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February, 2008

Business Principles for Lumber Pricing

Determine your price, and then sell quality. 

By Bob Heidenreich

There is considerable confusion in the lumber industry when it comes to defining “markup” and “margin.” While sometimes used interchangeably, these two terms have significantly different meanings, and to properly price any kind of retail merchandise, it’s important to understand them fully.

Let’s look at markup vs. gross margin: Markup is generally defined as the percentage added to the cost of an item to create the final price.

Let’s say you want a 30% markup on a product. If you paid $100 for the item, you’d multiply that by 30% and get $30. So to price your item with a 30% markup, you’d in turn sell it to your customer for $130.

But if you examine this transaction, you’ll see that while your markup is 30%, your actual margin on the product is less than that.

To find your margin, you subtract your cost from the final price and divide it by the sales price. ($130-$100)/$130 = 27%.That means that in this case, a 30% markup actually translates to a 27% margin.  But if you know both your cost and the margin amount you want to achieve, you can find your sales price like this:The formula is Cost/(100%-GM%) = Sales Price.

So by using our example above, if I want to achieve a 30% margin on my $100 item, I’d divide my cost by .70 ($100/ (100%-30%). That means my sales price for that particular item would need to be $142.86 for me to achieve the desired 30% margin.

So why does this matter?

The customary markup percentage for decks is usually between 25% and 40%. However, I firmly believe that high-quality materials can justify higher margins because these goods are harder to find and more desirable. High-quality materials also reduce unusable materials, which also improves the bottom line.

It’s a good idea to lay the groundwork for this kind of thinking in your company by determining your upper and lower limits for acceptable margins. If you set your margins too low, you won’t be able to support the costs to operate your business. On the other hand, if you set them too high, no one will buy your goods.

In the lumber industry as a whole, and especially when selling to deck builders, I think its important to emphasize quality over price.

Customers sometimes ask me why our materials are priced higher than they are at other lumberyards. I explain the difference in cedar grades and the improved performance of southern yellow pine over Ponderosa pine for framing materials. I give them a tour of our lumberyard and let them see how straight, stable, and clean our materials look. Presentation is a key ingredient in our sales process.

Most customers are willing to pay a premium for high-quality materials if they understand the differences between the grades. Deck builders should be aware that all decking materials are not created equally, and unlike framing materials, these surfaces will be visible.

I never try to compete with discount lumberyards since I want my customers to recognize and appreciate the benefits—and costs—of quality materials. Our staff emphasizes smart design and teaches how to build more efficiently. We also encourage the use of fewer but more substantial materials to recover increased costs.

 

The lumber industry is a competitive market led by giant corporations. I feel the only way small businesses can compete is by specializing in premium materials and offering superior customer service.

 

 

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