Subcontracting has always been a unique business. There are many extra challenges a subcontractor faces that other businesses do not. In most business models, you develop a product, develop marketing strategies, buy raw goods, fabricate and then sell the value-added product. Reality television shows today focus on these fundamental principles. These shows are certainly entertaining but subcontractors have to deal with much more.
Subcontractors are called specialty contractors for a reason. They are not general contractors, which even the name infers general knowledge; you are a specialty expert. If you think this is an exaggeration, a litigation example will quickly highlight my point. You will likely be asked about your license and training in your trade. You must convince them you have expertise—otherwise, why are you calling yourself a specialty contractor? Smart attorneys point out general contractors and architects are relying upon your expertise.
What about pricing? Consider most businesses can see their competitor's pricing by merely walking into a store. When the subcontractor hears, “Your price is too high,” how do you know it is? You can’t pick up the phone and ask your competitor. Even if they told you, would you believe it? Subcontractors must rely on their experience, knowledge and established production values, and can only guess what a competitor’s bid might be.
What about the workload? It is almost impossible to get the right amount of work. Most subcontractors will agree their world is feast or famine. When you hit that sweet spot, it feels incredible but experienced subcontractors know it won’t last. The labor—or more accurately—the lack of skilled labor, is a significant concern that shows no signs of improving.
One state contractor’s license board recognizes that many new subcontractors tend to lack business acumen. The lack of business skills can hurt a skilled tradesperson; it may even finish them before they start. This can be especially true when it comes to pricing the value of your work. One example is known to seasoned contractors as the “20 percent rule.” Twenty percent refers to the industry standard for mark-up regarding profit and overhead. Overhead is that cost that is constant and not directly related to the job. Examples would be insurance, office supplies, utilities, accounting cost, etc. Profit is what is left over after covering all related costs and overhead. Simple and basic, right?
Most bid work, then add 10 percent for profit and 10 percent for overhead. The flaw is highlighted when an owner wants something extra done requiring a Change Order. You calculate the cost of material and labor then add profit and overhead, and 20 percent is commonly acceptable. However, depending on how you figure that percent, it can determine what you truly make in profit.
Let’s say an owner wants an extra that has a labor and material cost of $10,000. If you add your mark-up of 20 percent, it results in a total change order of $12,000. However, if you divide the overhead and profit portion of $2,000 into your costs of $10,000, it only comes out to 16 percent. Since overhead costs do not change and are constant, the missing or drop in 4 percent is from your profit. This revolves around what is known as cost of goods sold. The more accurate mark-up ratio for a 20 percent overhead and profit is 25 percent. If you consider 25 percent of $10,000, it is now $2,500 for overhead and profit. Take this new overhead and profit margin of $2,500 and divide it by $12,500. The result is 20 percent for your overhead and profit.
Being a subcontractor is tough enough without cheating yourself out of a deserved profit. All companies must cover overhead costs and also make a profit to survive. Another commonly overlooked item is that some smaller subcontractors forget to pay themselves. Some simply live off the profit. It would be best if you calculated all your costs—after all, you are not in business for free. Set a salary for yourself; include this number into your overhead. If you take some money out of company profits, great, that is your bonus for a job well done, but it is not your salary.
The reality is there are some excellent skilled workers that should make good subcontractors but they may lack in the business-skill arena. Do not take pride on workmanship to a level where you lose money. You have to feed your family, pay your bills and make the business successful. Getting work for less than your value is not hard and many customers will be only too happy to squeeze all they can get out of you.
Subcontracting is a risky, tough and challenging business. A new subcontractor should carefully monitor material costs, keep good records and seek educational advancement. Being a contractor is being in business and few other businesses can appreciate all the complexities you face.