Example
During the hot property market years in British Columbia, a kitchen design company employed the standard business model of selling an entire kitchen design, buying the cabinets, installing the cabinets, and putting a markup of a few points on the cabinets and the installation. The cabinet manufacturer demanded 100 percent of the cabinet price up front and was frequently late, especially for small customers like my client.
On first examination, it appears that the designer would have a $6,000 job profit on a $35,000 job — a 17 percent profit margin. On a job sheet or a profit and loss statement, it would be difficult to find fault with this model. However, when you considered the cash flow and the market circumstances the picture changed horribly.
First, the dollars paid to the manufacturer for the cabinets — $20,000 — came from the customer’s initial deposit. The entire customer deposit had been used to buy the cabinets.
In order to complete the job, the company had to use its own cash reserves to cover the cost of installation and design. This was a cash flow nightmare for my client. When the cabinet manufacturers did not deliver on time (a frequent occurrence); or delivered only a portion of the cabinets ordered — almost 90 percent of the time — the customers were understandably unhappy. If the customers demanded their money back — and they did — the company did not have the cash reserves to comply.
The company fought to get around this difficulty; upon completion a significant number of customers refused to pay the 10 percent holdback on the entire job — $3,500 or 58 percent of the entire anticipated profit.
The risk-return ratio was wrong for the market circumstances due to the unreliability of the cabinet makers.
In remedying this problem, the business model had to be turned on its head by unbundling the transaction and getting the profit paid first.
Initially, the customer paid the company for a kitchen design. This translated into $8,000 in revenue that paid for the design and overheads. All of the profit to be expected from this transaction was therefore paid up front, plus $2,000 for future costs.
Then the customer was introduced to the manufacturer from whom they bought the cabinets directly. Blame for late or incomplete deliveries came home to roost with the manufacturer and the designer could commiserate but never had to take the blame.
When the time came for the installation, it was paid by the customer to the company and the company paid the installer.
Even better, the design company got a sales commission from the manufacturer.
From a price point of view, the cost to the customer did not change. However, perception of added value did change. In the first place, they believed the designer was getting them the manufacturer’s best price and since they paid the manufacturer directly, they were not being “taxed” by the designer. The customer paid for performance and the designer that designed the kitchen and was paid. When the cabinets arrived, the installer was paid. Even with a normal holdback, the risk to actual profit was minor.
Table 9: Kitchen Design Examples
So, in your business, are you risking large amounts of cash on deals that stand a chance of going sideways? What is the realistic risk? And how do you avoid it?
Five Business Wreckers
In the interests of exploding all the pricing myths I could find, the following carefully places dynamite under some people that can distract an owner from making the best decisions for his or her business.
Ways to identify a business wrecker[7]:
• Business wreckers imagine all business rumors to be true. They believe that all competitors are undercutting them and believe every customer who tells them they are too expensive.
• Business wreckers believe that if sales go down, it is the fault of high prices. They fail to look at the total industry numbers or share of the market the company is taking.
• Business wreckers always concentrate upon some prices only, to the exclusion of others. They also believe that costs are the only factor influencing prices.
• Business wreckers hide in a crisis. They believe that the crisis will blow over without them doing anything about it and that the price they have is the fair price.
• Business wreckers are often honorable people who believe that there is a moral price and a moral profit. As such they are willing to forgo large profits but have no recovery plan against awful losses.
Summary
Wake up!
Examine the ways you do your pricing and estimating. They can be improved. Absolutely!
There is no perfect market with demand perfectly balanced by supply. Even the advent of the Internet and its ability to convey detailed information to millions of customers and clients has not yet altered the supply and demand scale. So if your response to your business woes is supply and demand, then remember Alfred Marshall said that if you could teach a parrot to reply “supply and demand” to every question, you could bestow an economics degree upon it.
Following the crowd by pricing like all the rest is a recipe for the lazy spiral of mediocrity. You can do better. You can get a better price than your competitors. But it will take some examination of your business and pricing methods.
Estimating methods like WAG, SWAG and STICK are clumsy and unprofessional. There are better ways, with the expenditure of either time or cash, to develop methodical estimates with a relationship to cost and get the right price in minutes, not hours. And to get the right price each time in response to your customer’s needs. And be able to teach this method to staff so that someone can buy your business an expect it to make a profit.
Driven crazy by your customer? Perhaps you are the tail wagging the dog instead of the dog wagging the tail? This is a trap where you let customers dictate the price. The business wreckers mentioned in this chapter are all too common. If you drive them out of your company they may concentrate on your competitors. However, listening to the customer can give you valuable insight into the motivations and value placed on your goods and services. But be careful and measure it. Anecdotal evidence is a business wrecker.
And speaking of measuring, you cannot get a better baseline to see where you need to improve than buying a cost of doing business survey for your industry. Armed with these one or two pages, you can examine your business item by item and line by line to see how well you compare. Better than average? Good. Keep up the good work. But never settle for mediocrity. Below average? What can you do to improve?
This chapter was about exploding the complacent attitudes about pricing and estimating that build and maintain mediocre businesses. These businesses consistently underperform, and at the same time cause stress for the owners. The pricing methods described here disguise the fact that the business has not clearly thought through its position in the marketplace; how the business can get top dollar for its services; and how to communicate this value-for-money argument to the customer. The next
