Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
Should you lower prices? How much can you afford to do this? There are two factors to consider: the health of your business and the health of your industry.
First, consider your industry. If you’re getting underbid consistently, there are two possible reasons: either your competitors have found a way to operate with lower costs or they’re taking on projects at a loss. What can you do if the latter is the case?
Your competitors can only take projects at a loss for so long. They’re not doing themselves or the industry any favors because they’re driving prices down across the board. If you can stand to wait, they will either fill up with cheap work or not be able to finish the work they’ve taken on. Hanging in there might be the strategy needed to get work that lets you make a profit.
If enough people refuse to come down on price, the market readjusts. This is an important reason not to discount more than you need to. If you can continue to operate with fewer projects, you might make less money in the short term but you’ll survive in the long term.
Next, consider the health of your business. I’d like to walk you through some of the numbers that tell the health of your business and then I’ll address some of the common questions I’ve been hearing.
Break-even points and contribution margins are critical to not only understanding how much you can discount, but also knowing where your business is still strong. The break-even point is the minimal amount of sales necessary to cover your operating costs so there is zero profit or loss. If you don’t already know this number, your accountant should be able to help identify this minimal level of sales to break even.
When you know your break-even point, you know how much work you need to perform and at what price. It can also show you how much your business outlook will improve if you can reduce fixed costs or increase your gross profit. Fixed costs are the costs that remain constant and have to be covered before a profit can be made. Variable costs vary proportionately to the level of sales; for example, your rent is fixed but materials costs are often variable.
The break-even point gives you a baseline to adjust your costs around or to help set your pricing, but there is another calculation that can be as powerful: the contribution margin. This is the difference between the selling price and its variable costs: the higher the contribution margin, the more successful the project. When you know the contribution margins of your projects, you can start to see which ones have been more successful and which to more aggressively pursue.
Now is the time when you should be reviewing your contribution margins. Look for where the margins are highest-this is where you’re making a better profit and should be an area of focus.
Let’s say you have some room between your normal price and the point at which you no longer have a contribution margin (that is, you don’t make any profit.) You can accept work below your normal bid price as long as you still have some contribution margin and provided you have idle capacity in your company.
If people are sitting around waiting for work, it makes more sense to discount. But the more you discount, the more of that work you need to take on to get the same result. If you normally had a 10 percent margin and you discount down to 2 percent, you need five times more work. Be careful not to discount so much that you fill up all your capacity with low-margin work.
This might also be a good time to look at projects with low contribution margins. Because of the low contribution margin, you have very little room to move on the price of these projects. If the low-margin work is drawing resources away from your ability to do higher margin work, you might want to discontinue bidding it.
When you take whatever job comes along, you take on more risk because you may be doing low-margin work you’re not very good at. You may have bid the job thinking you’re going to have a margin, but because of your inexperience in this type of work you lose money and would have been better off not having the job at all.
Even if you have idle capacity in your company, you don’t want to take on a project that you are going to lose money on. This means identifying the work you’re best at and discounting that work before you take on a riskier job outside your core competencies.
In the last year, I’ve seen concerned business owners bid on any work that came their way, well below normal margins, even for work that was a new area for that company. We’ve all seen it before when one bad job in a year wipes out the profit of all the other profitable jobs. If a company is going to continue to be in business it cannot afford to make this mistake too often, if at all.
Another way to give yourself more room with your pricing is to reduce your fixed costs. Remember, fixed costs are the same month-to-month, regardless of sales, while variable costs only go up when your sales go up.
If you have a high ratio of fixed costs to variable costs and your sales tend to be very elastic from month to month, you’ll see large fluctuations in profits each month. You’re going to need to either reduce these fixed costs or stabilize your revenue base to eliminate some of this risk.
Compare your current fixed costs to previous years and what you have budgeted for future years. Also review industry trends for your business. If you see the industry trend is lowering its fixed costs while yours are rising, you need to start cutting costs to remain competitive.
Just because a business is closely held and the share price isn’t readily determinable, it doesn’t mean the owners shouldn’t expect a return on their investment. Owners of closely held businesses should be entitled to a return on the money and time they’ve invested in their business that is equivalent to the risk of being in business. Pricing a product or job too low will not provide the necessary return for their investment.
In the last year I’ve heard many business owners say that they’ve never worked so hard just to try to break even. By paying attention to your margins, fixed costs and idle capacity you can effectively discount your products and services when needed, but discounting across the board isn’t the best strategy.
It’s time to start to increase prices in some areas so that business owners can get back to earning a reasonable return on their investment.
