Originally published by Cast Polymer Connection, Fall 2017.
In so many small businesses goods and services are priced based on guesswork – WAG method (the Wild Ass Guess) or add just a few numbers for SWAG (a Scientific Wild Ass Guess). Perhaps you use the STICK method where every stick and nail is costed out? Why don’t they work – and why do the always result in C minus profits?
WAG is an experience based method for pricing where trial and costly errors have already taken place. The assumption is that if for the past ten years, it has cost $5000 to renovate a bathroom and presumably it will always cost $5000 to renovate a bathroom. Faced with creeping labour costs or perhaps sudden spikes in the price of plumbing fixtures, this method is frequently unable to change. Faced with a new competitor in the market who is willing to undertake the same bathroom renovation for $3500, the WAG method practitioner doesn’t know what to do. There is simply too much information that must be kept in the estimator’s head to stay current and remain competitive yet profitable. Worse yet, estimators are human and tend to respond to the last comment they had from a customer. If that comment was a customer saying the price was too high, then the price on the next job will drop. If the business owner is also the estimator, then the price can reflect not value to the customer or even costs, but the threadbare state of the bank account at the time. Sound familiar?
SWAG method, as the name implies, has some numbers to back up the experience based approach. “OK, so that job will take 4 men 5 days to complete and I pay them $20 per hour. With labour cost at $3200 I then add $3200 for materials and then $3200 for profit, that should be about it.” This rough and ready method does not take into account travel time, overhead and management costs, payroll taxes nor a fudge factor in case things go wrong. This job might actually lose money.
The STICK method is the name given to the clumsy and time consuming method of working out the costs of each and every nail, foot of strapping, 2” by 4”, pot of paint and labour to the nearest 15 minutes to arrive at a total cost. It is very time consuming. In fact, the typical delay from computer bashing can often be the deciding factor in whether or not your company gets that job.
STICK is, in fact, an adaptation of industrial manufacturing cost accounting methods to service providers and custom builders. I have seen some very elaborate spreadsheets meant to cope with the vast amount of information. The advantage to this method, having gone to the trouble of detailing every aspect of this “virtual build” is that, if and when the customer says “Okay”, you have a bill of materials and a plan for the carpenters.
The disadvantage is that, having committed so much time and effort to the quote, the price is not easily altered to reflect customer expectations. In other words, if the quote is $7000 and the customer’s budget does not extend beyond $5000, you cannot easily find the savings to meet the value expectation. There is simply too much information on the table to alter the quote quickly. The only line item that can easily be altered is the bottom line and doing so may mean the job makes no money. What a dilemma!
What to do? Estimating Solutions
Increasingly there are industry related packages for estimators. Many of them utilize the power of computers and spreadsheets to manipulate large quantities of information without error. This is the STICK method on amphetamines.
The best place to look for software packages is in trade magazines and other publications. If you choose this approach to estimating systematically and correctly, it is always good practice to have a test run of the software: entering data from an existing quote to see if the numbers work. If the software is truly sophisticated, then it will also create a bill of materials for your purchaser, saving you hours of time.
Estimating books – OEM and industry service providers
Significantly, there are companies that provide estimating in a more packaged form that quickly get to the final number. The one with which I have a working familiarity (Walt Stoeppelwerth Estimator Books and Software. Home Tech. www.hometechonline.com) is focused on the construction trades. They have created formulae into which you plug the square feet, height over normal, number of windows and/or doors and economy, medium or fancy outcome. In a few minutes out pops a number which is then multiplied against a regional factor to arrive at a selling price. They keep track of cost differentials through regional surveys which become a factor number that you plug in to give a final price.
Similarly, the auto body industry gets from the manufacturer, books specifying how long it will take for a fender to be straightened or a side panel to be hammered out. From this it is easy to determine what your costs are going to be and to apply a markup factor. Typically, the auto body people use this information to apply standard rates and then encourage their technicians to improve upon those numbers. If they accomplish in 24 hours what the book says will take 32 hours, the price does not change but the costs do, throughput increases and everyone wins.
You can Do It Yourself. If the industry you serve has no package to offer you, you can create an estimator package to standardize your costs as follows:
- First list all of the steps in the information gathering stage. What types of material, size, finish, and availability? List all the extras. What does your customer expect?
- Then list how you currently price jobs focusing on the commonly deployed steps that must be taken. Do you always begin with a site visit? Do the raw materials always have to be sandblasted first?
- Apply costs to each step.
- Apply your markup factor to get to a selling price.
- And now the most important step – the virtual trial run. Review using some previous jobs that worked out well and where you made money. Punch in all those numbers
All these steps would be taken by a software developer and can be incorporated into a spreadsheet programme.
With more tinkering and constant upgrades the above can be made into a comprehensive price list that covers the basics and some of the eventualities.
COST PLUS LEAVES $$ ON THE TABLE
You will have recognized in the above example that you are looking at a variation on cost plus mark-up, pricing. Estimating software can deliver consistent if unexciting profits because the costs are known unlike WAG and SWAG.
But it leaves money on the table.
Why? Because we have lost sight of the customer in this equation by focusing on costs.
Your customer has called you to solve a problem for them. Do they want flashy but inexpensive countertops because they are putting the house on the market? Do they need new countertops because they cook regularly and have scarred the old surfaces? Are you going to build a price for these two types of customers based on cost structure alone? Just like you, all customers are not equal in expectations or ability to pay. If they were, no one would buy Rolex watches or Mercedes cars.
The answer is to value price for your customer. This is a pricing strategy and by working hand in hand with your costing solutions will be the key to improved profits.
By definition 50% of businesses in your industry are below average. The point in having a solid grasp of costs is to get everyone to the baseline. But to soar above that you need a pricing strategy that focuses on value to the buyer.