- Newsletter Article -
STOP GUESSTIMATING!
How a cost-based approach can ensure that your quotes are more accurate, competitive and profitable
By Harry Ludwig
Product Manager - Business Solutions
DynaSCAPE Software
Overview
Do you have complete confidence in your quotes? Do they always cover all of your costs and bring in a profit? In this article I’ll show you how using a cost-based estimating system can help you determine more accurate and consistent prices. We’ll be looking at two of the most common pricing methods used in the industry today – unit pricing and multiplier method – and why these methods don’t always accurately reflect the price you should be charging. Then I’ll show you how to determine the costs for each element of a project, and how to use that information to determine the right price for the job.
The problem
Most contractors are extremely good at designing and building stunning environments with quality workmanship. Unfortunately, many do not have a pricing method that they are confident will cover all the costs of a job; much less make them a profit. First, let’s take a look at the problems with the two most common methods of estimating in the industry today and then see how a better alternative, namely the cost-based estimating system, can ensure that your estimates are profitable and competitive.
The Problem with the Unit Pricing Method
The unit pricing method is most often used for hardscape projects and involves simply multiplying the takeoff quantity of the particular item being estimated by a predetermined unit price. For example, if a contractor is pricing a paving stone patio, they would multiply the square footage of the patio by a square foot price of the paving stone to get the total price. This unit price is assumed to include the cost of all materials, labor and equipment needed in order to install the patio. The problem is that it’s hard to know whether everything has been accounted for in this price.
Most contractors base this unit price simply on what the competition is charging for the same type of project, even though you may not be able to do the same job profitably for the same price as your competitors, for any one of a number of reasons. For example, you may use more expensive materials or techniques. You may have better trained and more experienced employees. You may take longer to do the work because you don’t have some of the heavy duty equipment which makes the work less labor intensive. You might have higher overhead expenses than some of your competitors. Or your competitors may be setting their prices at a point where they are not able to make money.
Other contractors base this unit price on what it cost them to do a similar job in the past. The biggest problem with this is that not every job is the same. Some jobs will cost more due to soil type, site access problems, site preparation, travel time, etc. These job-specific conditions simply cannot be accounted for when using unit pricing. What happens when the job you based your unit pricing on was a job with ideal conditions at a nearby location? Any subsequent job you do for the same unit price will be extremely difficult to perform while earning an acceptable profit.
Another problem is that your costs can easily change over time. The costs of materials, fuel and labor may go up or even down. Your overhead costs may increase or decrease over time. Since they are not based on costs, unit prices are not designed to adjust to these changing conditions.
The Problem with the Multiplier Method
The multiplier or material mark up method is another common practice that is often used for planting work. It involves taking the cost of the item being installed and marking it up by a predetermined percentage or multiplier. For example, if a contractor was pricing a planting job, they would multiply the cost of the plants being planted by 3. This multiplier is assumed to cover all the labor, equipment and additional materials required to install this plant. Much like with the unit pricing method, the actual multiplier used is based either on the competition, a previous job or the company’s profit and loss statement. The problems with the unit pricing method also apply to this multiplier method. As illustrated below, the cost of the plant is not indicative of the amount of labor required to plant the tree.
Example using the Multiplier Method:
Item |
Cost |
Labor Cost |
Overhead |
Breakeven |
Profit |
Price (Cost X 3) |
Plant A |
$300 |
Unknown |
Unknown |
Unknown |
Unknown |
$900 |
Plant B |
$100 |
Unknown |
Unknown |
Unknown |
Unknown |
$300 |
Example using the Cost-based Method:
Item |
Cost |
Labor Cost |
Overhead (40%) |
Breakeven |
Profit (10%) |
Total Price |
Plant A |
$300 |
$150 |
$360 |
$810 |
$90 |
$900 |
Plant B |
$100 |
$150 |
$160 |
$360 |
$40 |
$400 |
In this example, the price for Plant A is the same in both scenarios. For Plant B however, the multiplier does not cover the cost of labor and overhead, much less make a profit. In this scenario, the contractor is losing $60 or 20% every time they install this plant. On a $20,000 estimate, this would add up to a loss of $4,000.
Another problem is that even on jobs where the unit pricing and multiplier estimating methods do produce a profitable price, the client may want to negotiate on the price you present them. Unfortunately, neither the unit price nor multiplier you are using is going to allow you to determine what your breakeven price is. Which means that you don’t know how low you can go in your negotiations. If you simply knew all the exact direct and indirect costs associated with this project, you’d at least know when you’re losing or making money on the project.
The solution: Cost-Based Estimating
Though many contractors today still price their jobs using the multiplier and unit price systems, more and more have started to streamline their pricing and go with a more consistent, structured system, and that system is called ”cost-based estimating”. By using a cost-based estimating system, you can ensure that your estimates account for all the direct and indirect costs that will be incurred and will result in a profitable project.
Here's how to do cost-based estimating:
1. Start with the material takeoff
The material takeoff is familiar to every contractor. It basically means going step by step through the design or specification and making a list of all the measurements and quantities specified. These numbers are then used to determine the amount of other materials required. For example, if a contractor is installing a patio, they know that for every square foot they will require a certain amount of gravel or sand as well as the actual paving stone.
2. Determine the costs of all materials
Once you have the material quantities, the next step is to determine the actual costs of these materials. These prices can be obtained from internal or supplier price lists, or by obtaining a quote from your suppliers. Make sure that you include any taxes, warranty or delivery charges at this point. Once you’ve added up these numbers, you now know exactly what the material costs for this job will be. These are all the fundamental costs that cannot be avoided.
3. Estimate your labor costs
Once you know the materials that are required, you’ll need to estimate the amount of labor required to complete the work. This can be done by using production rates that you have from monitoring previous jobs, or by getting an estimate from your supervisor or foreman. You will also have to account for any site specific conditions such as soil type, site access or travel time. Once you have determined how long it will take to complete the work, you multiply those hours by your labor cost per hour. This cost should include payroll taxes, benefits and insurance costs. Again, once you’ve added up these numbers, you’ll know exactly how much it will cost you in labor in order to install this project.
4. Estimate your equipment costs
Once you have estimated labor hours, you will know how many days the crew will be on the job. Based on this information, you can determine the number of days that each piece of equipment will be on site and multiply this by the equipment cost per day. This cost should include purchase costs, maintenance costs and fuel costs. Equipment included in an estimate is usually limited to the actual equipment used to do the work and not the trucks used to mobilize the crew.
5. Include your subcontractor costs
Subcontractor costs must also be determined for any work that will be outsourced. The safest and most accurate way of doing this is by requesting a quote from your subcontractors. In some situations you can use a unit price given by your subcontractor, but it is always safer to have your subcontractor quote each project individually.
6. Estimate all the miscellaneous items
The final step in determining your direct costs is determining any other costs that will be incurred for this project. This includes things like permits, design fees or portable bathrooms.
7. Calculate and recover your overhead costs
All of the numbers we’ve added up so far are the costs that cannot be avoided on this project; these are called your direct costs. You also have other costs that you’ll need to cover on every project and include in your final price. These are your overhead costs which are all the costs that are not directly associated with this specific job, but they are costs that are necessary to run your business. These costs include things like salaries, rent, office supplies, professional services, etc. You need to allocate a certain amount of these costs to each job you do, so that at the end of the year you are able to pay all of these bills.
There are a number of different methods for overhead recovery promoted in the industry today, including the Multiple Overhead Recovery System (MORS), Single Overhead Recovery System (SORS) and Overhead and Profit per Hour (OPPH). There are pros and cons to each overhead recovery method which will be explored in future articles. The important thing, regardless of which overhead recovery method you prefer, is to ensure that every dollar you spend in overhead is recovered in your estimates.
8. Determine the final Price
Once you have estimated all the direct costs and overhead costs for your project and added these together, you will have determined your breakeven price. This will allow you to arrive at your final price by adding your desired profit margin. The final bid price is determined by a number of factors including risk, project size, market conditions, customer impact and how much the company needs this project. Keep in mind that any adjustments to the final bid price without changing the scope of work will affect the profitability of the estimate. Using a cost-based method will give you the confidence to adjust your final price, without worrying whether the estimate will still be profitable.
Summary
You may be asking yourself, why doesn't everyone use a cost-based estimating system? The biggest reason is that it takes more time to price your jobs this way than the unit pricing or multiplier methods. Prices for all materials have to be determined, labor has to be accurately estimated, equipment costs have to be calculated and you have to spend the time at least every year to prepare a budget and determine your overhead recovery numbers. It is certainly a lot quicker to just multiply your square footage by your unit price. However, a cost-based approach allows you to know your costs, to know when you’ll break even, and to bid with certainty. It takes the guesswork out of the estimating process.
This is where DynaSCAPE Manage can really help you save time in a number of areas, by generating an automated material takeoff, a centralized price list, and default labor rates, and by automatically calculating the amount of overhead you need to recover. DynaSCAPE Manage also provides the following benefits:
- Ensure that all costs related to a job are being charged to the customer.
- Allow you to determine your break even price on every job, allowing you to adjust your prices without the risk of losing profitability.
- Keep your pricing consistent from project to project.
- Allow you to create a list of all the materials required for each job.
- Estimate the amount of labor required for each job.
- Make it easier to account for changing costs because you’re always accounting for the exact cost of each material on each job.
- Make it easier to adjust for site conditions.
If you’re ready to stop “guesstimating”, cost-based estimating is the solution that you’re looking for. And with DynaSCAPE Manage, using the cost-based estimating system is no longer too time-consuming to consider.
Fall 2009 Newsletter Article Links:
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Understanding the Difference Between Imaging and 3D Software
- DS|Manage Continues to Grow
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Stop Guesstimating! How a cost-based approach can ensure that your quotes are more accurate, competitive and profitable
