Lockdown restrictions are easing across the country just in time for Christmas, which tradies know is usually a critical time even without the added pressure of the pandemic. Tradies will have a much easier time this holiday season with onsite access; however, many of the same issues that plagued the construction industry during lockdowns will continue to persist even into the new year.
Australia’s relative global isolation has caused supply chains to fracture during the pandemic when demand for construction work is skyrocketing, leading to material shortages and inflated prices. Even with international travel resuming, labour shortages will continue to impact the industry for the foreseeable future.
We’ve spoken to many tradies this year who have been forced to re-quote work and renegotiate timelines. One of those is Queensland-based electricians KVA Group. The owner told us material price inflation was having a huge impact on his business, often leading to renegotiating costs and disgruntled customers. KVA priced a job in February to build 135 homes in a retirement village, but by the time work finally kicked off in August, overall costs had increased by 30 per cent.
All construction jobs come with some inherent risks, but most tradies haven’t had to face scenarios like this before, meaning there’s a lot to learn about navigating difficult trading periods like the one we’re in now. If tradies want to come out the other side of this holiday season intact and with a healthy profit margin, they must first understand their costs and how to choose a pricing strategy.
How to determine your costs
There are five key figures you need to be familiar with before pricing your work:
- Sales revenue – the price you charge the customer for a job.
- Cost of sales – the direct costs associated with the job, typically covering labour and material costs.
- Gross profit – the amount of money you have left after subtracting the cost of sales from income.
- Overheads – your fixed expenses for each month like rent, insurance, loan repayments etc.
- Net profit – the final amount you’ll end up with after subtracting your overheads from gross profit.
One of the most common mistakes we’ve seen from tradies is when they price work based on their cost of sales without considering their indirect overhead costs. This is the fastest way to price yourself out of a profit. Your sales revenue needs to consider your overheads, the cost of your labour and materials, and have enough left over for you to make a profit.
You may need to experiment with pricing to determine what works best for your business, but a general rule of thumb is that your overheads should be around 25-50 per cent of your sales revenue to make sure there’s at least 10 per cent net profit left over. That means adding at least 35-40 per cent on top of your cost of sales. You’ll have a better chance of ending up with a healthy profit margin if you add these costs correctly.
Tradies use three common approaches to pricing work, each with its own pros and cons:
- Estimate: A rough estimate of the final price that is not legally binding and subject to change
- Quote: A legally binding agreement where the tradie offers a fixed price ahead of commencing work
- Do and charge: Hourly rates, overhead charges and margins on time and materials are agreed in advance, and final invoices are based on the costs actually incurred on the job.
Many customers, particularly large organisations, prefer fixed prices to help them plan ahead, which means providing a quote can make it much easier to secure larger jobs. Quoting a job ahead of time also means the customer is less likely to dispute the costs at the end of a job if they’ve already agreed to your terms.
However, the drawback to quotes means if there is an unforeseen issue that causes you to run over budget, you’ll have to pay the additional charges out of your own pocket. You’ll also be responsible if you make a mistake in your quote and your costs don’t cover all of your expenses.
One of the pitfalls of quotes is the uncertainty of customers accepting your proposal. They will be fielding quotes from your competitors as well, so it can be tempting to understate your costs just to win a customer, leaving you out of pocket when the work is done. Customers will naturally try to reach a compromise between cost and quality, so tradies should aim to win around 50 per cent of quotes. If it’s much lower, you could be overcharging customers and missing out on work; much higher and you could be charging less than the industry average, meaning you’re missing out on potential profits.
“Do and charge up”, on the other hand, means tradies factor in their gross profit margin when the job is completed and charge the customer for work as they complete it. This can get complicated when it comes time to collect what you’re owed. If you’ve managed your customer’s expectations correctly, they won’t be shocked if costs overrun.
Mark-ups vs. margins
Much like trades, pricing is a skill that must be trained before you’re good at it. There is one key exercise that tradies need to know, especially if they want to maximise their net profit: mark-ups. A mark-up is an amount you add to your costs to reach your desired profit margin. However, you can’t just mark up every product and service the same way until you reach the margin you want.
Higher costs typically have lower margins because they’re more expensive, whereas smaller components like screws and fittings can be marked up higher. For example, an entire wall may have a 20 per cent mark-up, but something like screws might be marked up as much as 100 per cent. By employing this mark-up strategy, tradies will have a much easier time earning a net profit, and the customer will have a deeper understanding of why there are additional costs.
With all the strategies and plans for pricing your work, the fastest way to determine your worth is by understanding your customer, what they need and what matters most to them. It’s all about managing your customers’ expectations so they’re satisfied with the work you’ve done for them at the price you’ve charged while still ending up with a healthy profit for yourself.
You can find more tips and details about pricing your work in “The ultimate guide to pricing for tradies”
Read more:The theory behind pricing and ‘value’