through as a way of just sort of putting some numbers against the terminology and maybe just painting a picture for people to listen along and try and fill in some of the gaps that they’ve now got?
Speaker 1 (25:28):
Yeah, I’ve got two examples. One’s a builder, one’s a tradie, and recently doing this with Ben who runs a business based up in Brisbane. And same thing, I was on the strategy call with him and I asked him that question, markup versus margin, didn’t understand it. I mapped him out and he’s like, Rob, I apply a 30% margin to my work, to my materials and everything. I’m like, okay, and markup versus margin. He goes, oh yeah, 30% margin. And then he goes, no markup. And I said, mate, that’s not margin, that’s markup. And then when I explained around how they all operate in a predictable way to be able to get there and I unpacked it, I’m like, mate, that’s not 30% margin. And he goes, I get it now. I can now see A why I’m winning lots of work and B, why I’m not as profitable as I expected. Because in his mind he’s like, I should be hitting 30% GP on each job on my profit and loss, but he was leaving percentage points on the table and so there’s a great example. The other one is Grant the builder, this is for builders. If I could teach this one strategy to every builder out there in the marketplace around markup and margin, it’d literally change all their worlds.
(26:54):
Grant couldn’t understand why he had cashflow problems despite winning lots of work and he thought he was going in at 15% margin, but in reality it was 15% markup, 13% margin, and for a resi builder, 13% is way, way too low. It is not a scalable model, you just can’t do it. What we’ve done is over the time with Grant is we’ve been able to educate him on the difference between the two. Now he factors in contracts administration and project management. We’ve been able to help him dial in his cost base plus get his margin 20%, which is a 25% markup. And so now he’s beefed out his cost base to include that management, plus he’s getting a 20% margin, which is where you should be for a residential builder. And it is just changed his world. It was the difference between him breaking even or going backwards or actually making money in his world. And there’s two examples of a trad and a builder where when you get this markup versus margin and understand how to apply it in your pricing spreadsheet or your job management system, when you pricing work, if you get it right, it’s a difference between making money and losing money.
Speaker 2 (28:20):
Yeah, we talked about friction last time. I think for granted it’s a lot around, it’s almost the difference between feeling like you’re suffocating in your business or you’re able to breathe. There’s that room or there’s not. And if it’s not making sense to you or you are feeling like, well how does this happen? I’ve priced it a certain way, I think I’m doing it all right. Yet it feels like there’s no money at the end of the day, there’s no profit, where’s it all going to? Chances are it’s not going anywhere. You never had it in the first place because you’ve got this, the equation wrong, you’ve applied it the wrong way and now you’ve just mistakenly left or there’s a massive hole in what you thought you were going to be taking out because you’ve used the wrong terminology.
Speaker 1 (28:59):
Correct. And so for Grant, let’s use hardcore numbers here, 13% margin on a million dollars versus 20% margin on a million dollars, that’s 7%, which on a million dollars is 70 grand. You do a $2 million, that’s 140 grand on a $3 million, it’s $210,000 plus he’s recouping money for $150,000 overhead in there. So he’s 210 plus $150,000 better off from a net profit percentage without having to do any more work.
Speaker 2 (29:34):
Nothing. Yep.
Speaker 1 (29:35):
So that’s 210, 150, it’s 360 grand better off without having to win any more work or manage anything differently just by going in there and pricing correctly.
Speaker 2 (29:49):
And it’s applying. If you go back and listen, you’ll hear that we applied the exact same thing we talked about in episode one to two to three. It’s not difficult. You’ve just got to take the time to understand and apply it to your will.
Speaker 1 (30:02):
Game changer. Understanding the difference between the two and understanding an appropriate margin for you to have a sustainable business for where you sit in the marketplace, assuming price sensitivities and everything, this is what will change your world from a pricing point of view.
Speaker 2 (30:21):
Yeah, absolutely. So let’s have a think now and let’s go into I think how we sort of bring this together and if you’re listening to this and you’re going, well, why am I either winning lots of work or am I getting too many nos? Because to me that’s sort of the big, it’s almost the giveaway, right? Guys can’t understand why they’re winning so much work but don’t have any money or they’re not winning any work and they still got no money. But whenever we get into that, why am I winning work, losing work conversation, you can almost put your coaching dollar on it that it’s going to come down to pricing and the fact is they’re going to get to cost base being out or they’ve misunderstood or misapplied margin versus markup.
Speaker 1 (31:02):
Yeah, absolutely. When I think around why you’re winning a lot of work, it’s probably because you’re too cheap and for example, you think you’re going in at a 30% margin on a job, so you put your quote in for a hundred thousand dollars and you think you’re making 30 grand, but really what you’ve done is you’ve marked it up to a hundred thousand dollars by 30%, and so a 30% markup is a 23% margin. And so what you’ve done is you’ve left 7% margin on the table and so your sales prices all out because yeah, you may have got your cost base correct, but you think you’re generating a 30% margin, but what you’ve done is marked it up by 30%, which is a 23% margin, which means, which means whoever you’re doing the works for is going, how good is this? These guys are coming in cheap, they must be desperate to get this job. Boom, drop your pants and really all you’ve done is just priced. You’ve got your cost brace, right? You spend all those hours getting your cost base right, but you just haven’t applied the right margin appropriate for that type of work and you’ve just sold yourself short on the sales price.
Speaker 2 (32:21):
Absolutely. Now I want to drive home here, Rob, what you just said there because when you break it down like that, I know I’ve got my cost base, right? So it’s got to be the application at the margin level of my pyramid that I need to go and explore. Now I can go, well, hang on, have I applied that part of the pricing equation correctly as opposed to, geez, that number I charge must’ve been a bit high or a bit low, but I don’t really know, so I’ll just stuff around with the very pointy end of the number versus understanding what are the levers and what’s gone into that price. So this is really where the rubber meets the road from all of the episodes we’ve talked about in terms of getting to know your pricing.
Speaker 1 (32:57):
Yeah, absolutely.
Speaker 2 (32:59):
Huge. Alright, what about losing work? I think this is another one where guys just can’t win work or they’re losing work. What’s the go here and how would you apply that?
Speaker 1 (33:09):
Yeah, this is a big one where, this is where a lot of guys go wrong is because there’s a couple of reasons around this where ultimately your pricing is model wrong is because you’re pricing too high. And we see this a lot with guys who have got multi-service offices, service offerings in their one business. So they might be service and construction and what they try and do is have a one size fits all pricing model where they’ve got a really good pricing model, they’ve got help from a service point of view, they do their callout fees, they’ve got their hourly rates, and then they talk to their mates in the Facebook group and they’re like, well, if you’re not charging out $150 plus GST an hour, then you’re not making money. And they go, great, well I’ve just spoken to someone and they didn’t even ask what type of business they’re in.
(34:04):
And that might be right for service. So they go, boom, they equate that into service and then they go, right now I’m going to go and push harder into the building game in construction and then they start charging out guys at 150 bucks an hour and they keep losing work and they’re losing work because they haven’t factored in that when you’re in the service and maintenance game, your hourly rate has to be higher because your overheads are higher because of your marketing costs and downtime in your workforce. So your levels of productivity are going to be less because you’re going from job to job to job during the day and your cost to manage the amount of work and the marketing cost to generate that work is way higher than some construction where they can drop someone on that job for eight hours permanently billed and there are no marketing costs. So there’re two different business models which need two different pricing structures and that’s where guys go so wrong because they haven’t dialled that in for the different arms of their business.
Speaker 2 (35:16):
Absolutely. They haven’t got their building blocks in alignment, they just think it’s all the same and I’ll just throw it all together and that number will stay the same and we’re all good. Correct. So that takes care of the one size fits all area where guys are trying to just either shortcut the process, haven’t applied it correctly, or they’re trying to double dip on hourly rates. What about, I’m going to use the words that I’m going to let you describe this one, but what is it about overhead recovery rates and how do people trip themselves up so that they lose work as a result of overestimating, let’s call it their cost base?
Speaker 1 (35:51):
How do I explain this? This may rustle a few feathers looking at you, your sparkies who use simPRO and you use your overhead recovery rates. I’m sorry to do it to you, but this is where it gets very, very dangerous using overhead recovery rates. Now it’s good, we probably need a whole episode on this around it, but what I do want to say is you’ve got to remember, let’s use the example of you pay someone $45 an hour, the on costed rate’s 70, you work out that your overheads are a certain amount and that you need to factor in a $30 per hour overhead recovery rate to be able to cover all your overheads. That’s what an overhead recovery rate is.
(36:39):
What that means is you then add that $30 to be able to go, well, $70 cost factor in $30 an hour. That means my charge out rate has to be a hundred dollars. For example, what you’re doing remember is you are factoring in a hundred dollars an hour rate less $70 cost base is 30% GP $30. So what you’re doing is deriving a margin out of that hourly rate, but where so many guys go wrong is they factor in overhead recovery rates and then they try and whack in a margin on top. So then they get their $70 plus overhead recovery plus margin and they double dip on margin. So instead of having a 30% margin, for example on labour, they might drive it up to 60 and they’re trying to generate all their margin from labour to cover their overheads and they price themselves out of work because in coaching we call it double dipping.
(37:42):
They double dip on margin on overhead recovery rate and whack a big margin on top of that labour rate and then they price their labour rates out and then they get feedback that they’re too expensive. So overhead recovery rates are a good way of understanding what are your overheads and if you’re trying to derive a lot of your margin from labour, what should you be charging? It gives you that sense check to be able to go, well, am I at least covering costs? But you’ve got to remember there’s lots of different ways you can generate gross margin. Labor’s not the only way and you’ve got to be careful you don’t double dip.
Speaker 2 (38:21):
Yeah, absolutely. Again, I think what it does is it focuses you on the end price number versus understanding the inputs that have gone into that price. If you skip that step and you just let, in this case we will use, if you let simPRO do the kec for you punch all in all the numbers and it spits out a price and you never check that, you never go against it. You just sort of go, well, it must be right. It knows better than I do. It can work this stuff out. It understands it. Then you miss that trick, then you haven’t got, your building blocks are all out of whack and the pyramid’s way out of skew and that’s what guys do all the time. They forgo that part of it and then all of a sudden it’s a wonder, why am I not winning any work and then why am I getting compared or why am I getting my price compared to someone else? And they’re saying, well, you are looking pretty good on your materials, were good, but geez, your label was off its head. It’s crazy to think you were ever going to get to charge that.
Speaker 1 (39:17):
Correct. And if we link it back to the conversation we had earlier in this episode, there’s two types of margin, gross margin, net margin when you factor in overhead recovery that’s working on a net margin, and you remember I sat at the start of this episode, the most important margin percentage number you need to know is your gross profit margin. And so that’s why that is. Now, when we teach this in launch, we teach it in two different frameworks and then connect the dots. Number one is you’ve got to understand your P&L and you’ve got to understand your break even point and your break even number, which then you can reverse engineer to be able to really understand your gross profit percentage based on actuals. Then when you work on your pricing to profit principles that we’ve got and that framework that we have there, we can grab that number based on our breakeven points and then translate that into our pricing model as per the pricing pyramid and if you can connect the dots between understanding your financials and breakeven points and how that correlates to your pricing, my preference is is that you work on, you don’t focus on overhead recovery rates, you focus more on how much margin overall at the end of the day, sales price less costs and margin left over after the shooting match is all done around labour materials and everything.
(40:45):
That’s my preference, so you could focus on margin rather than trying to get fancy with overhead recovery rates where so many guys trip themselves up.
Speaker 2 (40:54):
It is, it becomes a real red herring once you understand the numbers and breaking it down the way you’ve just described, and I don’t think we’re going to solve it on a podcast going through this. It’s something that you need to see drawn up, you need to practise it. We’ve got templates for this. We can walk people through, like I said, if we did a live trade den thing, we’d invite you two to come and see it or again, make that discovery call and learn and understand this. Invest the time that you’ve got to be able to get a really clear picture of it.
Speaker 1 (41:24):
Yeah, those two frameworks that we teach in launch, that’s eight weeks of coaching that we teach live coaching each year and I would go as far as saying they’re the best eight weeks that clients will ever invest in their skillset to be able to move forward because once you understand this and get the foundations around really unlocking the vault and knowing your numbers and getting your pricing, it just opens guys’ eyes to go, holy shit, now I get it. And so you’re right. We’re not going to solve it today on a podcast, but I wanted to tackle that conversation because it’s one thing where guys get caught so much.
Speaker 2 (42:00):
Yeah, absolutely. Absolutely. Alright, what about we summarise, I want to come back, then we’ve gone, we went into the weeds there. I think we did a reasonable job of that. Let’s go back and just summarise what we’ve covered today and maybe what we want just as takeaways, but also the key points that we want you to take out of this episode in terms of starting off or continuing this journey in the three parts that we’ve done in this series.
Speaker 1 (42:26):
Yeah, I think from a summary from today, number one for me is before you can start to dial in your pricing, you must understand the concept of margin and what is your target margin percentage per job for your business to be profitable. You’ve really got to understand that for your business and how does that work for you and your unique business so that you can make sure that you price properly going forward.
Speaker 2 (42:55):
Yeah, absolutely. I think the second one then is there are two types of margin. There’s your gross and then there’s your net and really understanding what you’re talking about and what’s gone into that gross margin that you’re talking about as a cost base, so your variables and what goes into that, your labour, your materials, all the stuff that we talked about in the cost base episode, what goes into that to derive the margin, the profit that comes out at a gross level and then being able to distinguish that versus the net profit that’s going to be generated after you apply overheads. I think the challenge of pricing gets greatly reduced when you at least understand which margin you’re talking about.
Speaker 1 (43:32):
Yeah, correct. Action steps from today, there’s a couple of different things you can do is use the old 80/20 rule and I think it’s your ability to be able to go in there and look at the top percentages of materials that you regularly use and determine where you sit from a margin point of view and are you charging an appropriate margin loans of materials. Now there is no one flat rate. You can use a sliding scale, you might get 5% here, 10% there, 200% markup on something. That’s a certain bit of material, but it’s your ability to get in there and get the big bang for dollar ones and really review the margin you’re getting on materials. You might be able to up it for a few basis points of percentages and it might be able to drop a couple extra percent on your bottom line.
Speaker 2 (44:24):
Yeah, for sure.
Speaker 1 (44:26):
The other one is your hourly rate, and this is just understanding your costs, charge out rates, seeing where you sit in the marketplace doing a bit of research. Now it’s just your ability to compare it and I think you don’t want to copy other people’s rates, but you might be able to see that you’re charging $110 an hour and you’ve done all your sums and you’re charging out at $110 and maybe the market can handle $120, so that’s just extra fat you can build into it, but remember you’ve just got to do your research and it’s a guide, not gospel. That’s a big thing to remember.
Speaker 2 (44:58):
Yeah, it’s flexible. As we sort of said and we’ve said all the way through, it’s not held to anything. It can change from job to job from moment to moment. Really, there’s no right way to do it. There’s a profitable way and there’s a sustainable way that’s going to allow your business to grow and thrive and understanding what goes into it. Like we’ve said many times, the mechanics of learning how to price and what it actually means and the differences between these subtle terms. Really getting to grips with that is going to be the difference and the starting point, quite frankly, this is something like it’s eight weeks of coaching that we teach, it’s also trial and error over time. You practise this, you have to really stop and think and it’s something you’ve got to do very much consciously. It’s not on the kitchen table at 11:30 at night after a big day and all that sort of stuff. You’ve really got to put in the effort.
Speaker 1 (45:46):
Yeah. What a series though. Understanding the principles, the costs margin, three big factors which come down to pricing to profit, and remember the whole reason we did this is because you’re not just here to price to win work. You’re here to make profit in the end of the day. That’s the bottom line. The bottom line is you’re here to make money in your business and if you don’t price correctly, you’re not going to make money. That’s just the bottom line, and so we’ve covered so much ground and hopefully you’ve grabbed so many golden nuggets from the principles, the cost base, the pricing pyramid to the markup versus margin, the rough percentages in the marketplace. There’s been a lot that we’ve covered, so remember, knowledge is one thing. Execution implementation is the most important thing, so learn what you need to and get in there and make some good tweaks and let us know how you’ve gone adjusting your pricing accordingly.
Speaker 2 (46:39):
Absolutely, and if you get stuck, reach out. That’s what we’re here for. We’re here to help. So really if you’ve got questions, great, make sure you ask them either in the trade debt community, join it if you haven’t already on Facebook, or make your time to have the discovery call and get your questions answered.
Speaker 1 (46:55):
Yeah, absolutely. Looking forward to wrapping this up now and thanks very much for bearing with us over the last couple of weeks as we’ve spoken through lots of numbers and stats and percentages, but hopefully you’ve enjoyed it. We love talking about this stuff and yeah, have a great week ahead and looking forward to coming back to you next week with another episode. Thanks guys.
Speaker 2 (47:15):
See you soon.