Why is The Price is Right so Important?
If the price isn’t right you will quickly run out of opportunities to sell your services and make money. Without sales and revenue, what will your business do? No revenue no business!
So making sure the Price is Right is about as important to your business as anything, right?
Here are the 2 Essential and Fundamental reasons you need to arrive at the Right Price:
- To Make Money: Making a fair and reasonable profit
- Being Competitive: Getting more work/sales when competing with similarly qualified competitors
When the Price is Right you will be able to achieve a sufficient gross margin to “cover the nut” or pay for your overhead expenses and then have enough left over to make a Fair Net Profit.
When the Price is Right you also will be within 10 to 15 percent of your best competitors’ pricing.
• Learn the basics marking up your direct costs to arrive at the Right Price – to MAKE MONEY
You have determined that in order to cover “the nut” or your overhead costs and make a net profit that you will need to generate an overall combined Gross Margin of 45 to 50 percent (average range needed). The combined Gross Margins from all of the departments need to add up to a number that will cover your overhead expenses plus what you have set as your targeted Net Profit. Remember, not all departments are created equal. Some departments may generate more Gross Margin than others so you need to determine separate Gross Margin goals for each Department as well.
Determine Your Direct Costs:
- Know your HAW’s (hourly average wage) per crew, per department
- Know your materials cost per department
- Get a handle on your total direct costs per department/revenue stream
OK, now what do you do with all of this?
How to Determine Your Price
Here is one simple formula that we have used is to arrive at the targeted Gross Margin:
Divide the Direct Cost (labor + burden + materials) by the reciprocal of the desired Gross Margin desired.
- Direct Cost = $100 and the desired Gross Margin is 55 percent
- Divide $100 by .45 (the reciprocal of 55 percent) = $222.22 Sales Price
- Take Sales Price of $222.22 minus Direct Costs of $100 = $122.22 Gross Margin
- Take $122.22 Gross Profit Dollars/Sales Price of $222.22 = 55 percent Gross Margin
Now ask yourself, will this mark up generate enough margin to cover overhead and deliver a fair profit?
You have determined that your HAWs: Hourly Average Wages for maintenance is $12 per hour and your maintenance material costs average 10 percent of HAWs so your Direct Costs for maintenance equals:
$12.00 x 10% (materials) = your cost is $13.20 per hour
In order to generate a 45 percent Gross Margin on $13.20 cost you will need to divide $13.20 by .55 (the reciprocal of 45 percent) = $24 Charge Out Price needed to generate a 45 percent Gross Margin
Know and Love Gross Margin
Understanding the power of Gross Margin is essential. It basically will boil down to getting enough Revenue generating the right Gross Margin to cover the overhead costs and to make a Net Profit.
We know this sounds oversimplified but it really is that simple.
Sounds pretty easy (not at all)… that is now one of the great challenges you will always be facing to be financially successful in this business.
The Price is Right – How to Markup the Direct Costs Summary
Getting the Right Price includes the proper markup of Direct Costs to arrive at the desired Gross Margin that “covers the nut” (overhead expenses) and to make a Net Profit. Use the simple formula of dividing your direct costs by the reciprocal of the desired Gross Margin and you will be well on your way to having the Right Price to MAKE MONEY!