The Way to Profits

A pricing strategy is one of the most crucial business policies a contractor or builder needs to establish. As nearly everyone in this industry can attest, it’s a decision fraught with uncertainty. After all, no one business model governs all circumstances, leaving the builder to rely on everything from analytics to competitor intelligence to gut feelings before rendering the policies and procedures that could permanently impact profitability. Phrases such as “cost basis,” “market basis,” “value pricing” and “psychology based marketing” can lead to endless second-guessing even after the key decisions are made.

To complicate matters, there are many variables beginning with the nature of the construction business that relate to price. Price analytics applicable to a general homebuilder most likely will differ for a custom homebuilder, while the final decision for a subcontractor or a commercial builder may be based on previous winning bids submitted by the competition. Then, there is that ever-growing emphasis on green construction and the costs certain to accompany most environmentally friendly efforts. Despite all of these considerations, one universal rule can be applied to pricing strategy and although it is a cliche, it is still quite valid: nothing can be etched in stone. Prices have to be fluid and market sensitive. It is the only way construction, or any business for that matter, can improve its chances for profitability.

Pricing and Complexity

The National Association of Home Builders (NAHB), one of the largest nationwide trade associations consisting of hundreds of local homebuilders, is well aware of the myriad of issues associated with pricing decisions. NAHB offers numerous courses and workshops aimed at teaching its members about the elements involving in pricing strategy and how to explore marketing opportunities after pricing has been established.

Some of the topics covered by the NAHB include understanding “key relationships that should exist among company strategy, finance and marketing,” as well as connecting price, place and product with promotion. All of these topics are important components for every builder’s strategy.

Sometimes approaches to pricing can run counter to established logic. In today’s economy, the prevailing wisdom among homebuilders might be to emphasize attracting cost-conscious customers with low prices, but some builders and contractors in Southern California have taken an opposite view. According to an August 2010 article in the Los Angeles Times, “savvy builders raise prices several times before they ever get to a grand opening, which is the event most buyers take as a signal that the builder is ready to start taking orders.” Psychology is clearly part of this pricing strategy, as builders in a none-too-subtle way encourage customers to purchase now before the prices go up again. In fact, prices are certain to increase again if the market responds positively to this approach.

Also included in the equation is market intelligence, since there is no way pricing can be determined solely based on operational and material costs and abstract profitability targets. Powerful analytics have been developed for just that purpose and some certainly are within the range that the smaller or mid-sized builder would consider affordable.

Technology’s role in understanding market and demand is growing in acceptance, and companies may feel bound to have this type of support when determining the pricing they hope the market will bear.

Positioning, usually associated with marketing, applies to pricing strategy as well. A builder’s ability to attract interest largely may be due to public perception of the product. It helps the customer to know in advance if the business is a low-cost tract housing provider or an upscale custom homebuilder. Here, too, any decision on positioning should be made with sophisticated data on sales probabilities, demand and public perception of the company and its track record.

The Pros and Cons of Price

Businesses learned long ago that every pricing strategy has its upsides and downsides, and both are dependent on public perception. Low-cost providers have to deal with questions about presumption by wary buyers of cutting corners, inadequate workforce and, possibly the most sensitive item, an ongoing demand from customers for even more discounts. Homebuyers, sensing control in negotiations when there is a glut of unsold new homes in their market, will demand additional discounts, which will place even more pressure on margin, price and profitability.

This issue is not limited to potential homebuyers. Think of the phrase “squeezing the supplier” and recognize that this is an ongoing dilemma for every subcontractor, especially those with low profit margins. A pricing strategy has to take account of these possibilities especially in an uncertain economy.

Don’t assume that these problems are limited to the low-cost end of the spectrum. Even premium homebuilders have their challenges. If there is widespread resistance to a fixed price, the builder has unwittingly alienated a segment of the market that might mean the difference between cost absorption and profitable investment. In a June 2006 article in Residential Design & Build, writer Jay Grant suggested that custom builders avoid fixed-price strategies and instead consider cost-plus. Noting that custom buyers will seek competitive bids whenever a fixed price is involved, Grant argues cost-plus “eliminates the prospect’s need to seek multiple bids from several (custom) builders since you are committing to securing one or more bids in all major phases.”

Whether one agrees or disagrees with Grant’s suggestion, it is clear that creative thinking is a must in today’s pricing strategies. For example, a number of builders have chosen to build homes in phases and increase their prices with the start of each new phase. Rather than build all at once, they only build several. When those are sold, they adjust pricing upward with the next group. As California realtor Allen Wong put it on his real estate company’s website: “the idea behind all this, of course, is to create a sense of urgency on the part of potential purchasers.” Other creative possibilities for encouraging results include variations on value-added selling and partnerships with financial providers to offer creative payment options for buyers.

Creativity, however, does not deemphasize the importance of such essentials as the calculation of construction costs and comparison with profit goals, the setting of standards for every component that affects building costs and periodic reviews of determining estimates and submitting bids. All affect profitability and all can be subject to change.

Pricing in the construction industry can never be uniform, if for no other reason than the occasional unpredictability of so many different market factors. Whether the customers are end-users or primary contractors, builders need to accept that ongoing analysis and market intelligence are critical for understanding the current market picture and using the data to stay profitable. The same applies when bidding on a contract since companies need to decide whether their bid formula – fixed, cost-plus or variations of both – will be sufficient to assure profitability.

To help resolve these issues, examine the various programs of sophisticated analytics available today, especially if there is a history of underestimating actual costs. Many of these offerings are constantly updated, giving the builder an up-to-date picture of market, costs, demand, potential pitfalls and all other elements critical to developing a profitable pricing strategy. This may be the best opportunity to keep a pulse on the market for any change or fluctuation. A fluid market requires a fluid pricing strategy.

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