In my April column (“Get high profits with design/build,” page 60), I went to a bid opening where 38 landscape companies bid a school construction job. My client finished 10th despite tightening his pricing factors and production standards.
Sure there’s a part of you that says, “Let ’em have it at that price.” But there’s also a thought that gnaws at you: “I will get nothing at my current price if this keeps up.” Welcome to the new world. It’s hard to define what distinguishes high-profit from low-profit companies in this environment when survival becomes the driving force.
There’s only so much past relationships do for you in this environment, so fashion a “survival budget” that reduces costs and prices — and gives you a better chance of generating revenues. A survival budget must provide enough profit to recapitalize the company for next year. Using the chart below, let’s review the budget’s basic elements.
The starting point is expected revenues. In this example, we anticipate a 50 percent year-to-year reduction in revenues. We then establish a survival net profit margin. I use 3 percent as the low-end recap target, which reflects the working capital needed to fund longer Accounts Receivable collection periods and some level of hard asset replacement.
Overhead reduction
We keep overhead in line with revenues at 22 percent and conclude that overhead costs need to be halved. This is a painful, but necessary step. We add the 3 percent net margin to the 22 percent overhead expense to equal a gross margin of 25 percent.
Labor cost reduction/hour
Given the reduced gross margin expectation, materials costs are now likely 50 percent of revenues — up from 35 percent. We can calculate labor expenditures and hours from this assumption.
Revenues of $2.5 million, less $1.25 million in materials, leaves $625,000 for labor. Dividing this by a $13 hourly wage rate yields 48,077 labor hours.
To lower labor cost, we must lower the average wage 15 percent, from $15 to $13 per hour. Some of this comes from less overtime and some from tighter management of non-billable hours.
Pricing reduction
Lastly, we can calculate the hourly labor billing rate. Revenues minus the materials cost at its 10% markup, divided by the labor hours, provides the rate of $23.40 per hour, 27 percent less than the prior year. In effect, prices are lowered 27 percent to achieve the desired margin.
With this survival budget, we can manage through a downturn and still have reinvestment income for the future. Those companies with solid balance sheets (debt-to-equity ratios lower than 40 percent and current ratios of 2.5 or better) will survive.
It is truly a stomach-churning case of survival of the fittest out there in the bid build world. Be prepared, and next year might look a little better.
