Dave, before I write anything I am thinking maybe I'd better clarify my position regarding Michael Stone's
Markup & Profit and this is going to sound really ironic but I think it is an otherwise excellent book for contractors EXCEPT for what it has to say about Markup & Profit. I still recommend it to contractors I talk with but for other topics and reasons.
Regarding:
... just re-read (after seeing this thread) the capacity based markup section in his book. The hole I see in capacity, is what happens when you don't have work for two weeks, then get a one week job. Do you apply 3 weeks of O&P to that job? That could easily be a 100% markup. It seems like you need to stay booked for that to work.
Whereas with Stone's method, you need to hit your projected sales number, which he emphatically emphasizes (even more than construction itself); and he provides an in depth chapter on sales.
In my case, the Stone method makes more sense: on a good job for me (20K), with a few subs, the job will be complete in 2 weeks. On a small job for me, I'll spend the better part of a broken up week by myself for 1.5K. And then there's three weeks inbetween with nothing (but incurred OH).
Your observation and question there is one that even Michael Stone himself has argued but in reality it's logically inconsistent thinking and not entirely thought out.
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!
In a post in blog last October Michael Stone wrote:
Second[ly], when you put your overhead burden on labor, your overhead is dependent on every employee working every day. If someone misses work, the overhead expense is still incurred, but the opportunity to recover overhead for that day is gone. Overhead is a 24 hours a day, seven days a week, 52 weeks a year monster. It doesn’t stop because somebody doesn’t show up for work.
and I thought that was just patently naive and ignores the fact that...
Contractors and any service or manufacturing business for that matter get paid to produce and deliver products and services. If someone doesn't show up things don't get produced and delivered and regardless of what type of markup methodology you use and you don't get paid!
The idea that an Estimated Sales Volume Based Markup solves the problem of employees missing from work is just ridiculous unless there is some magic trick to it we don't know about yet. Following that logic out to its absurd end couldn't we say we don't really need production employees to ever show up at all to make money! Wouldn't that be great!
And clearly if any contractor for that matter is having trouble recovering their Overhead Costs because their employees just aren't showing up to work has a much larger problem on their hands that markup methodology isn't going to solve for them.
That said the problem with Volume Based Markup in that you never know what your client projects will require in terms of subcontracting and materials until you actually have those clients in hand still exists. A Volume Based Markup has to be critically concerned and astutely aware that they need to sell a certain minimum quantity of three different things to cover their overhead. They have to sell a certain amount of their company's labor, a certain amount of materials, and a certain amount of subcontracting. Unless you are hiring and firing all over the place your company's labor is a pretty predictable constant. Your material and subcontracting sales are in reality unknown variables that are totally dependent upon the whim and preferences of clients we haven't even lined up or met yet so how can we know exactly what they want and in what kinds of quantities? In good times or bad a Capacity Based Markup contractor only has to focus on one target. He or she needs to make sure they are selling enough of their company's available billable hours (capacity). You can keep you eye and focus on one ball or you can keep your eye on three.
Gerstel says, "You can run into trouble using a uniform percentage if you move away from a narrow range to a much wider range of projects -- or if you experience large variations in your total volume of work." This seems to be my situation, but the uniform % still seems better. Am I misunderstanding these formulas? I suppose your targeted job/client will have a bit to do with which method works better.
I'm not sure why you seem to think the Uniform or as I like to refer to it Volume Based Markup is still better but perhaps you can tell me a little bit more about just what you are thinking.
Let say you develop Volume Based Markup based on this kind of distribution. You plan based on your Direct Job Costs being 27.1% Labor, 42.4% Materials, and 30.5% SubContracting and your first job out of the starting gate comes in as 41.5 % Labor, 33.4% Materials, and 25.1% SubContracting. What do you do? Do you change your markup on the next job to fix the shortfall you now have? Do you even know you have a shortfall problem? Or do you readjust your markup according to that new percentage distribution? Remember though you still only have a certain number of available labor hours in a year to work so you can't make up for lost volume on work you don't have time to produce.
The simple truth is a Capacity Based Markup contractor doesn't have to do all that thinking. He or she only needs to think about selling enough work to keep their employees busy all year. If they do sell Materials and SubContracting the markup they place on those sales for Net Profit only is just icing on the cake because they've already covered their overhead with labor sales.
