The day before this column was due, I suffered a serious hand injury which made it impossible to write on a keyboard. I gave up on writing with dictation software years ago, as it is the connection with the keyboard that allows me to do my best work. With my editor’s permission, I dusted off an educational column I wrote almost 18 years ago and updated it, as the concepts all those years ago on how to price a yard of concrete still hold true today. As obvious as the below may seem, it is interesting to see how this gets lost from time-to-time with the noise of running our businesses every day.
As prices fluctuate in our industry, it seems that the competitor down the street gets scared about replacing that last big job that just finished, which is almost always followed by prices that trend downward, and believe me, this is a dangerous trap to fall into. We are often called in to examine troubled companies during times of instability in certain markets, and inevitably, selling price erosion often coupled with spread compression are two of the biggest culprits of falling financial performance.
Pricing a job based upon known internal costs is the key to profitability. We regularly see examples of ready mixed concrete producers who quote a job on a per-yard price that is actually lower than what it costs to produce that yard of concrete. In some instances, pricing concrete below cost is a by-product of a long industry tradition of pricing: the producer that submits the lowest per-yard price usually wins the project.
At some point during the project, the producer becomes aware that he will be lucky to break even on the job. Naturally, the bigger the project, the greater the likelihood that the producer will lose a significant amount of money, potentially crippling the business. These producers then ask us, “How can we prevent this from happening again?” Avoiding a pricing strategy that repeatedly results in projects that are quoted below cost is the key, and the basic tools needed to assure that jobs are quoted profitably are widely available and can assist in establishing a certain margin for the company.
The first step is to determine the variable costs associated with each mix design. Next, the producer must budget yearly fixed costs, which should include SG&A expenses and direct fixed expenses. Once a budget has been developed for fixed costs, the total number of yards for the year is projected, and then the total budgeted fixed cost is divided by the projected yardage to obtain a fixed-cost-per-yard number. Adding the variable-cost-per-yard to the fixed-cost-per-yard will yield the total cost for a yard of concrete produced. A great reference for the various costs associated with the production of a yard of concrete is the annual NRMCA Performance Benchmarking Survey, which provides data on the profit margin for industry leaders and laggards, typical members, members in various geographic regions, and members of similar size.
Armed with this information, we can determine the profit margin a producer requires. This can be accomplished in several different ways, including Return on Sales, Mark-Up over Total Cost, Return on Assets, and Return on Equity. For illustration purposes, I will utilize Mark-Up over Total Cost; to achieve a profit margin of 8%, add the total of the variable-cost-per-yard and the fixed-cost-per-yard, then divide by 92% (1 minus the profit margin percentage). The resulting number is the bid price for a yard of concrete that will generate the desired profit margin.
So what happens if the calculated price is higher than the current market price? First, determine the amount of marginal contribution (i.e., selling price minus variable costs) the quoted job will produce at the current market price as compared to the marginal contribution earned if at the original calculated price. Then there is a decision to be made:
1. Meet the price, which is an easy decision
2. Beat the price, which can lead to a loss
3. Walk away
But there is a fourth option: convince the buyer that your quality and service is worth your higher price.
A producer doesn’t need to re-invent the wheel to establish a quality pricing model. There are a number of commercially available “Job Costing” programs that are easy to implement, and every salesman should be armed with one.
In summary, every producer should determine the ideal bid price for a yard of concrete. The benefits are clear – making more money. The drawbacks are also clear – lowering your return or even losing money.
Pierre G. Villere serves as president and senior managing partner of Allen-Villere Partners, an investment banking firm with a national practice in the construction materials industry that specializes in mergers & acquisitions. He has a career spanning almost five decades, and volunteers his time to educating the industry as a regular columnist in publications and through presentations at numerous industry events. Contact Pierre via email at pviller[email protected]. Follow him on Twitter – @allenvillere.