Episode 15: How To Price Your Jobs With Russ, Sky and Andy

In episode 15 of the Professional Builders Secrets podcast, our host, Bosco Anthony is joined by Co-founders of the Association of Professional Builders Russ Stephens and Sky Stephens, along with APB’s Head Coach, Andy Skarda. Throughout this episode, the trio reveal how builders should be pricing their jobs. 

The Association of Professional Builders is a business coaching company that helps residential home builders across the globe systemise their building companies. Specialised coaching on sales, marketing, financials, business operations and even personal development in order to operate a true professional building company.

During episode 15 of the Professional Builders Secrets podcast, Russ, Sky and Andy discuss how builders should be pricing their jobs, the difference between net profit vs gross profit, markup vs margin, how to stay on top of fixed expenses and SO much more!

The traditional method of pricing jobs is to apply a margin to the cost of sales. The problem with this method is that you are hoping you will make enough profit to cover your overheads and wages. Building companies with revenues of less than $6m DO NOT enjoy the same economies of scale as traditional businesses like manufacturing or retailing. 

This results in builders making little, or no net profit at the end of the year, despite taking on more work and increasing their revenue. When a building company grows, their net profit margin decreases, even when they don’t reduce their margin, they can still end up losing money.  The problem lies in the method they are using to price their jobs, and during this episode, Russ, Sky and Andy reveal the secrets to avoiding this problem. 

Tune in to the full episode to hear the APB trio uncover how builders can price their jobs for profit. 

 

Russ Stephens - Co-founder

Co-founder of the Association of Professional Builders, Russ is a data analysis expert who has introduced data-driven decision making to the residential construction industry. Russ is also a proud member of the Forbes Business Development Council.

Connect with Russ

 

Sky Stephens - Co-founder

Co-founder of the Association of Professional Builders, Sky specialises in taking complex business strategies and converting them into actionable step-by-step guides for building company owners. Sky is also a proud member of The National Association of Women in Construction and the Top 100 Women in the broader construction sector.

Connect with Sky

 

Andy Skarda - Head Coach 

Head Coach at the Association of Professional Builders, Andy specialises in helping business owners in the building industry identify and implement the skills and systems they need to be successful, without needing to go back to school. Or more importantly, without going bust.

Connect with Andy

 

Timeline

1:09 How builders should be pricing their jobs.

2:46 Net profit vs gross profit.

3:49 Margin vs markup.

7:35 Why builders need to stop focusing on dollar amounts.

12:04 Staying on top of your fixed expenses.

14:53 How builders increase margins and stay in demand.

21:52 The pricing strategy for success.

28:50 Why more clients does not equal more profit.

33:30 The industry benchmarks you need to aim to exceed.

 

Links, Resources & More

FREE DOWNLOAD: Professional Builders’ Secrets To Increasing Margins
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Join the Professional Builders Secrets Facebook group for builders & connect with professional builders world-wide.

Bosco Anthony:

Hello and welcome to the Professional Builders Secrets Podcast, a podcast by the Association of Professional Builders (APB) for building company owners, general managers, VPs and emerging leaders. Here, we discuss all things running a professional building company from sales processes, financials, operations and marketing. Today I'm joined by Co-Founders Sky and Russ Stephens, as well as Andy Skarda, Executive Business Coach and Head Coach for APB. Welcome everybody. I’m excited to speaking to all of you today.

Andy Skarda:

Hi, Bosco.

Russ Stephens:

Hi, Bosco.

Sky Stephens:

Hi, Bosco.

Bosco Anthony:

A key component to running any successful business is getting pricing right. Plenty of good businesses fail every year because they use the wrong pricing model. So, tell me, how does a building company price their jobs?

Russ Stephens:

There's a common practice, I think, within the industry where typically a builder will mark up their cost of sale. That’s materials and labour that can be directly attributed to a job. They'll calculate that as a total and they will simply add a percentage markup to that figure. At the end of the day, they'll then hope to get to the end of the job and make a net profit, i.e., they just hope they're going to cover all their fixed expenses. But the best practice for a building company is to follow what we call the pricing for profit method. That is where you will calculate a net margin that goes onto your jobs rather than a gross margin. That's really important, because the fixed expenses for each job will vary. So, you've got to understand your fixed expenses, and then you need to apply that on a per job basis.

Russ Stephens:

Obviously, the longer a job runs, the more fixed expenses need to be attributed to that job. The shorter ones will have a smaller amount. But by understanding what that figure is on a per job basis, and then adding that to your cost of sales, what you're now effectively doing is adding a net profit. The reason that's so important is because we're all in business to make a net profit rather than just a wage. A lot of building companies that we see are simply operating at breakeven point, i.e., the owner is drawing some earnings and there's nothing left over at the end of the year.

Bosco Anthony:

What's the difference between that gross profit and net profit? You know, these are two interesting terminologies. I just want to dig a little deeper there. What do you think the difference is there that builders should really pay attention to?

Russ Stephens:

Gross profit is the revenue; say the income from a job, less the cost of sales. That’s the materials and labour that can be directly attributed to that job. The bit that's left over is your gross profit. There are two important numbers there: there is the gross profit as a dollar figure, and then there's that dollar figure as a percentage of the revenue, which then gives you your gross margin. 

Russ Stephens:

Net profit, however, is the figure left over at the end, after all your fixed expenses, which are expenses that can't be directly attributed to a job; they're your office costs, your marketing, your advertising, etc. Fixed expenses are all of those costs, including the owner’s salary as well. All of those fixed costs need to be deducted from your gross profit, and you then end up with a net profit. That's the bit we're all targeting. That's the bit that gets left over at the end of the year.

Bosco Anthony:

You mentioned markup and margin. Do you want to just explain how those two terms are different as well?

Sky Stephens:

If we start with margin, builder's margin, it's the amount of gross profit on a contract as a percentage of the selling price. Now, I'm going to do my best to explain this with an example with the figures. It can get quite hard when you're just listening. Anyone listening at home should grab a bit of paper here, so you can write these figures down, so it can all come together visually, if you're a visual person. Basically, it means that if say you've got a job or a project, and it's costing you $400,000 to build, and you add say a $100,000 profit – that becomes a $500,000 contract. So, the profit on the contract, which is $100,000, is 20% of the selling price.

Sky Stephens:

Then we need to compare that to markup. Markup is the percentage added to the cost of sales. So, if your cost was $400,000, if you were to add 25% which is $100,000, that gives you your building contract. So, the builder's markup is 25% and the margin is 20%. You're probably still following along so far. That's quite simple on the surface. Once it's explained, most builders are nod along, thinking, “Yeah, that makes perfect sense. So, what is the real problem?” 

Sky Stephens:

There are actually two major problems that cost building companies a lot of money. First, if you've got a contract that allows for 25% margin on variations, provisional sums, prime cost items, but you're only marking up those items by 25%, you are actually losing $80 of profit on every $1,000 worth of variations. That's an 8% net margin on every transaction, which in business and running a building company, is huge.

Sky Stephens:

The second problem is a lot more sinister because most building companies' financial reports make no sense month on month. We covered this in one of the original episodes. This is all because of the Work in Progress Accounting Adjustment (WIPAA), and usually building companies do not have this inside their accounts. One month they're up, the next month they're down, so they're just not making sense. And because the financial reports make no sense, builders tend to do quick mental calculations. If we go back to that original example that you might have written down there, if you have that $500,000 contract. Say you've done a claim and you've just claimed $100,000 on that $500,000 job. Twenty five percent of $100,000 is $25,000.

Sky Stephens:

Builders typically at this point think, “That's my gross profit.” But it's not. That's what we need to remember. Twenty five percent was the markup and not the margin. Now we have a builder who thinks they made $25,000, but really, they only have $20,000. And that's a massive problem when that imaginary $5,000 just gets spent. And as soon as you multiply that by having five jobs on the go at any one time, you can see, Bosco, that it's so easy to get into a real mess.

Bosco Anthony:

The builder is basically touching money that doesn't belong to them, which is scary on its own.

Sky Stephens:

Exactly. And that one difference, it's so easy. So, a 25% margin, if you wanted to be achieving that, you need to be marking up by way more than that; it's 33.33%. We can go through all the ratios, but that is the biggest problem.

Bosco Anthony:

And let me guess, the accountant's not bringing this up when they're filing their taxes or they're going in and trying to look at their financial analysis. I'm assuming a lot of these things are being overlooked year in and year out, when they're looking at their numbers, too.

Sky Stephens:

What the accountants are looking at are the actual margins, and they're just thinking they've got lower margins, they're not involved in pricing the jobs. So, it just comes out in the wash so much later.

Bosco Anthony:

Why do so many builders get their pricing wrong and end up in this mess in the first place?

Andy Skarda:

It's primarily, again, a situation where they don't know what they don't know. I think most of the builders who we talk to are taught how to build houses. They're not trained as accountants; they're not necessarily trained as cost accountants. Therefore, when they get into the difference – and although it's a major difference in the way it plays out – most people think, “Margin, markup, what's the difference? It's the same thing.” But, it actually isn't. 

Andy Skarda:

In a lot of cases, those two terminologies are used interchangeably when they are very definitely not interchangeable. So, the problem, as Sky has laid out very nicely, and that builders forget, is that from the time you give the client that contract price, the cost of the job disappears into the ether because every dollar of profit that you earn is now a percentage of your revenue and no longer has any bearing on what the original cost of the job was.

Andy Skarda:

Literally from the point you hand over their contract price, you have to be talking margin. Markup is irrelevant from that point on. So really, it's education. To be totally honest, it's why we exist. The reason why builders get it wrong is because they just aren't trained and educated in the differences and how to apply these things properly.

Russ Stephens:

I think an interesting thing we see as well, Andy, is how many times does it happen? The bigger the job, builders want to trim the margin because they want to win bigger jobs. It's the exact opposite to what they need to be doing. They need to be earning more from the bigger jobs, because they're more complex and they run for longer. What that means is you need more money to cover your fixed costs.

Andy Skarda:

Yeah.

Sky Stephens:

But the worst part of that is building companies think they are earning more because it's a bigger dollar amount.

Andy Skarda:

Correct.

Sky Stephens:

That is the worst part - they're focusing on dollars, not percentages. I remember, Andy, you telling us about one of our builders and this was their massive aha moment. Stop focusing on dollars, focus on the percentage because you don’t want to get sucked in on how many dollars are you earning out of it. No; you are laser focused on the margins. You're not going to compromise that.

Andy Skarda:

Absolutely. Russ's point earlier, I think, is that very few builders track and know their fixed expenses. Therefore, when they are doing that markup on the job, they literally don't know how much they need before they even start making real profit. As Russ said earlier, you're in business to make net profit. You're not in business to make gross profits. So, if you don't know what your overheads are, you don't know what your break-even point is. And you don't make real profit until you get beyond that break-even point where you are covering, first of all, the fixed expenses of your business. 

Andy Skarda:

Then there's the problem that most builders undervalue themselves. They almost feel that they don't deserve those bigger amounts of money. They don't realise it's not a question of deserving, it's a question of necessity. For their business to grow and succeed, it's an absolute necessity. It's not a ‘nice to have’. They literally have to be doing this in order to be staying in business, and that's before we talk about cutting margins to get jobs, which makes me want to jump out the window.

Andy Skarda:

Many builders think the way to get a job is to come in cheapest. In simple terms, that's a race to the bottom, because materials cost the same for everybody. With subcontractors, you're drawing them from the same pool. There are three elements in any job: materials, subcontractors and profit. If the first two are fixed for everybody, the only thing you’ve got left to cut is your margin. And when you do that, you are literally putting yourself into a downward spiral and eventually you will go out of business.

Bosco Anthony:

It sounds like many people are doing this subconsciously, because they're not aware of this.

Andy Skarda:

Exactly. Inadvertently doing it, yeah. And they're busy. The piece that we get really heartbroken over is the builders who come to us burnt out, exhausted, emotionally wrecked because they are working 980 hours a week and earning less than what they pay their apprentices. It starts with this question we are talking about today.

Bosco Anthony:

How do builders stay on top of their fixed costs? I'm going to assume that fixed costs and fixed expenditure are the same term here, but how do they stay on top of this?

Russ Stephens:

Yeah, you're right, it's the same term. The way to stay on top of it is, first of all, you've got to create a realistic budget based on what's happened in the past and where you're heading with your company in the future. So, the budget will reflect your growth plans. Once you've got that budget, you then create a plan. You create a 12-month plan and you break it down into quarters and months, and then you can look at that plan. This is where you're going to do a bit of a loop, because once you've done that plan, you might realise that the budget will need adjusting. Maybe the figures, the ratios, aren’t coming out where you need them to be. So, you might need to go back in and readjust the budget, and re-look at the plan.

Russ Stephens:

Once you've done that, you've got a final plan. Now it's time to execute, measure and react. So, it's very important that your business plan doesn't get tucked away in a drawer and forgotten. You've got to be looking at this in detail every month, comparing the plan to what's actually happened and react. Update your business plan. Update your budget. “Are we going to realistically hit the revenue target, which is effectively going to cover our fixed expenses and give us the net profit we need?” 

Russ Stephens:

In terms of the profit and loss, I would urge builders to make sure they've got easy online access. Software nowadays is just so accessible, whether you're using Xero or QuickBooks or MYOB, you need to jump into your profit and loss statement and look at it every day. A lot of people are not going to be as obsessed as me, but if you're not looking at it every day, you've got to be looking at it at least weekly and comparing those actuals to the budget. Just one tip for staying on top of the fixed costs. I'd probably say every quarter, go through your fixed expenses in detail and question every expense. Use zero-based thinking: “Do we really need this expense?”

Andy Skarda:

I think that's a great point, Russ. It's one of those things that in our Private Mentoring program, we actually get the builders to come up with what we refer to as the core fixed expenses. In other words, those expenses that are going to be there in the business every single month, come what may. Then builders need to understand that in some months and therefore some quarters, they're going to have things that are seasonal. They're going to come in either quarterly or annually or half annually. 

Andy Skarda:

I'm thinking of vehicle registrations and insurance premiums and those kinds of things. They need to be aware of what those are, because in that way, you're actually conscious of what the basic number should be. You're also aware of the fact that there may be fluctuations in the month or the quarter that you're in. That allows you to keep track and ask yourself, “Are we in line with what we're expecting these things to look like?”

Bosco Anthony:

How do builders increase margins and still stay in demand?

Sky Stephens:

I love that question, because when we always say that builders should be increasing their margins, it's the first thing everyone comes back with: "If I just increase my margins, I can't win the jobs. Can I?" You know, plain and simple, no, of course you can't because you can't just increase all of your prices. You know, certainly if they're quite low margins, to then hit the industry benchmarks could be quite a swing. You can't just do that overnight and expect everyone to still sign up with you because you instantly can show that value. No. You actually need to demonstrate a lot more value, and you know how you can do that? It’s going to be through better marketing. We've talked about this previously: marketing has the direct correlation to your margins.

Sky Stephens:

If you can invest into a proper, detailed, regular and valuable content marketing strategy, that's how you can influence your margins. The reason why is quite simply because you are attracting a better quality lead. You are going to be attracting the kind of consumer who wants to pay a premium to go to a professional building company that can handle everything for them and deliver a wonderful client experience. 

Sky Stephens:

The way you show that isn't by talking about yourself constantly and just saying, "Come and build with us," and doing very B minus kind of marketing. No, it's a proper content marketing strategy. We're talking about helpful regular content articles, getting in front of the camera, sharing some tips about designing a dream home. Talk about how to design a home that fits your unique lifestyle. Give suggestions for some things people may want to include in their kitchen design or whatever it may be. Get helpful, and make sure that you are visible everywhere.

Sky Stephens:

You are putting this on your website. You are publishing these videos online on Facebook, on Instagram and on YouTube. Make sure you are showing up and posting regularly on those platforms. Make sure you are following up everybody professionally and regularly in the background via email, and that you've got a very good, detailed and systemised sales process so that you can get back to people promptly. You follow up. You are taking people through a systematic approach to getting them into some concept designs. Then you are refining those designs. Then you're doing a preliminary building agreement before getting into a contract. That is how you win high margin contracts.

Russ Stephens:

The beauty of this is its simplicity as well, because it's all supply and demand. That's all we're talking about here. We're talking about generating more demand for your services. When you do that, not only can you grow your building company, but this is how you increase margins. Very simple stuff.

Sky Stephens:

Yeah. The bigger the line, the longer people are willing to wait, and they're willing to pay more.

Andy Skarda:

The point that Sky made is that you've got to improve the number of people you help on an ongoing basis. That content marketing side where you are educating and delivering valuable content that helps people get into the home that they want within the budget that they want. I heard this wonderful metaphor for dollar bills – they are actually people giving you certificates of appreciation. And essentially, if you make people appreciate what you do more, they'll give you more certificates. It's as easy as that.

Sky Stephens:

I love that.

Bosco Anthony:

That's a great analogy. Well, what is the recommended business model for builders moving forward now that they know a little bit more about the financial awareness of these terms?

Andy Skarda:

I think it's a great question, because what we find with a lot of builders when they come to us in the early days, is that they are trying to be all things to all people. It’s that age old story of Jack of all trades, master of none. The problem is, if you spread yourself too thinly, it's almost impossible to run a business at a level that makes it ongoingly profitable. So, the first thing we always say to people is they must determine their niche. What that really means is, we want them to identify a particular part of the market that they can dominate, that they become the go-to person for that particular geographical region, that kind of home at that kind of price point.

Andy Skarda:

As soon as they do that, to go back to what Sky said earlier: they're not trying to market themselves as professionals in every kind of building to every kind of person. They are now starting to become that specialist. The wonderful analogy is obviously out of the medical world. You go to the GP – what does he do? He gives you a referral to a specialist. The specialist demands significantly more money per hour than what the GP does, because he has specialised in a particular realm of the medical field. It's exactly the same principle here. 

Andy Skarda:

One of the other ways that you can add that additional value that Sky mentioned earlier is to go into the design and build side of things, not just the build side. For a lot of people, the frustration in building a home comes from the fact that they get it designed and drawn up by an architect. They're given a price guide, which they then take to a builder and they find that the price guide is nowhere near the real cost of building that home. 

Andy Skarda:

If the builder is involved from the beginning of the process and actually works with that client on the design side, to make sure that it fits their budget, obviously once again, you are adding value. You're actually helping those clients to get to the home that they want to get to. Then, of course, there's the big one, and that is fixed price contracting. Literally globally, across the world, the single biggest fear that most people have when they go to build or remodel or renovate a home is, “I heard it was going to be this price. By the time it was finished, it was double.”

Andy Skarda:

We've got to get to a point where builders are professional in terms of their estimating and adding relevant margins to make sure that everybody is covered. If they can do that properly, they can then offer a fixed price contract and minimise the risk to themselves and particularly to the buyer, which then obviously makes them even more attractive.

Sky Stephens:

Yeah. To add to that, the difference is transforming from being a commodity, isn't it? If you're being a commodity, quoting other people's plans, you can increase your margins pretty quickly the second you take over the design process. If you're a commodity, you're competing against maybe half a dozen to a dozen other builders that these clients shopped around these with plans too, to get quotes on. 

Sky Stephens:

How are you competing on value? You're not. You're competing on price because they don't know you from the next builder. They're just shipping out these plans to anyone. What are they going to choose? Of course, the cheapest price. So, if you can transform from being a commodity, just as Andy said, into a design and build company, instantly you can increase your margins a few percent that way. And then it's everything else Andy just mentioned.

Bosco Anthony:

It sounds like what you're asking our builders to do is to build a successful pricing strategy more than anything else right now. I'm just curious, what does that look like? And does that pricing create consistency in growth? How does that growth look like for builders moving forward?

Russ Stephens:

Yeah. Well, I think to be successful, you've got to be working towards and then exceeding the industry benchmarks. As Sky says, margins are linked to marketing. That's key within pricing. We tend to look at pricing and think that pricing is all about the numbers. No, it starts way before then with creating the demand. 

Russ Stephens:

In terms of a magic number, there isn't one particular magic number. We do talk about a minimum double digit net profit margin for builders, but that can go as high as 15%, sometimes even higher. I know there are probably builders falling off their seats laughing at the moment when we talk about 10%, 15% net margins, because that means marking up your jobs in the first place by 33% to 55%. But we've seen it done. We've got the numbers. We've seen this been executed successfully by a lot of residential builders.

Russ Stephens:

It all comes down to supply and demand again, which can really be reflective of what's happening in the global economy and even your local economy. This is because when you have low competition in your area and a good reputation and a lot of demand, that's the time you've got to be making the most of that situation, building up your reserves by heading towards a 15% plus net profit. When that happens, sooner or later you'll find more competition will start arriving on your doorstep. Then your net margins will get pushed down, but at least you've got somewhere to go. But you never really want to go below 10%. That's pretty much the operating benchmark for a successful building company, between a 10% and 15% net margin.

Andy Skarda:

Just to underline that it's important to anybody listening, we're talking net margin, after all of your overheads and fixed expenses have been covered, because that's the critical piece.

Russ Stephens:

Yeah. We don't want anyone thinking, "Oh yeah, my job's up by 15%. I'm going ahead." No. If you're marking up by 15%, you are probably breaking even at best, but more likely, because it's a markup, you’re losing money.

Sky Stephens:

This ties it all the way back to exactly what you were talking about in the beginning, Russ. When we’re talking about our formula of pricing for profit, it’s all about net. When we talk to so many builders, we talk about their margins, net margins. Anytime a builder talks about their own margins, all they're talking about is gross.

Andy Skarda:

Gross, yes.

Sky Stephens:

Which again, you can mark up your costs of sales, your materials and your labour to get a gross markup. But when we talk pricing for profit, we want to ensure you get a net profit inside every single project so that there's a net profit at the end of the day in your entire company.

Andy Skarda:

Yeah, and I think the important thing, Russ, in terms of what you mentioned earlier is that we are very fortunate that we work with builders all over the world in every element of the residential construction industry at every size and at every level of business development. So, when we talk about builders who are achieving 25% gross margins, 10% to 15% net margins, that's not a particular type of builder. That is literally in most cases, the minimum that we are striving for. There are guys who are achieving more than that in various parts of the world, in various parts of the building industry. So, it's absolutely achievable.

Sky Stephens:

To add to that, if we go back to something you were saying before, Andy, I think there was the reluctance to increase those margins.

Andy Skarda:

Yeah.

Sky Stephens:

There was a reluctance to charge that because you don't feel like you're deserving. I don't think we've had one member who has increased their margins and regretted it, but you tell me.

Andy Skarda:

No, absolutely not. Absolutely not. I think the point you're raising there, which is important, is this: if what you are going to do as a builder is go after being the busiest builder in your city, well, that's up to you. But I think most builders that think this through logically would rather be the most financially successful builder in their city. 

Andy Skarda:

Many guys come to us with their plans to grow their business, want to double the number of jobs that they're doing at a ridiculously low margin. They've realised they're only making $2 on a $1 million contract, and if they want to make $20,000, they must do 10,000 of those $1 million contracts. If you move your net margin and obviously your gross margin up by one, two, three or five points, the compound effect that has on working less and earning more is phenomenal to see. And when builders get that, their lives change forever.

Sky Stephens:

Remember our comparison, Andy, for the clients? I think builder A versus builder B. We had a little example of traditional pricing versus new pricing, which is pricing profit. We launched builder A versus builder B to all of our private clients. I remember you saying that builder A and builder B are famous among the builders now. It just compared a three year growth of doing the exact same projects, investing actually slightly more in marketing on builder B, who was using the new pricing model. Their fixed expenses went up, but they were doing the same number of projects every year trying to grow. 

Sky Stephens:

They were just pricing different, literally. Builder A, who was using the old module, started to lose money, and the worst part is they probably didn't realise it. But with builder B, we were doing so conservatively. We were using tiny net margins, but he made money every single year. And that, I think, is the kicker. If you are pricing wrongly now, that's painful. But wait until you grow, because that's when it gets really painful.

Andy Skarda:

Yeah.

Bosco Anthony:

I'm just curious. What is the percentage of builders who come to APB, thinking they've got their numbers figured out and their margins and their markups, and then they have this shocking revelation that they've been doing it wrong all along? Is there a percentage or a number?

Andy Skarda:

In terms of the guys who we work with in the Private Mentoring program, I would say it could easily be as high as 85% to 90%. Again, I'll go back to what we said at the outset. That's not because they're not intelligent. It's just that they've never been trained. They've never been shown the implication of some of the decisions they're making or not making. What is even more noteworthy is when you show that 90% of builders how it really works. You literally see the tension lift out of them. That aha moment: “Ah, that’s why every job I work my backside off on, I lose money on.” They see it in black and white, which is an absolutely fantastic revelation.

Sky Stephens:

Or just immediately, “Oh, there's my couple of percent or my few percent, because it was that markup and margin difference.” It’s as quick as showing it like that, and it’s done.

Andy Skarda:

Yeah.

Bosco Anthony:

It's vanishing cash, isn't it? “So, that's where it went.”

Andy Skarda:

Yeah.

Bosco Anthony:

It goes back to that old saying ‘When you know better, you do better,’ I guess. Do you get builders coming to you saying, "Let's just take on more clients to solve this problem"? Is that a common question that you guys get, too?

Sky Stephens:

Totally. As Andy just said before: “I'm making X amount of net profit on 10 projects. I'm just going to do 20 projects next year. That's how I will grow.” Yes, that could logically make sense, but not in the real world because your fixed expenses go up exponentially, compared to that. But also, revenue is sexy. We all chase revenue. We suddenly have our big building company. The more revenue we have the better and we suddenly have a big company that we can be proud of. There's a really great, fascinating book, which you may or may not have read, called Profit First. It's by Mike Michalowicz. It's a very simple, yet profound book. It's helped so many people, and essentially, he's talking about profit first.

Sky Stephens:

I'll park that idea for a second. Something he raises in the book, which he talks about quite extensively, is not comparing companies on revenue. It means nothing. That's just how much you're taking into the business. Instead, it's actually comparing them – and I'm going to oversimplify this – on their gross profit. He actually has a little bit more to that formula to make the gross profit, but in terms of a building company, let's say gross profit. So, it's the revenue minus the materials and labour, the gross profit figure, as Russ explained just before. That's really what you should be judging a building company on and comparing them, because it's no use comparing a building company's revenue to the size of the building company. When you are building homes, you can hit $5 million with one job if you're building quite amazing homes, or you can do a lot of little projects to hit that amount. So that's semi-irrelevant.

Sky Stephens:

Let's compare a building company that makes $1 million a year in gross profit compared to another company that makes $10 million a year gross profit. They are very different companies. So, let's talk about that. Then you're actually able to talk about margins, and then we want to know what your fixed expenses are, certainly as a percentage of your revenue. Then we can work out what your net margin is. I know that's a super long answer, but some builders think, “I wish we could just take on more clients. And then that solves all of our problems and our margins go up.” 

Sky Stephens:

But your fixed expenses go up exponentially when you start to grow, because suddenly that's a lot more staff. You're investing a lot more in marketing. Suddenly you need more software and systems. So those fixed expenses never stop. If you keep chasing that revenue, you are literally going broke.

Russ Stephens:

I see this a lot in the information coming through from builders on our database, asking them about where they want to go. It's always about growing the building company with no regard to actually growing the margins. I imagine you see this in a lot of detail, Andy, as well when they come through to mentoring.

Andy Skarda:

Yeah. And in fact, I think in terms of Bosco's original question, does taking on more clients solve the problem? I think it actually exacerbates the problem, because we’re talking and we’re deliberately simplifying it down to, “Let's talk about a single job and easy numbers.” When you've now got multiple jobs at different stages – and I think we spoke about this in the WIPAA – building business's finances can get very complex. If you don't have this under control and you don't understand the basic principles and all you do is try and add more load to that, it's just going to fail more quickly, unfortunately.

Sky Stephens:

It's 100% why we have our saying that we probably sound like a broken record, but at APB we will grow building companies, but safely and securely. We will never grow an unprofitable building company. We talked about this a few episodes ago, or maybe in one of the original ones. But Russ and I went to an event with a very well known, renowned business coach generalist, who was great at marketing. On stage, they were boasting about working with a building company. Its systems were so good. They were able to scale up and grow, because growth is sexy. They grew the revenue. They really took on more clients. They did so well, but they grew it so well and so fast that the building company totally failed. We are not helping our builders to be chasing that. We're not here to chase the revenue. Let's help them chase better margins and profit so that they can be very safe and secure as they grow.

Russ Stephens:

Yes. That’s what APB is all about, isn't it? Fundamentally, we have people coming to us who want to grow their building companies, but we never attempt to scale an unprofitable building company. We always start with the financials, which then leads us to fix the margins first and put that company in a position where it can be scaled.

Bosco Anthony:

What are the industry standards of benchmarks that builders should be striving for? Do they vary based on geographical location?

Andy Skarda:

I don't think they vary based on geographical location, but there may be slight differences within the kind of building that the builder is doing. So, we would expect to see slight variations in gross profit on, for example, somebody building new homes versus somebody doing renovations or remodelling of homes. 

Andy Skarda:

Generally, we'd expect the gross profit on the remodelling jobs to be higher. The reason for that is quite simply, you're taking a far bigger risk. When you're building a new house, let's call it from scratch, you're in control. You've got a blank canvas. You have far greater control over how that project is going to run and what the eventual outcome is going to be. When you take the drywall off a 120-year-old building, you have no idea. Not only is Grandma buried behind that wall, but there's all kinds of other snakes and dragons and things waiting for you.

Andy Skarda:

That would be the first one. The gross profit obviously must be something that you're very well aware of. But in terms of the business as a whole, as Russ and Sky both said, net profit is actually where it's at in terms of making sure that you are at that double digit level. Staying there consistently is really the key. You don't want an up and down feast and famine kind of world. You want to be hitting those margins and then delivering the projects at those kinds of margins. 

Andy Skarda:

We do look at things like the relationship between your fixed expenses and your revenue as a percentage, because that really plays a large part in what's left over after you've covered all of those overheads. We look at what your advertising and marketing spend is and how that then translates through into how many contracts that's delivering, rate per contract.

Andy Skarda:

But the only reason to go into business is so that you, as the owner, have the opportunity to benefit from the outcome of the business. We talk a lot about starting with the end goal in mind. I was going to kind of leave one nugget for builders, the day should come somewhere in their future where they either want to hand the business over as a legacy or they want to sell it. There may well be a time in their lives where they no longer work in the business, but their sole income from the business is the net profit. In which case, it makes a lot of sense to be building that now so that at the point that happens in the future, there's actually something that they can work with.

Russ Stephens:

I think that fixed cost ratio is a really interesting percentage as well, because we've analysed hundreds of building companies, and we’ve found that the benchmark is round about the 15% mark. What's interesting is that companies that are below that mark, typically have a lower gross profit margin as well. The reason their fixed cost rate ratio is so low is because they're scrimping on the advertising, the marketing, which should be around about 3% of their revenue. So, they think they're saving money on the advertising, the marketing, and it's reducing their fixed costs, but it's always at the expense of their gross margin. That comes back to the same principle: it's supply and demand. If you are not generating the demand, then your margins get hammered and that's where it comes out.

Bosco Anthony:

Wow. Well, this has been a very insightful interview. As always, Sky, Russ and Andy, you leave our listeners better than you found them. I hope that we can all start to apply some of this knowledge in our day-to-day applications. Any final words from any of you?

Andy Skarda:

I think the reality is, the biggest thing that builders need to do is to understand that fundamental difference that Sky explained earlier. Get to understand the difference between markup and margin, and then make sure you're looking after your fixed expenses. Those would be the two keys.

Sky Stephens:

Yeah, I'd probably agree with that. In our experience, with fixed expenses, not enough business owners in general, but specifically building company owners, are going into their accounts regularly and actually reviewing their fixed expenses. We call this cutting the fat. Russ mentioned do it quarterly. You probably will have to do it monthly for a period of time if you've never done this before. Go through line by line all of your fixed expenses and just be very objective. Do you need this? Do you still use that software? Because no joke, when we walk members through this and they're doing it for the first few months, they find software they thought they cancelled. They've not been using it for months. Get a handle on your fixed expenses would be my biggest tip.

Andy Skarda:

Yeah.

Russ Stephens:

Yeah. Definitely know your numbers, because I think what we do see is when you know your numbers in business, that leads to a mindset change and you start to value yourself. You value your time, and you get a bit angry because you realise that you've been building houses for no profit, to benefit people who are already quite wealthy.

Sky Stephens:

You don't want to be bitter, that's the thing. It's not a nice emotion. If you can get through that as quickly as possible, then you can move into being optimistic and actually making that profit.

Bosco Anthony:

Well, on behalf of our listeners today, thank you so much for joining us. We really appreciate your time and your insights.

Sky Stephens:

Amazing.

Andy Skarda:

Always a pleasure.

Russ Stephens:

Thanks, Bosco.

Bosco Anthony:

Thank you for listening. Remember to subscribe to Professional Builders Secrets on your favourite podcast platform and leave a review. To learn more about how the systems of APB can help you grow your building company, visit associationofprofessionalbuilders.com. See you next time.