The Terrible Lie about Low Overhead
If you are a small company, your overhead is no less than your larger competitors. If you are basing your prices on the idea that your costs are lower, you may be killing your company and cheating yourself and your family.
Many of you have been lied to. Someone you trusted may have misled you or you may have fooled yourself. Many of you were under the impression that a small company has less overhead than a large company. Believing this lie you have kept your prices low; thinking that you did not have the overhead of a big company. That’s a lie and believing it will hurt you!
Owners of small contracting companies (doing less than 1 million in annual sales) are under the mistaken impression that they have less overhead than large companies and therefore can tolerate lower prices. This is not true. While their overhead, in terms of dollars, may be lower than a large company, their overhead, in terms of percentage of sales, is very similar. Here is an example: A company doing $500,000 in sales may pay $500 per month for rent. Rent is equal to 1% of sales. A company doing $2,000,000 may need four times the space and therefore pays $2000 per month or 1% of sales. This means that you and your large competitor both pay 10 cents out of each dollar for rent. And if you currently don’t pay rent, you will eventually have to pay rent. You can’t work out of your house forever.
That holds true for all expenses including Worker’s Compensation, General Liability Insurance, etc. You will need these products eventually so you might as well learn to charge for them now and not latter. If you don’t, you will struggle to pay for these essential overhead items. Many managers make the error of taking on overhead and then trying to pay for it. Make sure you can pay for (IE: higher rate) before you acquire things or take on more overhead.
Larger companies can often make more efficient use of office space, office machines, and other capital assets. These companies enjoy significant buying power and can obtain equipment and material at a lower price and on better terms. They are often able to get better insurance policies and at better rates. Vehicles can be obtained for less and money can often be bowed at lower rates. Employee benefits can be obtained cheaper and large companies often have better choices.
One of the largest elements of overhead is owner(s) compensation. When you became self-employed the idea was probably to make better money than you could while working for someone else. If you work 70 hours per week and get paid $70,000 per year, you have a $15.84 per hour job. If your overhead is low, your own compensation is likely low. That’s nothing to celebrate. You should be charging enough to pay yourself better.
You do not have a cost advantage when you operate a small company. Your overhead (as a percentage of sales) is essentially no lower than most big companies. In fact, it may be higher. You should be working to charge rates that are high enough to pay you and you people and good wage and provide the company with a healthy net profit. The only way to charge less is to short change yourself and your staff.
Great article. I see this all the time in business. Small businesses can go bankrupt if they don’t charge accordingly. Another issue I see is when big service companies approach small service companies and think since they have a 3.0 multiplier, they should be able to buy the services of an independent for 1/3 of what they plan to charge. For instance, they want to charge $150/hour for the independent and then pay $50/hour. to the independent. I have no idea how they figure 200% markup when they usually charge their clients 15% markup on non-labor services. I do understand a higher markup for labor due to additional risk associated with labor vs other stuff being marked up, but 200% vs 15% makes no sense. The funny thing is, most of the big service companies have high paid accountants with MBAs and they still can’t understand this simple concept. Cheers