Published In September 2000
Successful electrical contracting firms consistently earn higher-than-normal profit margins in the voice/data/video (VDV) market by providing VDV solutions, not just by selling time and material with a markup. Expanding a business paradigm goes beyond expanding its scope of services. It involves the way the company values and markets those services. One of the biggest mistakes that new VDV market entrants make is taking the traditional view that their sole value to the customer is in effectively and efficiently managing the installation process, based on time and material usage. Unlike traditional power distribution work, customers do not view VDV system installation as a commodity because their businesses often depend on reliable communication and control systems operation. Customers are not just seeking hardware installation; they want innovative information technology (IT) solutions. By providing these, the contractor adds value to the project, which justifies higher profit margins. Profit is a necessity Profit is more than desirable: it is necessary. VDV market entry requires the firm to invest its resources into personnel, installation, and test equipment, training, marketing, and other necessities. As in the traditional power distribution market, there is always a delay between when the company pays suppliers and employees and when the customer pays the company for work performed. These necessities and payment delays require resources to be invested in your VDV business. Whether you internally reallocate assets within your existing firm, invest your own funds, borrow from outsiders, or use a combination of these sources, your return on your VDV business investment must be commensurate with your risk. You wouldn’t put your money in a bank that doesn’t pay interest, so why would you invest resources in a business that’s not expected to yield a return? Also, you would expect greater return on your investment if the customer’s risk or value were greater. For example, you would expect a higher return on a newly hatched Internet company than on a risk-free U.S. Treasury Note. Similarly, you would expect a markup to reflect your value to the customer when services you provide require specialized knowledge, abilities, and experience that are unique to your company. Pricing versus costing Pricing VDV work is not the same as costing it. Costing involves estimating the direct and indirect costs of performing the VDV work. Direct costs attributable to the project include direct labor costs, the cost of materials and installed equipment, allocated cost of owned tools and equipment, lease or rental equipment costs, and overhead directly attributable to the project. In addition, home office overhead must be allocated to the project. Costing provides the firm with the projected cost of necessary resources to complete the project. For the purposes of this article, the total installation cost includes both the direct and indirect cost of performing the work. In the traditional power distribution market, pricing is often seen as a function of cost. In other words, a percent markup is often applied to the cost of performing the work to get the bid price. Typically, this markup is either a standard percentage that is determined in advance for all projects or is set for individual projects based on the perceived competition for the work and other internal and external factors. A competitive bid project that is either partly or exclusively VDV for an overall electrical installation may be bid this way. Under conditions where the VDV work is well defined and the customer views the installation as a commodity that can be provided by any number of firms, then competitive bidding is acceptable. However, where the company has the opportunity to assist the customer in project definition and design or bring greater value to the project in some other way, it can use other pricing strategies. Pricing strategies There is a variety of possible approaches to pricing your VDV services. None is right or wrong, it just depends on your market strategy and goals. “Good job,” “plus a markup,” “buy customers,” and “choice customer” pricing strategies are commonly used. Good job. Many small contracting firms working in the VDV market use the “good job” pricing strategy. These companies may have one or more principals who enjoy doing VDV work, like the independence of owning their own business, like working for their existing customers, and have no interest in growing their firm. Basically, the principals of companies that adopt this pricing strategy have provided themselves with a “good job.” These firms are often spin-offs of larger firms and the customer or customers they work for are typically the same ones they worked for before leaving their previous employer to start their VDV business. They also tend to be extremely good in their technical specialty and operate with very low overhead. The “good job” strategy is not effective for the full-service electrical contracting firm that wants to grow with the VDV market. If the company is just recovering its direct installation costs and overheads, or is just breaking even, it will not grow. To grow, the firm needs revenues that exceed its costs, which include the salary and benefits of the firm’s principals. Profits must be available to continually improve and expand the business by reinvesting in people and equipment, as well as to compensate the business owners for their investment and risk through dividends or bonuses above their base salaries. The full-service firm is at a decided disadvantage when competing with a small VDV firm using the “good job” pricing strategy. If the customer is selecting its installer based on price alone, the electrical contracting company will probably not be able to compete because of its cost structure and the desire to receive an acceptable return on its investment. Similarly, if the customer is looking solely for the VDV firm’s service and doesn’t value the electrical contractor’s ability to provide a wide range of services, then the firm should not attempt to compete. Not only should the full-service firm that wants to grow its VDV business not adopt the “good job” strategy, but it should not attempt to compete against companies that do. Plus a markup. “Plus a markup” pricing strategy has roots in traditional competitive bid construction. The “plus a markup” pricing strategy involves costing the work and then applying a percent markup to arrive at the final price. This works in a bid situation where low price is the deciding factor and all bidding firms are perceived to be equal by the customer and the project is well defined at the outset. The problem is when “plus a markup” is applied universally and the markup does not reflect the true value of the services delivered to the customer. “Plus a markup” pricing strategy applied to negotiated VDV work often does not adequately compensate the company for its risk in performing the expanded scope of work or for the greater value provided to the customer for services rendered. This is especially true for design work and for guaranteeing the installed VDV system performance. Buy customers. When entering a new market, companies tend to want to lower prices to woo customers away from their current VDV installation firm. They hope to demonstrate the quality of their work, then keep customers while raising prices. The problem is that, if a customer is willing to switch from his or her current VDV installer for the electrical contractor’s lower price, then the firm is unlikely to be able to raise its prices back to an acceptable level later. If the customer is focused on price alone, he or she doesn’t value the firm’s services. The customer is likely to leave your company for the next opportunity for the next lower-price offer. Another “buy customers” pricing strategy is to lower your price for a prolonged period of time and hope to drive your competitors out of the market. This strategy is workable in highly concentrated and capital-intensive industries, where the larger competitor has the staying power to sustain reduced profit margins or even losses for as long as it takes to drive less well-capitalized firms out of the market. Once competitors are gone, the remaining firm can raise prices and enjoy a near-monopoly position until another incumbent challenges the firm’s position. This looks like a reasonable strategy for a company trying to break into the VDV market, but it has a major problem: construction is not a highly concentrated or capital-intensive business. Construction, including VDV installation, is a very fragmented industry with low-entry barriers. So competitors who are unknown today may be actively competing for your customers tomorrow. Price is not a sustainable competitive advantage. There is always someone who believes his or her business can perform the work less expensively than yours can. Like the traditional power distribution market, the problem in the VDV market is not getting work. Rather, it is making an acceptable profit on the work you get. Choice customer. The most successful VDV market contractors choose their customers. They focus on “choice customers” who understand today’s economy VDV systems are at the heart of their businesses. These customers also appreciate the project management expertise, technical knowledge and experience, dedication to a quality installation, financial and organizational stability, and ongoing technical support and maintenance a full-service contractor brings to the project. These customers value the services they get and select their VDV firm based on factors other than first cost. Pricing your VDV services Whatever pricing strategy your firm chooses to adopt, the price for your services must still be compatible with that strategy. You must also consider other internal and external factors. These external factors include demand, market position, and risk and uncertainty. Demand. Customer demand for specialty VDV services your company provides is a very important consideration when pricing or even deciding to offer certain services. If demand is low, you are probably not going to be able to obtain the markup you would like, and may not want to offer the service. On the other hand, if the VDV services you offer are in high demand, you can certainly obtain a higher markup. How high a markup you set will depend on your firm’s long-term goals, your VDV service’s importance to your customer, and that customer’s retention and long-term business. If you view the VDV service you are pricing as ancillary to your core VDV business and not critical to retaining customers, then you can exploit your market position and charge a higher markup now, knowing that it may attract competitors and result in lost business. On the other hand, if this VDV service is important to customer retention and central to your VDV business, your company may want to accept a lower profit margin in order to retain customers for the long run and make the market less attractive to possible competitors. Market position. Competition as a price determinant is closely tied to demand. If your firm is working in a segment of the VDV market where competition is high and the installation viewed as a commodity by the customer, then the market will typically determine the price through the bidding process. For example, customers often view cable installation and termination as a commodity, because comparable installations can be obtained from a number of VDV firms. The only differentiator is the efficiency of installation, which is reflected in the bid price. On the other hand, if your company is providing unique services, such as system integration, or is a certified installer or authorized representative for a particular VDV system, then you can probably justify charging a premium for your market position. Therefore, pricing of different VDV services may vary depending on your firm’s market position. In fact, for projects that involve various services, the pricing should reflect the reality of the marketplace. Otherwise, you might find the customer divides the project among multiple VDV companies based on price and gives your firm only a portion. Risk and uncertainty. Risk and uncertainty should definitely be factors in setting your pricing strategy. Risk can be in the form of contract or system performance requirements that exceed industry standards. Uncertainty may result from undefined technical requirements, questions about site conditions for a renovation project, or other project factors. The higher the risk and uncertainty associated with taking on a particular project, the greater the markup to compensate. Usually, it is not just one factor that you take into account when setting your price for a particular project, but a combination of these and others. Select your pricing strategy The electrical contractor has only two viable long-term pricing strategies for entering the VDV market: “plus a markup” and “choice customer.” The preferred strategy is “choice customer.” However, to be successful with this strategy, your company must offer customers greater value and educate them about it. If customers don’t understand the additional value your firm provides in meeting their VDV system needs and solving their VDV system problems, this strategy will not work. Your business plan needs to address both your planned customer base and pricing strategy. The two must be compatible for your business plan to provide a realistic picture of your VDV business’s profit potential. If your VDV work is focused mainly on the bid market and cabling and infrastructure, then your pricing strategy will probably be “plus a markup” and your workload, competitors, and market conditions will determine projected profit margins and growth. On the other hand, if you select the “choice customer” pricing strategy, most of your work will be negotiated and you should probably project a lower volume with greater profit margins. Acknowledgement This article is the result of ongoing research into information technology’s impact on the electrical contracting industry that is sponsored by the Electrical Contracting Foundation, Inc. The author would like to thank the Foundation for its continuing support. Dr. GLAVINICH is chair and associate professor of Architectural Engineering at the University of Kansas. He can be reached at (785) 864-3435 or firstname.lastname@example.org.