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Gross Margin and Pricing Policies

The sales goals you set will tell you how much money will be available for operating expenses, net profit, and owner income, but you also need to know your company's gross margin (GM).

Once again, actual past performance becomes the basis for future projections. You can learn last year's actual gross margin from your year-end profit-and-loss statement. The gross margin is calculated by subtracting all direct costs — or cost of goods sold (COGS) — from total sales.

It helps to consider this figure both in dollars and as a percentage of sales.

For example, if total remodeling sales amounted to $679,542, and your direct costs were $489,270, your gross margin was $190,272, or 28 percent of sales.

If you expect to sell at the same prices and produce at the same level of efficiency, it is reasonable to use a 28 percent gross margin as your benchmark in setting next year's budget.

To assess whether your targeted gross margin will be adequate, you need to project operating expenses and net profit. Begin by reviewing last year's actual operating expenses and net profit as shown in your year-end profit and loss statement. Examine each line item of operating expense.

• Is it likely to change? Up or down? Why?

• Will you incur new operating expenses next year? By, say, opening a new office or hiring a bookkeeper?

Answer these questions and thoughtfully estimate next year's operating expenses.

Once you've made a reasonable projection of operating expenses, decide on your net profit goal.

Let's assume for simplicity's sake that you decide on a net profit goal of 5 percent.

Given your sales projections, your gross margin goal of 28 percent, and your projected operating expenses, will you be able to achieve a 5 percent net profit? Or does one of the variables need to be changed?

You might realize that you need to increase prices — which is preferable to increasing sales volume at the same margin — or possibly hold the line on your operating expenses.

Remember, there are only two ways to increase your gross margin: by raising your prices or by lowering your direct costs. Unless you are ready and able to do one of these two things, use your actual gross margin percentage from last year to predict your gross margin for next year.

Your gross margin goal informs your pricing policies. Typically, to allow for slippage, your projects should be priced to achieve a gross margin several percentage points higher than your company target.

That means if your company target GM is 28 percent, you should be pricing individual projects at a 31 percent or 32 percent GM.

Company Budget

The most straightforward way to write a company budget is to mimic the format of your P&L statements. The budget is simply a projected statement rather than a historical one. Instead of actual sales, you insert your sales goals.

Using your projected GM percentage, you can calculate both direct costs (COGS) and GM dollars. Subtracting the projected operating expenses from the gross margin will give you the projected net profit figure.

It's helpful to write an annual budget and then break it down into monthly averages. You can then create a spreadsheet comparing each month's actual performance with the budgeted amounts. Information from this budget tracking report is an invaluable management tool that can help you spot potential problems and take corrective steps before they become critical.

Productivity Goals

The final issue you need to address in your business plan concerns field staff: What will be required to produce those sales? To answer this question, you must analyze past productivity and set productivity goals.

Productivity can be objectively measured by dividing the total value of work completed in a specific time period (a month or week, for example) by a relevant unit, such as lead carpenters or direct-labor hours (DLH).

If your P&L sales figure from last year was $679,542 and you employed two lead carpenters, your output per lead carpenter was $339,771. If your total direct-labor hours amounted to 4,432, your output per DLH was $153.33.

Calculate your last year's actual productivity rate. Use that figure as a starting point for setting objective goals for next year. Remember that productivity can be greatly influenced by a variety of factors. Raising your prices will increase output/direct-labor hours (OP/DLH); using a higher percentage of subcontractors will increase OP/DLH; employing better management and scheduling will increase OP/DLH.

There is no "right" productivity figure across the remodeling industry. The correct figure for you will depend on a mix of factors unique to your company.

Calculating your actual historical productivity rate enables you to predict how many direct-labor hours or lead carpenters you will need to produce your projected volume of work next year. It also gives you a benchmark for working to increase your productivity and measuring the results of your efforts.

For illustration purposes, let's say you set a productivity goal of $185 per DLH. If your sales goal is $824,000, you will need a total of 4,454 direct-labor hours. Assuming a full-time field-staff person works 2,000 hours in a year (40 hours a week for 50 weeks), you will need 2.23 people.

Establishing accurate productivity benchmarks has many benefits. These benchmarks help you schedule projects, anticipate needed staffing changes, and identify individual performance that either exceeds or falls short of company expectations.

Bon Voyage

The first time you write a business plan, you'll most likely need to rely on educated guesses for much of your benchmark data. But as you track actual progress in key areas on a monthly basis, you'll build a company database that will allow you to make accurate predictions and better decisions with every planning cycle.

The numbers in your plan have power only if you know what lies behind them and believe in them. Goals plucked from the air cannot pull you forward. Your plan will be an effective map if you visualize the reality behind each goal and thoughtfully accept it.

As with any endeavor, the most difficult business plan to write is the first one. Once you've done it once and have used monthly reports to track progress in key areas, successive plans will become much easier. Instead of facing roadblocks that seem impossibly congested, you will be able to identify and follow the best avenues for your business, creating a practical map that takes you where you want to go.

Richard Steven is president of Fulcra Consulting, which specializes in helping contractors write their own business plans. He has offices in St. Paul, Minn., and Seattle.

by Melanie HodgdonA bookkeeper tells me, "He flies through here and drops some scribbled instructions on my desk, then gets annoyed when what I do isn't what he was looking for. How can I do my job correctly without getting the details I need? Maybe I should find a different job."

A lead man confides, "I go in to talk about a concern I have and he seems to listen, and I feel good about it at the time — but then afterwards I'm not sure that anything concrete really happened."

Personality idiosyncrasies? Unprofessionalism? Lack of consideration? Not necessarily. Often such comments (and the actions that provoke them) are due to differences in personality styles. There are many systems for classifying styles, and they can be divided into two camps: those that sort people according to inner states (Jungian psychology, for example), and those that sort people according to their behaviors.


Personality Types

The behavioral classifications are easier to understand because they're based on what you see people doing. Among this group are several models, but the one I like best is described in People Styles at Work, by Robert and Dorothy Grover Bolton.

The book is short and easy to read, and contains a simple 18-question "Behavioral Inventory." The authors identify four personality styles based on a grid in which the X axis describes degree of Assertiveness (to what extent your actions are seen by others as forceful) and the Y axis describes degree of Responsiveness (to what extent you are perceived to show your feelings or to be aware of others' feelings).

Each person falls primarily into one of four boxes: high assertiveness and high responsiveness (Expressives), high assertiveness and low responsiveness (Drivers), low assertiveness and high responsiveness (Amiables), and low assertiveness and low responsiveness (Analyticals).

I am an Expressive: My voice is loud, my gestures are sweeping, I am very people-oriented, I offer opinions easily and confidently. My facial expression is open; strangers on the street tell me their problems.

My Driver husband, Ed, is quiet, structured, logical. He struggles with small talk but speaks easily and authoritatively within his areas of strength. His face is less expressive, but people who know him confide in him readily.

My soft-spoken Amiable aunt goes along with everybody in order to make people feel good, and she would never dream of criticizing folks to their face for fear of hurting their feelings. Her expression is animated, she maintains constant eye contact, she's methodical and detail-oriented, and she's skilled at picking up on others' moods. Everybody tells her about his or her problems.

An Analytical for whom my husband worked lacked social skills to the extent that he was unable to engage in conversation unless it was argumentative. He preferred to work alone on challenging problems, was extremely systematic, and had almost no facial expression. Nobody would ever bother to tell him about his or her problems.

It's not hard to figure out that an Expressive would probably be a more effective motivational speaker than an Analytical, and that an Amiable would probably make a better customer-service representative than a Driver.

It's important to note that although the Boltons identify four types for purposes of discussion, the grid is meant to represent a continuum of traits: Each individual will of course have components and behaviors from each of the four boxes. The labels are for identifying each individual's primary or most often displayed behaviors.

Real-Life Applications

The bookkeeper in the opening paragraph of this story is an Amiable. She's detail-oriented; she wants to do a good job, to have the boss appreciate her work, and to retain her place within the group. But fear of displeasing the boss and frustration with his avoidance of detailed instructions are making her consider leaving.

The lead man is an Analytical. He has carefully noted things that could be improved and enters into conversation with a list of questions, grievances, and suggestions to be covered. He is focused and results-oriented.

The boss in both cases is an Expressive with a relatively low logic component. He is charismatic, flamboyant, and impatient; he wants simple, fast solutions. He frustrates the bookkeeper because he's not highly structured and detail-oriented, and it would never occur to him that somebody else needs those qualities.

He fails to provide the lead man with what he wants, too — a detailed plan for improvement and the discipline and attention required to follow through. He's seeing bigger pictures and instinctively says what needs to be said to win back the lead man's loyalty. This is not a deliberate avoidance technique; he's simply behaving in a way that feels natural to him and that takes care of the situation to his satisfaction. And this is why the lead man feels good during the meeting and only later realizes that, feelings aside, no tangible changes have been made.

A Word to the Wise

When dealing with people whose style occupies a vastly different position on the grid than yours, it's important to keep several principles in mind.

First, be aware of your own style and its accompanying mannerisms and needs. Second, consider the other person's position on the grid and acknowledge that his or her mannerisms and needs may be different than yours. And third, modify your behavior and expectations somewhat to allow the other person's needs to be met. Accept that you may want to speak more slowly and softly to an Amiable than to an Expressive, and that you may want to stick to an agenda and reduce small talk when dealing with an Analytical.

This isn't manipulating or giving in; it's acknowledging that our perceptions of — and expectations for — other people's behavior and needs are based on our own, and that everybody's style is equally valid.

Melanie Hodgdonis a business systems consultant for builders. She lives in Bristol, Maine.