In the interest of the continuing (or should I say reinvigorating) the debate and discussion surrounding the subject of “Markup” I wrote an analysis the other day that takes a look the two opposing schools of markup (Capacity Based Markup vs. Total Volume Based Markup Method) that illustrates what I think is another terrible flaw and handicap inherent in the Total Volume Based method.
In Comparing Markup Methodologies In Real Some World Pricing Scenarios I tried to illustrate that while Capacity Based Markup users will always be “right priced” on their project bids (provided they have estimated effort and material costs correctly) Total Volume Based Markup Method contractors will find themselves underpriced and will lose money on jobs where there is a ‘High Relative Cost of Labor to Low Cost of Materials, and SubContracting’ and will find themselves overpriced and priced out of the market on jobs where there is a ‘Low Relative Cost of Labor to High Cost of Materials, and SubContracting’.
What do you all think? Check and challenge my math and logic in the three scenarios I’ve written about.
Replies
I have skimmed your thesis and will get back to it later.
It appears to make a great deal of sense.
Jerrald,
Great article, thank you for sharing it with us.
Job senario #2 for Bill has the wrong figures in the tables for material and subs. Bottom line number appears correct but the supporting numbers are left over from Job #1.
Thanks again.
Thanks Bill. I jus fixed the error. It looks like in composing the article like I copied the table to get the formatting but overlooked changing some figures so they represented the correct scenario. I've only proofed the article once since I finished it off in a rush last Friday and that was for gross misspelling errors. I plan to clean up the spreadsheet I wrote to model the scenarios and attach it to the article sometime in the next few days that way people can look at the numbers in closer detail and even change the models if they so choose to see how the two differing methods work out.
View Image
I have a question that I have not seen you address before.
If I come up with a loaded labor rate of $70.56 for a one man operation does that break into a loaded rate of $52.88 if we are a two man operation where both people make same amount of money?
I ask this because if the second man cost me $66,587.70 per year and that is already figured in, he doesn't raise my actual overhead, does he?
To get my number of $52.88 here is what i did
total yearly labor cost: 66,587.70 X 2
total yearly overhead cost: 53,544.10
net profit: 13,367.00
total labor sales: 133,175.40
billable hours: 3784
loaded labor rate: 52.88
is there a flaw in my math or the way i am figuring this?October 17th, 2009
Jeremy and Lisa
Was there ever any doubt?
yes... and no... depends on how you are organized... run both your labor burden number and your overhead number again with the second employeeMike Hussein Smith Rhode Island : Design / Build / Repair / Restore
bstcrpntr — "I have a question that I have not seen you address before.
If I come up with a loaded labor rate of $70.56 for a one man operation does that break into a loaded rate of $52.88 if we are a two man operation where both people make same amount of money?"
Jeremy we actually we have discussed this, albeit briefly, in the past (Who has Higher Overhead?) but it is still a real good topic for discussion here and now. The straight mathematics in figuring out a loaded billing rate would seem to tell us that if you add an employee and all your Fixed Overhead costs stay the same then your loaded billing rate should be lower....or should it? There are a couple of problems with that math when it comes to actual real world practice.
Let's say you've figured your time in a one person operation at 80% of your hours being billable and 20% being non-billable and then you decide to add an employee at that same projected ratio without increasing your Fixed Overhead budgets at all. The billing rate should go down. But the problem is when you add a new employee that employee even if they are a better more efficient carpenter than you in all likelihood wont start out at that 80% billable hour efficiency rate. It will take them a while to get acclimated to the new environment, errors will be made (for example a material shortage leaves the new employee sitting idle waiting), and you will spend more of your own time supervising that new employee taking away from (reducing) your own productivity.
And another reality is you may think you can keep overhead budgets that same when you add a new employee but that may not really be true in the real world. You very likely will have to increase the marketing budget to increase the flow of leads supporting your business. As I already mentioned you in all likelihood will have to spend more time managing that employee. Etc. etc. the increases may be very small but they will all add up.
One of the reasons I often say that it is a far better idea to add a talented highly skilled (and consequently more expensive) employee than just cheaper "helper" is that highly skilled employee will likely be more efficient than the "helper" who will soak up a lot of your own productivity.
Still adding a new employee, the right employee, can be a real great way to increase net profits provided you can still charge the same rate you did as a solo operator and still keep your overhead costs in line.
View Image
You should have at least two loads for labor, the first one is based on things that are truly a percentage of salary (like FICA, perhaps some of your insurance). Then you add the fixed labor costs (health insurance, whatever). That yields the load direct labor cost.Now add your total non-direct overhead (this is where the non-billable hours come into play), and divide by the number of billable hours everyone works. That yields fully loaded labor cost.Now add fee, and divide by the same number of hours everyone works.That is the fully loaded including fee labor cost.