Point #1: If you are a business owner, you must act like one and think like one. An HVAC company sells fact-based consumer/customer education and results-based solution sets. From furnaces, to air conditioning systems, to indoor air quality: these are the components and accessories, that help you provide comfort SOLUTIONS and RESULTS.
Point #2: Pricing management and administration is a marketing tool.
Point #3: Your pricing future is in a variable gross margin approach with allocated overhead
Point #4: If your company is not departmentalized, including in “Cost of Goods Sold” (COGS), get it done quickly.
The year has just started, but you’re running short of the time you need to get this done properly.
You can’t calculate your gross margin by department without knowing your COGS. And, you must manager your gross margin needs by department. A department refers to the work category, such as HVAC service, plumbing service, residential new construction, and residential replacement.
Point #5: Know your Key Performance Indicators (KPIs)— including your break-even point — for the consolidated company and individual departments and gross margin targets for departments. Make sure you’re getting financial information on a timely basis. You are shooting for a daily, weekly, monthly, quarterly moving target.
Pricing is Cost Recovery
Pricing, by definition, is simply cost recovery. Costs, such as COGS — field labor, associated benefits, equipment, materials, parts, accessories, permits, subcontractors, freight, cranes, and sales commissions — are job specific and need to be captured by job and by department.
Operating expenses/overhead are those general business expenses required to keep the doors open. They include utilities, insurance, rent, marketing, financing buy-downs, depreciation, website, vehicle expenses (unless dedicated to a department and treated as COGS), etc. These operating expenses must be recovered in your pricing.
And finally, profit is a cost that must be recovered in your pricing. Yes, I said profit. Profit should be viewed as a bill submitted by ownership to the company. And the expectation is that this cost (like any cost) is “Paid in Full.” Profits are not what is left over after bills are paid. After all, Thanksgiving is many months away, and we’re not talking about cold drumsticks and white bread dressing. The minimum target for profits is 10% of sales revenue.
Always be on the lookout for unrecognized or unrecovered costs of doing business, such as a spouse working for free; or an owner selling installations and not getting paid a sales commission; an owner putting on the tool belt and working in the field but not filling out a time card for billable hours. (Employees will not work for free, so why should you?)
Like most issues in business, there is more than one way to produce desired results, and companies choose to do things differently. There are really no bad choices. The only reality is that different choices produce different financial results when it comes to managing a pricing process within the business.
The choices range from, on one end of the spectrum, — margin and mark-up techniques — to more sophisticated approaches, like the granddaddy of them all, the “Dr. Fails Dual Rate Allocated Overhead Recovery Pricing Model.” And there are several others. There is even a Triple Rate variation of the Fails method. ??????
There are many important components to profitable pricing techniques. It is a must to use accurate, current data, such as complete and realistic job estimates, appropriate overhead burden, current gross margin information and monthly profit targets. Whether determining a price for time and material, flat-rate or an installation, this data should be used in a profitable, professional pricing process.
In working with contractors for many years, Vicki and I find that if a group of 20 contractors is asked to price a sample installation job, we typically get 20 different prices to hand to a customer. That means 20 different financial outcomes, some good, some bad, some ugly.
The Labor Factor
One of the first questions to ask when pricing an installation job is whether the job is a “high labor” or “low labor” job. When labor is 20 percent or less of COGS, then that job can be considered low labor. Conversely, labor that is 20 percent of Cost of Goods Sold or higher is a high labor job. Any job that requires high labor should command a 20 percent to 25 percent profit minimum. Labor has risk associated with it, and high labor jobs may keep you from getting to the next job. Or, the odds are something may go wrong on a high labor job and cause additional costs.
Pricing on high labor jobs seems to create a more clustered grouping of retail prices; however, pricing on low labor jobs seems to create a wider distribution of retail pricing: there is more competition for low labor jobs because your crew can be in and out quickly.
Remember this formula for all pricing decisions: Gross Margin % = Overhead % + Profit %
This is future-based and should be variable. It is true, Gross Margin is also sales revenue minus Cost of Goods Sold, but that’s history. Pricing is about tomorrow’s jobs and what tomorrow’s income statement will look like.
John LaPlant is chief financial officer with Vital Learning Experiences, based in Pottsboro, Tex. VLE provides business management training for HVAC, plumbing and refrigeration contractors, and for distributors. He can be reached at 903-786-6262; or by email at [email protected].