Thursday, July 2, 2009

Big-Box Installed Services, Part I

About five years ago, we were approached by a big-box home improvement retailer to build decks under their name across the country. They wanted us to create a catalogue of pre-designed projects that their installation services staff could price quickly and sell in the store; and they also wanted us to provide them with labor-only services, since they would be providing the materials.

There were a number of issues that came to mind as I considered the potential relationship. The most important was the concept of a labor-only relationship. From my point of view, that arrangement would remove most of the value my company added, relegating our service to a commodity. That concern was heightened when they asked us for a single square foot price – basically, take our labor cost and mark it up. And since the industry standard markup is 50%, it felt as though we were viewed as just a carpentry service, attractive mainly because we had a presence in 30 states.

So put yourself in this scenario and run the numbers to see how you would fare compared to the retailer: Assume that your labor cost for construction of a simple pressure-treated deck is $5.00/s.f. A 50% markup on the labor would produce a contribution to your company of $2.50/s.f., for a total labor charge to the retailer of $7.50/s.f. Also let’s assume that a simple P-T deck costs the customer $20.00/s.f. After deducting your labor cost and their material cost of around $5.00/s.f. (remember, they’re the supplier), the home improvement company would receive a gross margin of $7.50/s.f. or 37.5% of the selling price. Your $2.50 would be 12.5% of the selling price.

Skilled labor is a scarce resource, and should be utilized to produce the highest gross margin attainable relative to the market value of a project. For custom-designed, custom-built projects, this margin should be in the 40%-50% range. Proportionately, labor costs should be in the 20%-25% range. This means that when you deploy a “unit” of labor, the markup should be 160% to 200% in order to achieve the desired margin. As the labor-only provider in the example above, your markup was 50% instead of 160%-200%; your margin was 12.5% instead of 40%-50%.

Because of this I decided to propose a labor rate far above the industry norm – one that would generate a real-dollar contribution to overhead & profit comparable to that produced on a typical project; with a discount to allow for the fact that the marketing & advertising, design and sales costs would be covered by their company instead of being paid by us as below the line expenses.

However, we still had overhead for these functions, which would have to be covered by non-big box work. So given a choice, we would commit our construction crews to projects that produce the greatest return. But in slow times (economically or seasonally), choice may not exist. So this relationship might make sense if the big box retailer could provide a consistent book of business that would help make the workflow more predictable and cover the monthly nut.

This is just the first set of issues I faced when considering whether or not to provide installation services for a big retailer. Tune in next month for Part II: Can you have a single per-square-foot price for multiple designs installed in different site conditions?

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