As soon as I mention margins, almost all business owners and managers turn their attention to pricing. Some are uncomfortable examining their margins and others may protest, "I can't raise my prices any higher, I'll lose business." And there are always a few who think they know what their margins are but couldn't demonstrate what they really are - and may be afraid to look too closely.
We all know that the margin we enjoy from sales in our business is what is left from the price we charge for our service and repair work after we subtract our costs. Naturally, prices directly affect margins. However, the other end of the calculation - costs - is also a critical part of the discussion. Often, I see business owners assume the costs are fixed and cannot be changed. Any consideration of increasing margins is automatically restricted to pricing decisions.
To properly address ways to maximize margins, I believe you need to look at costs, pricing and a lot more of the fundamental policies, which you use to run your business. It's not possible to look at margins without considering pricing and costs, and also the market you are in, where you position yourself in that market, the type of work you do and level of professionalism your people display.
I want to give you a five-step analysis you can use to determine where your margins should be and what you can do to get them there. Before I do that, I need to review the importance of spending time addressing your profit margins.
Importance Of Good Margins
Without adequate profits, your business will not be able to deliver the quality service your customers expect. You will not be able to pay top quality technicians or other employees, nor maintain your trucks properly or keep your shop in good shape. All of those requirements to stay ahead of the competition cost money - money that has to come from your margins. That doesn't mean an automatic price increase but it does mean close scrutiny of your profit margins on a continuing basis.All of the competitive efforts you implement still don't consider the fact that your lifestyle will suffer, despite your hard work, if margins are unsatisfactory. Other reasons to view margins seriously include the value of your business, now and in the future. If you ever want to sell, one of the first items on the financial statements a buyer will want to see is the profit margin. For every dollar you add to the bottom line profits, annually, you'll probably see from three to six times that amount returned to you in the sale price of the business.
For the time being, your banker should be interested in your margins, and certainly will be if you want to increase your line of credit, buy new capital equipment or expand your business. Any growing business needs capital, which is easier to obtain if you show respectable profit margins.
Even if you are not looking forward to the future when you might sell, those extra dollars you take in above your costs go directly to you. Small amounts of additional revenue dramatically increase your profits and return on investment. It's your money that you are leaving on the table if your margins are too low.
Step One: Costs
The first step in examining margins is to look at your costs - your real costs. What I mean by that is not rough estimates or ballpark figures, but the actual costs of doing business, including the hidden costs that are not always reviewed, like the costs of keeping your people up to date on their technical skills, customer service training, professional uniforms, modern well-equipped trucks. Your accountant can assist you in making sure all your costs are identified in your financial statements. Then you can use that data to help you set your prices.One of the advantages of a detailed analysis of your costs is an increased awareness of where you are spending your money. When you look closer at those expenditures you can control them better. So just keeping close track of your costs will allow you to reduce them. It's always nice to see where the money is going.
Step Two: Set Prices
Now it's time to calculate the prices for your services. When your costs are known you will be able to determine what you can afford to sell your company's services for. In computing your prices, you will need to include amounts that represent a decent return on your investment in your business. That return should consider the rate of return a person would receive with little or no risk (like a bank account or savings bond). Since you are taking business risks, you should be receiving a much greater rate of return than a no-risk rate of return.In looking at typical margins of service business owners all over the country, I have seen some businesses keep only 2 percent or 3 percent of the money they take in from service work. We analyzed our prices and found it was possible to get margins in excess of 15 percent if you properly set your prices.
You have to be convinced that running your business is worth your efforts when you set prices. Otherwise, you are working hard for a return that is no greater than putting the money in a savings account. With the software available today, there is no reason to have to suffer and do these calculations manually.
Step Three: Flat Rate
When you set prices to achieve a rate of return that makes it worth running your business, you will be preparing your business for another important step: flat rate pricing. By maintaining a professional flat rate system, you will reduce customer resistance to your prices and allow your technicians to focus on the primary need of all customers - fixing the problem. Flat rate pricing simplifies the technician's job of pricing the work and builds customer confidence by showing prices up front, without any surprises.Flat rate pricing also makes it easier to adopt a few policies that will increase your earnings. One example is the small charge we build into every job for technicians' education and training. For each job completed, we allocate part of the revenue to a training account. Technicians can spend the money in that account for courses they select. We do the same thing for setting aside money for trucks we know we are going to need in the future. A few dollars from the job is allocated to investment in new trucks and improvements in our current fleet of trucks.
These accounting techniques help us set aside the funds we need to run the business competitively and keep enough to make it worthwhile. It would not be possible to build these charges into every job if we stuck to a time and materials pricing system. With that method of pricing, you are encouraging customers to object to either the hourly rate or the cost of the materials. Flat rate eliminates those concerns and keeps the customer happy.
Step Four: Incentive Pay
By paying technicians the same way you would pay sales people - commissions - you pay on a performance basis. The more work they do, the more they earn. This approach helps your margins because you are not covering a fixed hourly cost paid for technicians when they are not producing revenue. At the same time, incentive pay is a motivator for the technicians who would like to earn more. The technicians are happy and your fixed overhead is reduced in slow times.Also, the practice encourages technicians to look for additional, legitimate work in the customer's home. More work on the same trip; it cuts truck expenses and customers are happy because they avoided the inconvenience of another service call in the near future, plus the additional cost. Don't omit incentive pay from your inputs when looking at pricing.
Step Five: Show Value
It is easy to talk about identifying and controlling costs, establishing satisfactory rates of return and using flat rate to produce acceptable margins. But none of those components of a system for maintaining good margins will work without this last step. Showing value is a focus on the customer, making sure they receive the best value for their money.Some customers will select the cheapest supplier of any services. There is nothing you can do about that. You don't want that segment of the market as your customers. Most people, however, will pay for reliability, quality work, professional appearance, manner and workmanship. No customer wants the company who did the work to come back because the job wasn't done right. And customers are unwilling to pay for technicians who appear unkempt, dirty and ill mannered (at least not more than once).
Unfortunate as it may be, the customer's assessment of the work often will be limited to your technician's appearance, demeanor and clean-up after the job. Knowing these traits makes a difference in the customer's willingness to agree to the service work, and call your company the next time. It's our job to make sure the technician provides the value the customer deserves. Otherwise, all our planning, accounting and efforts to boost margins will fail.
Training your technicians is the only way to assure they offer the value your customers deserve.
Once you have reviewed each of the above steps in your business, you can be comfortable that the margins you receive are both fair and acceptable. Now your business is working for you.
