PRICING TO WIN WITH A MAXIMUM PROFIT REQUIRES KNOWLEDGE
WHAT IS THE MARKET SEGMENTATION FOR CONSTRUCTION?
Deciding which segments of the market you will work in requires an understanding of how you describe who you will work for. Typically Residential, Health, Education, Commercial & Industrial. The ultimate clients determine what the market sectors are that you will work in. A list of those can be found in the Office of National Statistics, ONS. The ONS breaks the sectors down in to regions, new build, refurbishment and maintenance, public and private sector. Figures are given for the size of each of these markets.
Your segmentation could break the regions down in to smaller areas, by value of project and type of procurement, e.g. Traditional or Design and Build. Other combinations can be decided, depending upon what your skills, experience and accreditations are most suited to.
The aim should be to define the segments of the market you will work in to focus your efforts to save wasting time.
Are your marketing segments clearly defined?
WHAT IS BID-NO-BID?
If you have carried out a market analysis and decided what segments of the market you will work in, then the next stage is to define more criteria to narrow down your search for work. Criteria such as the financial stability of the client, if you have worked with any of the team members before and the clients alignment to your business values are typically additional criteria which can be added.
By listing exactly who you will work for and what what you offer will narrow down the search for work. The criteria become your Bid-no-Bid policy. By sticking to policy you will find yourself operating in a market you know well, which will give you confidence about your pricing as you learn more about that market.
Have you defined the attributes of clients who you will work for?
WHAT MAKES CONSTRUCTION ACCOUNTS DIFFERENT?
Construction accounting is different from general business accounting. In every other sector there is a direct link between production and accounts, leading to the functions, accounts payable, accounts receivable, and payroll transactions. In construction companies as there are contracts and many projects there is also retention, job costs, change orders, monthly progress payments and other anomalies to deal with.
These differences are not appreciated by many accountants who are capable of helping you set up a business but not to help manage it as the business grows. Construction is the only sector where there is a measurement function (quantity surveying) carried out between production and the accounts activities.
Do you have an accountant who understands construction and can you call on commercial (understanding contracts) support?
WHAT ARE THE DIFFERENT TYPES OF PROFIT?
The term profit is used with out definition by people in business. The profit which they are referring to will often be related to the level of the business they are working at. Gross profit is the profit made by taking all the income and deducting the cost of delivering all the projects. Ideally with construction companies you should know the gross profit for every project individually. From the gross profit all the overheads are deducted to leave the operating profit. Accountants often call the overheads, expenses which can be confusing as staff associate that term with travel.
Another term used for operating profit is EBITDA, which stands for Earnings Before Interest Tax Dividends and Amortisation. This is a useful term as it gives the order in which deductions should be taken to leave the Net Profit.
Deciding what should be project costed, charged to overheads and how much overhead each project should carry needs to be carefully considered, so the mark up calculation can be done accurately.
Do you know your gross profit on recent projects?
WHAT IS THE DIFFERENCE BETWEEN MARK UP AND MARGIN?
Both profit margin and mark-up use income and costs as part of their calculations. The main difference between the two is that profit margin refers to income minus the full cost of delivery while mark-up is the amount by which a project cost is increased in order to get to the tender price. The mark up calculation is often carried out incorrectly, effectively under pricing project, resulting in a lower margin than expected at the end of the project.
Do you know your mark-up to achieve your target margin?
HOW MUCH IS A GOOD MARK UP?
Many SME's accounts are compiled without the correct allocation of costs, as owners are happy to let their accountants assume where the costs belong. So the figures suggested below are rough but generally accepted as being what is used in the absence of accurate data. The figures are approximations as few SME's take the care to do the calculations properly.
However, it is thought that for an SME the overheads run at about 10% (Overheads or expenses / total income x 100) and operating profit is also 10% ((Income - direct costs - overheads) / total income X100). Adding these together suggests the mark-up needs to achieve 20%.
To achieve a 20% return on the project costs a project needs to be marked up by 25%. ( (1 / (1-0.2) - 1).
Every business is different and should use their actual figures. Using generic rates immediately puts you at a disadvantage in terms or competitiveness or at risk of making a profit.
WHAT MAKES A GOOD ESTIMATE?
The estimate for a project is the approximate cost of physically doing the works. The contractor's directors tell the estimator what business overheads to add, then will decide what profit is required. Generic advice might be given by external estimators as to what the considerations are for mark up but that figure will not give you an edge. It is better if the estimate is understood by the directors and they make the decision, as they should.
Good estimates in a business follow a standard approach if the person deciding the mark up is going to get a good feel for the market. It is no use giving back merchant or wholesalers rebates on some tenders and not others. Any discount should be accounted for in the mark up if you decide to offer it, otherwise you do not know the true expected profit.
When estimating the proposed contract should be checked for showstoppers and things like the level of LAD's reviewed. In particular, any clauses amended, removed or added to a standard contract should be looked at.
The next thing is the quality of the take off and who is taking responsibility for the quantities. The level of design, has it got planning? Has it got building control? Has implications for the accuracy of the quantities.
Some estimators, if they are busy working on lots of projects, because there is not a bid-no-bid policy, simply add a percentage for the preliminary's and accept what they are given for a programme. Clearly this is a missed opportunity to have an edge.
Finally, getting a number of prices for suppliers / subtrades and seeing the spread of them is something the person doing the mark up should see. External estimating services are good, but you need to manage them and identify where they have been over cautious, so there is no comeback or lazy when information is missing.
Are you aware of the context of the estimate presented to you and do you decide the mark up?
WHAT IS A TENDER ADJUDICATION OR SETTLEMENT?
The estimate and overheads percentage are largely a mathematical computation. In places there might be risks outstanding but the scale of the risk should be explained by the estimator. Before the price is submitted the estimate has to be turned into the tender by adding the profit. Academics have tried to suggest ways to do this but it has been found that it is largely an intuitive decision. The contractor's director should bring all their experience and knowledge to the decision. It should not be taken lightly as it will determine if they win the project and make as much profit as they can. The method ProfitableContractor.co.uk developed reduces the variables and makes the decision easier, by introducing current market data. Get a copy of the method by clicking the button below.
Want to understand how specialists can be used to carryout elements of the tender process, to leaving you free to work out the profit to be added to maximise your profits, then take a look at our "outsourcing tender roles guide".
"The importance of how the figures informed the management came through so strongly after just one session with Peter that we recruited a finance person."