What type of Markup/Pricing Strategy Do You Use?
All the way back in 2004 I conducted a simple small sample poll in the Journal of Light Construction Estimating & MarkupForum asking “What type of Markup/Pricing Strategy Do You Use?” Linda Case and Victoria Downing had just written an article on their Remodelers Advantage website entitled (ironically enough) The Volatile Issue of Markup (sorry it is no longer available online) and in that original poll I used their descriptions to categorize the different types of markup methods but in the years since I’ve done a lot of work looking into all of this and the definitions and category descriptions are now mine.
Joe is planning for his next business year. He is committed to achieving a net profit of $25,000. He’s planning to sell and produce a volume of $300,000 and his overhead runs $65,000. This leaves $210,000 for job costs. Let’s explore the different ways that Joe could develop a sales price for the jobs he sells.
• The Different Types of Pricing and/or Markup Strategies •
1. Estimated Volume Based Markup
(aka: Gross Profit Margin (GPM), Margin Based Markup, Across-the-Board Markup, SORS (Single Overhead Recovery System))
This is the method that was taught by the late remodeling industry icon Walter Stoeppelwerth in his books Professional Cost Estimating 1981 & Professional Remodeling Management 1985 and in seminars, he conducted as well as the retired icon Linda Case. It is currently being advocated by Melanie Hodgdon & Leslie Shiner in their book A Simple Guide to Turning a Profit as a Contractor and Michael Stone in his popular book Markup & Profit; A Contractor Guide. This is arguably the most widely recognized pricing system in the remodeling industry — simple, easy and quick to figure out (you just convert your desired margin into a markup number) but it is not as accurate, scalable, or robust as people might think.
The method can typically be represented by the formula:
Job Costs x Markup = Selling Price
or that same formula can be broken down into a little bit more detail as:
(Labor Cost + Material Cost + SubContracting Costs) x Markup = Selling Price
With this method, every dollar of Joe’s job cost ($210,000) earns the same amount of gross profit.
Joe needs $90,000 in gross profit.
He uses a 1.43 or 43% markup on all job costs to help him achieve this goal. $210,000 x 1.43 = $300,300
$300,300 – 210,000 = $ 90,300 in gross profit dollars
To determine the markup you need, simply divide the gross profit dollars by the job cost dollars. $90,000 ÷ 210,000 = 42.8%.
This equates to a 43% or 1.43 across the board markup.
2. Capacity Based Markup
(aka Activity Based Markup, PROOF, Schedule Based Markup, PILAO, OPH (Overhead Per Hour), or PIF)
Capacity Based Markup appears under several different names usually depending upon the industry or who was teaching the method. For instance, if you took some training in markup like I once did from PROOF Management Consultants you probably called the method PROOF, PIF which stands for Profit Index Factor comes from the automotive repair and maintenance industry and PILAO is used by early adopters of our Capacity Based Markup Workbook since that was the name of the Excel file while it was in development. I prefer to use the name Capacity Based Markup which was coined by builder/author David Gerstel in his seminal book Running a Successful Construction Company and it describes what it is based on (you are selling pieces of your company’s capacity to build projects) although I am also perfectly comfortable with Activity Based Markup too.
2a. Labor-Based Markup
Joe has two carpenter employees. Each of the three works and gets paid for 2000 hours per year. But not every hour of those 2000 is “productive” and actually billable to a client or project. i.e.adminstrative time, education & training, tool maintenance, etc. so instead of employees working 2000 productive hours, the figure for productive billable time is really about 1750 labor hours per year. So 1750 labor hours X 3 (Joe and his 3 employees) = 5250 hours. That means Joe’s company has 5250 hours of productive billable time AKA “capacity” to sell each year in which he needs to recover his company’s Overhead & Profit.
Within this time, Joe has to earn $90,000 in Gross Profit. Each hour of labor must then be marked up to carry $17.14 of overhead. (5250 hours x $17.14 = $89,985 or $90,000).
2b. Schedule-Based Markup
Joe’s company has 250 working days in the year in which to generate $90,000 of gross profit. Therefore, each working day must produce $360 in gross profit (250 x $360 = $90,000)
Joe runs one job at a time. The Harris job will take 4 weeks or 20 working days. (20 x $360 = $7200). This amount, $7,200 will be added to the job costs for a minimum mark up. For example, if the Harris job will cost $10,000, the sales price would be $17,200.00
With Capacity Based or Activity-Based Markup, there is no attempt to recover Overhead Costs via markups on Materials and Subcontracting costs although they are often marked a small amount up to contribute to Net Profit.
3. Differential Markup
(aka MORS (or Multiple Overhead Recovery System)
If you learned markup from J.R Huston (How to Price Landscape & Irrigation Projects) or Charles Vander Kooi (The Complete Business Manual for Contractors) in the landscaping industry you might talk about MORS or Multiple Overhead Recovery System where you have distinct unique separate markups for Labor, Material, and Subcontractor and each markup is intended to recover a portion of your company’s Overhead ( or Gross Profit).
The formula would look like:
(Labor Cost X LaborMarkup) + (Material Cost X MaterialsMarkup) + (SubContracting Costs X SubcontratingMarkup) = Selling Price
Labor, material and subs are each marked up with a different percentage. Usually, labor is very heavily burdened with gross profit.
$65,000 Labor X 100% or 2.0 mark up = $130,000
$17,000 Subs X 30% or 1.3 mark up = $93,000
$70,000 Materials X 10% or 1.1 mark up = $77,000
This system will allow Joe to earn more gross profit on heavy labor jobs and less on light labor jobs.
4. Flexible Markup Based on Conditions and Type of Job
The contractor looks at his/her costs and decides “I want to be able to make X amount over my direct job costs on this job” and charges accordingly. This is essentially a variation of Estimated Volume Based Markup and Gross Profit Margin (GPM) methods although each type of project has it own unique markup rate.
The formulas for this methodology looks like:
(Labor Cost + Material Cost + SubContracting Costs) x DeckMarkup = Selling Price
(Labor Cost + Material Cost + SubContracting Costs) x KitchenMarkup = Selling Price
(Labor Cost + Material Cost + SubContracting Costs) x AdditionMarkup = Selling Price
5. Charge According to the Market
With this method our contractor Joe relies on his experience and understanding of the market and his pricing is based on what he knows (or thinks) other contractors are charging for the same service, product or type of project. i.e. My friend Jack did deck project like this for around $30,000 so I’ll use that $30,000 figure as my Selling Price or other contractors are charging $1.50 a Square Foot for drywall installation so I’ll use that as my Selling Price too.
Materials x SomeFactor = Price i.e. a project with a Material Costs of $2345.00 X a factor of 2.5 = Project Selling Price of $5862.50
6. Other Method
If you think you are using another method that doesn’t fit into the categories described above please tell us about it when filling out our survey describing the thinking and/or mechanics (math) involved.
• Take Our Survey •
About the Chart Illustrating the Survey Results
I’ll be laying around with different charting options and tools this fall as I search for the optimal responsive display solution. This is NOT it. This chart I produced by entering the data into Google Sheets and then exporting the chart as an image. I found displaying the chart image in an iFrame unsatisfactory on mobile devices so until I find something I like better this is it for now.