Capacity Based Mark Up VS Volume Based Mark Up

rbsremodeling

OK Jerrald is going to make me take a look at using a capacity based mark up.

Post a link to the idea here Jerrald so everyone can have an idea what it is.

The guys that use this system currently should chime in.


Owen I know that you use it so give us your input

Lets get a discussion going on it and see where it takes us

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DavidC

OK, I've read enough of Jerrald on the forums to know, if he posts I'll read it. Maybe he'll take your bait.

We did a switch from the volume based to capacity based pricing a couple of years ago. I say we but actually my partner (who does the estimating) told me one day that I talked about it enough so he started doing it along time ago. His take is, on most remodels that we bid it's very much a wash when he arrives at the bottom line. He estimated both ways for a couple of months and then just quit the extra paperwork. Now all of our OH is recouped on our labor rate and we only markup materials for profit.

On labor intense jobs with little materials it puts us out of the park in competitive bidding. But on all jobs we do get it works out better.

A good question though is, how do we account for an extended and unexpected dry spell? We are just coming out of the slowest winter season that I have ever seen since starting in 1981. 3 mos. of nearly 0 production. I'm struggling with the question of do I readjust my figures (raise my rates) to recoup OH in a short year or carry on the status quo?

I think our turn around is at hand but am leary of raising rates at this time.

BY the way, nice topic rb.

Good Luck
Dave

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buildpinnacle

As an insurance restoration contractor, whether it be wind or hail damage to roofs or commercial fire losses, we have always bid line item with insurance based software using unit pricing. However, there are several areas of trade involved that I won't use SF pricing and estimate actual labor hours and use the units for the materials. As I am currently discussing the Capacity Based M/U with Jerrald on another thread, I am in. I know Ed and Grump have mentioned that they do insurance work from time to time and line item their estimating for such but still use actuals instead of databases. My interest in this topic is to actually get a firm handle on our profitability and to see how many different company setups this will spread to. (ie. roofing companies that do a little remodeling, mostly subs with a few hourly mechanics, 100% in-house contractors subbing only major trades, or 100% specialty)

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rbsremodeling

I find the capacity base mark up hard to swallow right now

Using Volume based mark up I can set a Gross dollar goal as a bench mark and adjust my markup to meet that goal through out the year.

Like David mentions what happens when there is no work for an extended period of time?


Jerrald got's some s'plaining to do

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Winchester

When there is no work for an extended period of time you're going to keep raising your price throughout that period and slowly lessen the chance of landing a job without miraculous sales skills?

How long without work before your prices would be triple everyone else?

I think you need to take everything and make it work for your business. I don't think you can just take a system from someone and drop it into your business like a perfectly shaped puzzle piece. Everything needs to be modified to fit your business, and changing as your business changes.

If you have no work, you don't put your "capacity system" on the shelf and pull out the "volume system" as if they were complete packages running your business and deciding your mark-up for you.

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Ryan

orson

I think a capacity based system can have advantages in this economy.

Jobs you might normally not want to deal with where the customer wants to supply the materials from Direct Buy or use their nephew the electrician will still be profitable when you use a capacity based system.

If you don't have enough work coming in to make your overhead w/ a capacity based system it is really no different than not hitting your sales targets for a volume based system.

If not enough work is coming in the door you either need to operate from capitol reserves or find ways to cut your overhead regardless of your markup system.

I know for me capacity works better particularly because I still do subcontract work where I am not supplying materials (yeah, I know the IRS says it's illegal, tell it to the GC's). I also take on small labor intensive jobs with small amounts of materials.

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silvertree

I'm no math Wiz, I never even finished freshman algebra (high school). But on capacity based selling all you really need to know and do is have your hours for field work. To over simplify I need $35 an hour for a carpenter and a % for overhead and a % for profit based on my expected sales I can just count on a 2000 hr year minus 80 hrs vacation, slippage and holidays and get my true hourly rate.
I can get you guys the page that explains this, but I can't do it tonight, I'll have to do some backtracking, but the biggest thing, and we all know this is if you use a 1.5 markup on everything, you make less on a labor intense job, or overbid on a job with expensive materials like a bath with glass tile and gold plated faucets.
I'll get the charts for whoever wants them.
I have talked to Jerrald a few times and he's for real, smart guy and helpful.
I am working to get my roundtable involved in a webinar, don't know where thats headed, you know, getting 14 people to agree on anything, especially contractors, isn't easy.

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Vote for Pedro
Kitchen, bath, St Paul remodeling
Minneapolis Remodel Blog
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Buck25

AhHAH. The missing link! I didn't know that, but that little key may help me understand the difference better.
I would love charts if it explains when the ratio of materials to labor makes volume based mu inappropriate.

Thanks Silvertree!
Dave

DavidC

Really we found that the difference to the bottom line total was insignificant between the 2 methods for most remodels we quote. The real difference is the labor rate we use is substantially higher than when we used the volume based method and the markup on materials is substantially lower.

If we land a labor intense job we are comfortable knowing that our overhead was not dependent on the materials we didn't sell. When our competition underbids us on such a job we wish them well.

I believe our predicament concerning an unexpected long dry spell would be similar with both systems. My current strategy will be to stay the course on pricing and get back to work as quickly as possible.

Good Luck
Dave

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silvertree

Your right, but there are advantages to using the capacity system. I just bid a job using the usual markup and then did it sticks and stone (or by piece) and then capacity based with a 20% on materials and subs.
Piecemeal $35,000*
Capacity $35,000*
Times 1.60 $32,729*
* approx
Wish I could explain it, I know how it works, but I'm not good at explaining this kind of thing. But I have been in business as Silvertree for 20 years so I got a decent grip on pricing to last this long.

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silvertree

Here's the link to the Capacity base markup blog
http://paradigm-360.com/Blog

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Vote for Pedro
Kitchen, bath, St Paul remodeling
Minneapolis Remodel Blog
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Mike Finley

You make less profit for the year. Your destiny is in your own hands. The real answer is you do something to generate more business or you make less profit for the year.

As long as your business operates only on a sheet of paper. If that was actually the case and your profits were just based on a number you decide on with a calculator why wouldn't you use a broken calculator and just set your dollar goal even higher regardless of what reality is and just make more profit. Set it at a One Billion Dollars and just raise your mark up to 10,000% and according to this logic you're rich.

silvertree

Mike, I won't argue your point, your sharper than most, but if you have no work, you have no work. You have no income period.
I may not understand this well enough to argue it, but the way I see it, and the way the HO's have been shopping materials I think capacity based markups make sense. You know that's how some manufacturers model their prices. So it is based on production as being more important than cost of goods.
Maybe I'm missing something here, but when I looked at the charts it made sense to me.

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Vote for Pedro
Kitchen, bath, St Paul remodeling
Minneapolis Remodel Blog
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Jerrald Hayes

G'morning RBS, as I've mentioned here before there is an excellent introduction to the concept and reasoning for Capacity Based Markup in David Gerstels book Running a Successful Construction Company in Chapter 5 Estimating and Bidding; on pgs 167 through 168. For anyone who doesn't own the book or doesn't want to look for it in their bookshelves they can read the that section online via google books too.

Beyond the issue that I address, debunk, and hopefully put to rest in a minute what are your problems or reservations with it?

And just how do you know how much to adjust it up or down to meet your target?

Are you saying that after you get a labor intensive job you raise your markup on the next job to make up for the shortfall you were just left with?

Or are you saying that when you recognize you have a labor intensive job you raise your markup on it? If so how do you know how much to raise it? In all the books advocating Volume Based Markup/Gross Margin Pricing I've never seen that adequately addressed anywhere.

I've already addressed this in the other discussion going on concurrently in the business folder here (WAG or SWAG?????????) but it is certainly worth addressing again since it is the core complaint the Michael Stone levels against the method.

The reality is if a Volume Based Markup contractor discovers he or she will have a two week gap in their yearly schedule with no work they are in EXACTLY the same jamb as a Capacity Based Markup contractor. Why would the problem be any different for a Volume Based Markup contractor? While the Capacity Based Markup contractor just lost two weeks of Labor to allocate his or her Overhead Cost to the Volume Based Markup contractor just lost two weeks of Volume to allocate his or her Overhead Cost to too!

The root of their problem isn't markup methodology, it is in marketing and sales. (But even then I can even argue that having a Capacity Based Markup methodology in place will give a business a better more accurate perspective of what actions they will need to take to work themselves back out of such a hole.)

Back in September of 2002 Iowa roofing and remodeling contractor Les Deal wrote an article entitled How to Charge for Overhead in which he laid how he was using what was essentially a Capacity Markup in his business. A forum member there asked the question "What's the deal with Les Deal" to which Michael Stone wrote a reply in which he said:

In response to that reply I would first of all say if a contractor doesn't know roughly how many billable hours he or she can generate in an upcoming time period of a week or a month they are flying blind and not running a stable business operation. Knowing something like that is a fundamental element of cash flow management. You may not be able to predict it exactly. An employee may get sick and miss a day of work or a snow day may cancel work for you crew but you still should always have a very good idea of how much production capacity you have available and how much billable production you can generate in the upcoming days, weeks and months in front of you.

With respect to "Mr. Deal does not talk about the times that his employees don't show up for work, or that employees quit and move on or he has to terminate an employee for cause." well while this was just a short trade journal article unless I am terribly mistaken no where in Mr. Stones book does he ever deal with the problem he has just described. Whereas I think most Capacity Based Markup contractors would understand that if they four employees and all of a sudden lost one because he or she took a job elsewhere they would know they have a problem (reduced capacity) that they need to deal with. In Michael Stone's case I don't think he recognizes that he even has a problem. When a Volume Based Contractor loses and employee he or she has lost the tool that generates that problem so the same problem exists for both types of contractors.

It's a moot pointless argument.

Hope that helps and clears up that issue but keeps the discussion going.

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Jerrald Hayes About ParadigmProjects.com

Jerrald Hayes

That is a very good point David. The way we look at it though is those jobs like that that we don't win are losers so we don't mind handing them off to the Volume Based Markup contractors who don't recognize the hole they are stepping into.

As I have already alluded to and I think you have responded correctly to too that problem exists for both types of contractors.

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Jerrald Hayes

Jobs you might normally not want to deal with where the customer wants to supply the materials from Direct Buy or use their nephew the electrician will still be profitable when you use a capacity based system.[/QUOTE]I absolutely wholeheartedly agree with that sentiment and that has been one of the points I've been trying to emphasize in some of the other discussions I engaged in on this topic.

While it may be the one thing I don't agree with Les Deal on in his article How to Charge for Overhead he doesn't markup materials and subcontractors at all and still remains profitable. Forum rules prohibit me to linking to them here but for some of the other discussions I engaged in on this topic I produced an Apple Numbers and MS Excel spreadsheet workbook that shows the user how head to head a Capacity Based Markup contractor can actually 'zero out' Material and SubContracting sales and soundly beat a Volume Based Markup contractor in the same scenario.


Exactly!

And that is exactly how we work tool. And while I think I know how you came to say that you think it illegal from the IRS perspective for you not to provide the materials for your subcontracted work to GCs I think you are mistaken. I did a productivity consulting gig a while back for an aerospace job shop who was producing specialized aircraft engine parts and while I was there I found out when you are working on government contracts you don't supply any of the materials, the government purchases all of the materials and provides them to you. While they don't use the phrase Capacity Based Markup I found that is essentially the costing/pricing methodology they all have to use in that industry.

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Jerrald Hayes About ParadigmProjects.com

Jerrald Hayes

Hey Paul your gold plated faucet example is a great analogy. In the past when I talked about this I always used an example of installing radically differently priced front entry doors but I think the "gold plated faucet" might be a more powerful, more memorable example to use in the future.

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Jerrald Hayes

Again I think you are hitting the mark perfectly with your observation and thinking.

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Jerrald Hayes About ParadigmProjects.com

rbsremodeling

Jerrald here are my answers.

I use a gross dollar goal to plan my year. Lets say 500K


I use a mark up 50%.

350k times 50% = 175K. 350 + 175 = 525k gross for the year.

Every month I go over what I grossed, sold, profit and loss. By doing this I can tell where I am at.


If one month I am below my projections I can raise my mark up and try to make up for it.

If times are lean I can break even on a job if I have to, I can use my break even mark up to make sure the bills are paid. ( we all know we should not operate on price)


I have kept my overhead and self paid while a lot of contractors are broke and out of business because I knew my baseline cost and bidded jobs using it to keep the wheels moving til the market picked back up.

If I sell jobs at a higher markup. I can achieve my overhead and profit goals faster and in theory If I have made my overhead and profit goals ahead of schedule I can lower my mark up if I have to.

So if summer I am booked solid and I raise my mark up 10-20% more, if winter is slow and I can make the extra money to cover it in the summer.

I agree with Michael Stone I don't want my money tied to a worker's production or showing up.

I have 5 guys that work for me. If they all went home tomorrow. I could sub out the same work using my mark up and make the same or more money with out any employees.

Every system has to be flexible. If I have a job that is heavy in the material, labor or sub side. I can adjust that markup on each item to compensate. My software I use allows me to adjust markup on labor, materials or subs as needed.


Capacity based is basically a volume markup with the majority of the markup shifted to labor in my opinion.

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silvertree

Yeah, so whats your point?

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Vote for Pedro
Kitchen, bath, St Paul remodeling
Minneapolis Remodel Blog
203K Loan Consultant Minnesota