There were family ties between my wife and Ray's wife. We had heard he was struggling in his new career and, with several rooms inside our house in need of painting, we were happy to throw some work his way. We didn't even talk price before hiring him. We could trust him to do right by us.
One day, Ray was still finishing up when I arrived home from work. He pointed apologetically to a receipt left on our dining room table for paint he had bought, for which he took no markup. Although we hadn't discussed it beforehand, it was understood that I would have to pay for the paint and any other materials used in the job. Yet, there was something about his shyness in collecting that made me strike up a conversation about his business. I learned the following.
Ray was going to charge me his standard rate of $35 an hour, which he said was the going rate for both landscaping and painting in our area. That's about what I'd likely pay if I had hired one of the big companies advertising in the Yellow Pages, he said. He pointed out that in the landscaping side of his business, most contractors used undocumented immigrant workers and paid them around $8 an hour with zilch benefits. Nonetheless, he felt that if he charged any more he'd never be able to get enough work.
During summer months his teenage son worked with him. His son's pay came out of the $35 an hour he charged customers. Ray lived about 50 miles away, yet he did not intend to charge us any more than his standard labor rate, even though his battered pickup truck slurped about a third of a tank of gas with each round trip.
Ray had been making $52,000 a year as a factory foreman with good benefits, he confided. He thought he would make more than that working for himself, but the business wasn't going as well as he expected. Didn't have enough customers, was the way he saw the problem.
I liked Ray. That's why I walked him through some basic arithmetic of a contracting business.
Do the MathSuppose, Ray, you had all the work you could handle. Suppose you were booked eight hours a day, five days a week, 50 weeks a year, allowing two weeks for vacation. That projects to 2,000 billable hours a year. Multiple that by $35 and it equals $70,000 in annual revenue for your little business. Out of that you pay your son for his labor, plus all overhead. Don't forget to include the cost of the benefits you walked away from.
No matter how lean you operate, I told him, there's no way your overhead is going to run much less than 20 percent of your revenues. Now do the math. The only way to improve on his former factory job while charging $35 an hour would be to put steep markups on paint and materials, although Ray assured me that's just not done in either landscaping or house painting.
But wait, Ray, your situation is even bleaker. Much bleaker. That's because you don't have a prayer of booking 2,000 billable hours in a year. You'll be lucky to get 1,000 billable hours, and that's only if you spend half your waking hours hustling up work. That projects to $35,000 a year in revenues, minus your son's pay and overhead. Are you beginning to understand why you're having trouble making ends meet, Ray?
Stinkin' Thinkin'The look on his face told me he had never figured this arithmetic before staking out on his own. "Rays" exist in every trade. They never think of doing this kind of arithmetic first. It's just one of the elements of stinkin' thinkin' exhibited by the vast majority of trade workers who decide to go into business for themselves. Here are some others:
- The "going rate" is sacred. Ray didn't dare charge more than what most others in the business charged. Even he admitted they get away with it by exploiting illegal immigrant labor, but he didn't follow the train of logic to understand that he would be little better off than them if he charged customers the same labor rate. Ironically, he was afraid to charge more than the going rate because he might not get enough work, but even with competitive rates his business was on the verge of collapse because he wasn't getting enough work. Figure that one out.
- Overhead doesn't count. When the average consumer hears that a contractor is charging $35 an hour, she or he thinks that's plenty of money. Doing a little arithmetic in her head, the consumer thinks 40 hours of work in a week times $35 equals $1,4000 a week. Hey, that's a pretty good living! That average consumer may know vaguely that there's some overhead involved, but usually thinks in terms of nickels and dimes rather than 20 percent to 30 percent of revenues. A trade worker should know better when he decides to become a contractor, but most don't.
- It's unethical to charge more than cost for materials. Ray didn't even bill me for the time he spent going to the paint store, or for the cash flow deficit he suffered by paying out of pocket. Pickup and delivery of materials is a value-added function that entitles contractors to a markup. If customers want to save a few bucks, give them the option to pick up and haul the goods from a supplier, but most have better things to do with their time. What exactly is wrong with charging customers more for materials you go to the trouble of providing?
- People close to you deserve a break. Even though he faced a 100-mile daily round trip to do my job, Ray refused to charge me more than his pitiful standard labor rate. In his mind, he was giving me a "family" discount. Most contractors are nice guys who will eat various expenses for relatives, friends, neighbors, churches, friends of friends and so on. Of course, most of their business comes via word of mouth from relatives, friends, neighbors, churches and friends of friends, so in essence these favors amount to a lowering of their already inadequate standard prices.
- Price is paramount. Yes, that's all many people are interested in. Low bidder gets the job, end of story. But not everyone's like that. I wasn't looking for the lowest possible price when I hired Ray. I was looking for someone who would do a good job painting my house with a minimum of hassles for me. Many customers are less interested in the price of a job than in the results.
Contractors who know how to market themselves can seek out these people and sell themselves on the basis of quality and innovation rather than price. Unfortunately, nine out of 10 contractors know nothing about marketing except finagling their way to the low bid price.
Calling It QuitsA few weeks after finishing my job, Ray and his wife came to our house for a social gathering. Ray asked me to explain to her the same things I'd told him. I ran through the numbers again and opined that Ray would have to at least triple his labor rate in order to make a decent living, or put hefty markups on the paint and plants he provided to customers or do some combination of labor and material increases. The last option was to mimic the big contractors and hire dirt cheap labor to do the work while concentrating on marketing the business. Ray had neither the will nor skill to do these things, though.
Ray and his wife had trouble believing he couldn't make a go of it simply by doing good work at prices people were used to paying. Yet, try as they might, they couldn't find any loopholes in the stark arithmetic. They moved out of town a few months later to pursue a different dream in a distant state. They struggled mightily for a couple of years, but recently I was happy to hear their fortunes had taken a turn for the better as both found steady jobs at decent pay.
Should I feel guilty about having extinguished someone's entrepreneurial fire?