Your gross margin is lying to you

Most small companies calculate gross margin in a way that flatters it by five to fifteen points. That gap is exactly where pricing decisions go wrong.

The three costs that get left out

1. Direct labour — all of it

The wage lands in COGS; the payroll taxes, workers’ comp, benefits and paid time off usually do not. The fully-loaded cost of a production employee is typically 1.25–1.45× the hourly rate. If you bid jobs off the base rate, you are bidding at a loss you cannot see.

2. The cost of getting paid late

A job at 30% margin that funds itself for 75 days before you collect is not a 30% margin job. If you are drawing on a line of credit to bridge the gap, the interest belongs to that job. If you are not, the opportunity cost still does.

3. Rework, returns, shrink and the “we just ate it” pile

Every business has costs that get written off to a miscellaneous account because nobody wants to assign them. They belong on the jobs and customers that caused them. Put them there for one quarter and the list of who is actually profitable usually changes.

What to do about it

Rebuild the margin on your last twenty jobs, customers or SKUs with fully-loaded direct cost. Sort the list. In almost every case, the bottom 20% is at or below break-even, and it is rarely the 20% the owner expected. Then you have three levers: reprice it, re-scope it, or stop selling it. All three are fine. Continuing to sell it while believing it makes 30% is not.