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What if we told you the secret to having a profitable custom home-building company does not include cutting costs or taking on more projects?
In this article, we reveal the three most common mistakes residential builders make when trying to increase profitability in their building companies.
By avoiding these pitfalls, you’ll also prevent attracting problem clients, cash flow challenges and, potentially, financial ruin.
#1: Offering the Lowest Price Wins the Project
Many custom home builders think they have a better chance of winning the project if they offer the lowest price. However, this approach can be a double-edged sword.
Offering the lowest price attracts problem clients who are focused solely on cost.
These types of clients are always looking to make changes to the scope of work but are not prepared to pay for the additional costs incurred. They will argue that any omissions in the contract are your fault and will question any profit you add to contract variations. Attempts to pacify the client by doing variations for free will only encourage these types of people to demand more from you as the job progresses.
Rather than attempting to compete on price, compete on value.
Identify the reasons behind a consumer's decision to want to build rather than buy a completed home. Understand their fears regarding the build process and use guarantees to address those concerns.
Studies show that less than 20% of consumers choose the builder with the lowest price. So, if you are only competing on price, you are targeting a very small percentage of the market.
#2: More Revenue Equals More Profit
A common misconception is that your building company will automatically make more money by taking on more projects.
You may have been tempted to scale up your building company after seeing numerous examples of other builders who have done exactly that.
However, what you don’t always see from the outside is the negative effect that growth has on the fixed expense ratio for a building company.
This is why building companies that grow too fast on inadequate margins and without a business plan always fail within two or three years.
It's essential to find a balance between the number of projects you take on and your ability to handle them using the resources you have budgeted for in the year ahead.
Using construction slots as part of your sales strategy lets you plan when projects will start, allowing you to maximise your resources and resulting in higher profitability. This simple strategy also helps create scarcity and urgency in your sales funnel, helping you to win more projects and increase your profit margins.
#3: Markup Equals Margin
In order to increase your profitability, you must know your numbers…
And to understand your numbers, it’s important to be clear on the difference between markup and margin.
Markup is the percentage added to the cost of sales. In other words, markup is the difference between the cost and the selling price (gross profit) as a percentage of the cost price.
However, this is not the same as the margin.
Margin is the gross profit as a percentage of the selling price.
A common mistake small building company owners make is adding a markup percentage to their cost price but then using the same percentage to calculate the likely profit on the selling price.
For a builder, adding a 20% markup - which is not recommended! - to their materials and labour (COGS) means they have only added a 16.6% builders margin.
If that builder claims $100,000 from their client, they may believe that they have $20,000 of profit sitting within that $100,000. However, because they only added a 16.6% builders margin, they have just $16,666 of profit included, and that’s before taking into account any cost overruns!
When you consider that the average building company operates on a 15% fixed expense ratio (Source: SORCI 2023), then that only leaves 1.6% net profit, which is not nearly enough to cover contingencies, let alone grow a residential building company safely and securely.
This is why professional builders building new homes markup their COGS by 33.33%, which is a 25% margin, in order to clear a 10% net profit after drawing a market salary through their fixed expenses.
Renovation and Remodelling companies markup their jobs even higher, typically around 55-60%.
By understanding your profit margins, you will have a clear view of how much money you're really making.
Increasing your profit isn't about offering the lowest price or taking on more projects; it's about making informed decisions that lead to steady growth.
To fully understand how construction financials work, the margins you need to be operating on and the strategies that will enable you to charge more while delivering a better building experience to your clients, you need to read Professional Builders' Secrets.
Click on the link below to find out how to get it for free.
