| Tricks of the Trade© |
Morning edition Monday August 14, 2000 |
ANALYZING PRICING
The statistics discussed above help the owner understand the operations of the business. It is equally important to understand the effects of pricing on the approval of estimates, and ultimately profitability. Specific statistics relating to estimates given and approvals of estimates are useful in monitoring pricing levels.
The estimate is a projection of the time and materials required to complete a job. The price is a function of the projected material costs, the projected labor costs, and the desired profit. Analyzing operations allows the owner to determine how well those projections were met and to make the necessary adjustments.
The statistics which follow are a tool to determine the proper pricing level. Pricing has two affects: it determines profitability, and it influences the work load. Both affects must be considered in determining the proper price level.
Closing rates: This statistic is calculated by dividing the number of approved estimates by the number of estimates given. The resulting percentage is called the closing rate.
The closing rate is not applicable to specific jobs, but rather to a period of time. The closing rate can be calculated weekly, monthly, quarterly, etc. An historical average for a longer period (such as a quarter) establishes a benchmark to which the weekly closing rate can be compared.
Two separate closing rates are used-- the percentage of estimates approved, and the percentage of estimate value approved. Each provides a different view of pricing and its impact on approvals. Used together, they provide a useful tool for determining price levels and projecting work loads.
Table 5 illustrates the percentage of estimates approved:
Week Estimates given Estimates approved % approved
1 10 4 40%
2 10 5 50%
3 10 3 30%
4 10 6 60%
Totals 40 18 45%
Table 5
The table above shows that over a four week period, the closing rate averaged 45% of the estimates given. Assuming that conditions (such as market demand and pricing) remain consistent, the owner can expect 45% of future estimates to also be approved. As the number of estimates given in a particular week fluctuates, the owner will be able to project the number which will be approved.
Table 6 illustrates the percentage of estimate value approved:
Week Estimates given Estimates approved % approved
1 $21,500 $8,000 37.2%
2 $19,250 $10,000 51.2%
3 $15,000 $6,000 40%
4 $36,250 $12,000 33.1%
Total $92,000 $36,000 39.1%
Table 6
The table above shows that 39.1% of the value of estimates given was approved. Again, this historical average allows the owner to project future approvals.
By comparing the two closing rates, the owner can identify the types of jobs (in terms of dollar value) which are being approved. In the two charts above, the average value of the estimates given is $2,300, while the average value of estimates approved is $2,000. In other words, lower priced jobs were approved at a higher percentage rate than higher priced jobs. This difference is reflected in the fact that the percentage of value approved is lower than the percentage of estimates approved.
Such discrepancies are neither good nor bad-- simply an identification of a fact. The reasons for the discrepancy will determine its value significance, i.e., whether it is desirable or not.
For example, two estimates are given-- one for $5,000 and one for $45,000, and the first estimate is approved. Fifty percent of the estimates given were approved, while only 10% of the value was approved.
The large discrepancy between the two closing rates is of less significance than the consistency of the discrepancy. Each contractor will develop specific patterns regarding the type of work it best performs. The skills and size of crews will play an important role in this. A two-man company will be less willing and able to accept a job painting an apartment complex than a company with a ten-man crew. Smaller jobs will be more profitable for the smaller company than for the larger company, and the estimating for each will reflect this.
As a result, the closing rates will also reflect the strategies of each company. A $200 job may not be profitable for a large crew, yet perfect for a small crew. The larger company may have to bid $300 for same job, while the smaller franchise may bid $50,000 for a job the larger business can profitably perform for $40,000.
The closing rates will vary considerably for these two companies. However, these rates will reflect the strategies, goals, and performance characteristics of the particular companies. The usefulness of calculating closing rates is not to compare companies, but to allow individual owners to track their performance in regard to their own goals.
Further analysis is possible by calculating closing rates for more specific situations, such as by zip code, by neighborhood, by job type (interior or exterior painting, for example), by price level (for example, for jobs over $2,000), etc. Such detailed analysis allows the owner to identify the types of work he is most successfully estimating.
Table 7 illustrates how closing rates can be used to determine pricing:
Labor rate $ value of estimates Appr % $ Appr Labor hrs. Expenses Profit
$40 $10,000 25% $2,500 62.5 $1,562 $938
$35 $10,000 35% $3,500 100 $2,500 $1,000
$33 $10,000 45% $4,500 136.4 $3,409 $1,091
$30 $10,000 50% $5,000 183.3 $4,583 $917
Table 7
For the purpose of illustration, expenses are assumed to be $25 per hour for labor, materials, and overhead. These figures show how the labor rate affects the approval rate, and ultimately profitability. As the labor rate decreases, the closing rate increases. As the labor rate decreases from $40 to $33, profitability also increases. However, as the labor rate drops further, profitability also decreases.
The chart above shows that decreasing the labor rate from $40 to $30 doubles the value of work approved. However, the labor hours required to perform the work triples. Consequently, profits are nearly equal, despite the larger volume of work.
The particular strategies of each owner will ultimately determine the appropriate price level. At the lower labor rate, the owner will have more crews working, or a greater back log of work. He will also capture a larger market share. More crews increases demands on equipment and management, while increased market share contributes to name recognition and repeat customers. The desirability of each alternative can only be considered within the context of the owner's goals.
MARKETING ANALYSIS
A seemingly endless number of advertising forums are available, with widely varying costs and rates of effectiveness. Two aspects of advertising must be analyzed: the work resulting from each method and the estimates generated from each method. The primary purpose of advertising is to stimulate requests for estimates; however, if work does not result from those requests, further investigation is required.
Table 8 shows this analysis:
Ad Cost Est Est $ $/ Est $/ Est$
A $250 8 $12000 $31.25 2.1¢
B $500 20 $40000 $25.00 1.3¢
C $1000 28 $70000 $35.71 1.4¢
Ad App App$ $/ App $/ App$
A 3 $4500 $83.33 5.6¢
B 7 $14000 $71.43 3.6¢
C 12 $35000 $83.33 2.9¢
Table 8
The table above shows that Method B costs $25 for each estimate generated and 1.3¢ for each dollar of estimate value. Method C, while costing nearly $11 more per estimate, has a higher closing rate, and costs 2.9¢ per dollar of approved estimates. Method C is the most cost effective in terms of revenues generated. However, because Method B costs less per estimate generated, improving the closing rates would lower its cost per dollar of revenue generated.
Each method can be further analyzed by zip code, neighborhood, type of work, etc. Again, the more specific the analysis, the deeper the understanding, and the deeper the understanding, the greater the control over advertising and pricing.
CONCLUSION The statistics discussed here do not exhaust the possible methods for monitoring a company's performance-- virtually any aspect of a company can be measured. The statistics discussed here have the most general application and usefulness.
Statistics, like any form of knowledge, are not magic pills. Ultimately, action is required to implement the knowledge obtained by statistical analysis. However, statistics can provide insight and steer an owner in the proper direction. Just as a contractor wouldn't attempt to paint with a hammer, he must recognize the purpose and function of statistical analysis -- it is a tool.
EgoCorps Inc. 5933 Bellaire Blvd, Suite 118 Houston, TX 77081 ph. 713-666-6968 fax 713-666-8993 If you have any home improvement questions, questions about our company or our work, please contact Brian Phillips at brian@egocorps.com
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