How do you set your prices? Silly question, right? Everyone knows an electrical contractor looks at the plans and specifications (or what passes for them these days), does a quantity takeoff, estimates the costs of labor and material, adds a markup for overhead, sneaks in a tiny bit for profit, and submits the quote. If you're not bidding on a lump sum, fixed-price job, you will do virtually the same thing, but you will format your final quote using unit prices and work on a time-and-material basis.
Such a narrow viewpoint, though perhaps the norm in the construction industry, ignores the wider possibilities of pricing theory. What's the goal you hope to achieve-profit or market niche? Are you pricing to beat competitors or to cultivate a specialty? A review of your strategy is definitely in order if you can't answer these questions quickly.
Let's assume that you understand your cost structure, your overhead level is well managed and reasonable, and your financial picture is stable. You're making a steady profit, which adds to the equity on your balance sheet, and the long-term market picture looks fairly stable. You need to break out of the comfortable formula you've been using, and decide where you want the company to be five years from now. Your pricing should be structured to meet your strategic plan, not just to keep you afloat. It should be targeted toward keeping your best customers and making it worthwhile to deal with the problem customers.
Decide whether you are determining prices based on company expertise and capability (internal factors) or competitive market conditions (external factors). Of course, you may use a combination of both. Just make sure to reevaluate your strategy regularly.
Using internal factors, your expertise determines the type of work you should be pursuing and the targeting of your marketing expenditures. If you are efficient in a particular niche, or build relationships well with a particular type of customer, then plan your estimates to get that kind of work for that kind of customer. You may be efficient enough to price below competitors in a particular niche and be able to increase your profit while still getting enough work. Or you may work well with demanding customers who are willing to “pay for the best,” allowing you the margins needed to cater to their every whim. Called “skimming the cream,” this approach weeds out the competitors who don't want to bother with the difficult customer, who may be worth the extra servicing in exchange for a larger profit.
Using external factors, you decide whether you want to survive or thrive. In a very competitive market, you may simply need “bread and butter” work to survive-at a very low profit-and keep valued employees working until the market changes. Hanging on is the goal, since competitive “buyers' markets” usually weed out some of the less-sophisticated competitors. Or if you can afford to wait for work, set prices high enough to let work go to your competitors. As they reach capacity, you will get work without sacrificing profit; your company will thrive.
If your goal is to increase market share, you may decide to price work at a loss, driving competitors out of the market entirely. This is a high-risk game and usually works only if you're one of the largest electrical contractors in the marketplace, and moreover, it only works in the short-term. Only car dealers claim to be able to survive while pricing below cost. You can only lose money temporarily without losing your business.
Certain economic theories work in every industry. One rule of thumb is that you can raise prices up to 25 percent while losing only up to 10 percent of your customer base. If that seems farfetched, start by quoting higher prices to the customers who use most of your resources and tax your patience. Those are the ones who make it most difficult for you to profit from their work anyway. Then, make sure your loyal long-term customers are getting your best prices and service.
No matter what strategy you decide to use, performance is the key to your success. Customers who try taking a lowball price and get burned will be far more loyal when they return. It's a fact that price is the first reason given for turning down a seller, but it is almost never the real reason. Relationships are still the path to profit. Just make sure that the price is right for your customers-and for your company. EC
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at firstname.lastname@example.org.