“The greatest danger in times of turbulence is not the turbulence. It is to act with yesterday’s logic.”
Overview
In 2023 it is clear that most independent kitchen and bath dealers are not taking advantage of the resources available to make their businesses as successful as they can be.
A few years ago, RICKI reported in Kitchen & Bath Design News that approximately 900 kitchen and bath firms averaged gross profit margins of 29% (2017). This low figure has not changed much for decades in the industry. At 29%, kitchen and bath dealers do not earn enough net profit to retain abundant earnings. Therefore, these owners are prevented from engaging in business opportunities or surviving a recession. A solution to this financial stagnation is to learn how to leverage concepts that create a better business and drive it to earn higher gross profit margins.
This white paper covers several key areas for independent kitchen and bath dealers to educate themselves – or sharpen their abilities – to achieve consistent gross profit margins of 38% or higher. A 31% improvement in this metric alone will go a long to elevating the overall performance of these highly skilled, independent remodeling businesses.
Average Kitchen And Bathroom Remodel Costs
National average cost of kitchen remodels
While the national average cost of kitchen remodels hovers around $25,000, the amount consumers invest in their kitchens varies widely. On the lower end of the spectrum, partial remodeling costs around $10,000, mid-priced remodels range from $50,000 to $75,000, and high-end remodeling jobs often exceed $100,000. The kitchen and bath remodeling industry came close to reaching $200 billion in market value in 2022, consistently rising by leaps and bounds since a few years earlier.
While the projected market value for 2023 is about 14% less, at $162 billion, it is an exceptionally healthy industry that continues to grow and develop and be very profitable for savvy dealers. Amid the major advancements in commerce and technology that the world has seen in the past ten years, many areas of this industry remain underdeveloped. One of the significant gray areas of kitchen and bath remodeling is pricing.
Factors that affect regional pricing
While there is a formula for pricing kitchen remodels in the kitchen and bath industry, independent dealers typically base their prices on local market competition. Most owners avoid investigating higher price points to determine how they may be right for their business. As a result, many independent dealers are not earning the full potential they could gain from their businesses.
Before determining a price point in order to sell products and services, it’s important to be clear about the different general factors that affect the pricing of a kitchen remodeling job.
Labor. Labor costs may be higher in regions with higher unionization rates or more stringent labor laws.
Shipping costs. The availability of materials, location of the contractor, client’s project timeline, and the cost and breadth of materials all factor into the total cost to ship the clients’ orders.
Permits and fees. Permits can change the cost of a project. Contractors may need to obtain permits from the city or state before starting a remodel. Permits are usually at a cost, and the contractor pays the authorities, passing that expense on to the dealer, who may pass it on to the client. In addition, obtaining permits and fee-paying may cause delays in the project timeline.
Cost of Living. Like the aforementioned factors, labor and material cost factor into the consumer’s price, depending upon their local cost of living. Building codes, regulations and property values may also factor in. Many areas with a high cost of living may have stricter building codes and regulations, which may increase the project’s cost. Likewise, property values may increase the project cost with respect to the value of the property.
Supply and demand. In addition to material and labor costs, the availability and quality of products also factor into a client’s remodeling project. Products in high demand may take longer to receive or be difficult to find. Some may simply no longer be available for ordering purposes. If the customer does not want an alternative product, the project timeline can be delayed, and its overall cost can be higher than expected.
Competition. The level of competition among contractors in a particular region can also impact pricing. If many contractors offer kitchen remodeling services, they may need to offer more competitive pricing to attract customers. Too often, kitchen and bath dealers think they can’t raise prices because they are already “the highest price company in town.”
Materials costs. The cost of materials and labor can vary depending on the region. For example, the cost of lumber or stone may be higher in some regions due to transportation costs or availability.
Economic conditions. The state of the economy can also impact regional pricing for kitchen remodeling. During economic growth, contractors may charge higher prices due to increased demand, while during a downturn, they may offer more competitive pricing to attract customers.
Four Factors That Influence The Overall Cost Of A Kitchen Remodel
1. Scope
The first determinant in pricing a kitchen remodeling job is knowing what kind and how big of a remodeling job the homeowner wants. Kitchen remodeling projects fall into one of three categories: partial remodeling, full replacement, and major remodeling. Each has its unique potential pitfalls where designer expertise is needed.
Partial remodeling. Most partials are necessary investments focused on specific smaller improvements. For instance, the homeowner may decide to update their laminate countertops to quartz or stone, and that’s the only thing they want to be done for a fresh look. The cabinetry, lighting, plumbing, and appliances might stay the same.
Full Replacements. Another area that could be minor remodeling is full replacements. The full replacements constitute jobs where entire kitchens will be made over. Countertops, cabinets, and appliances are all replaced, while there is no change to the kitchen layout or structural changes to the home.
Major Remodeling. Full-scale remodeling involves structural changes to the space and an entirely new kitchen design. A smaller kitchen may be blown out to a larger one by knocking down an interior dining room wall and adding an island with a sink on one side and a twelve-inch extended countertop with stools underneath on the other. Exterior walls may be removed to construct a family room space within a breezeway having all new windows and French doors exiting to a terrace, creating a brighter, more open and gracious space than existed before.
Additions. As indicated in major remodeling, additions occur when the homeowner wants a new room connected to the existing structure. New family rooms, bedrooms, sunrooms, and garages are all often desired additions. There are five factors to consider when pricing additions:
- Square footage. The more square footage you add, the higher the cost will be. This includes not only the physical materials needed to construct the addition but also the cost of labor to build it.
- Layout. The layout of a kitchen can also impact the cost of a remodeling project. If the client’s project calls for knocking down walls, the cost will be higher than if they want to update the existing layout. For example, if the designer is converting a closed-off kitchen into an open-concept layout, this will require additional construction and may involve moving electrical and plumbing lines.
- Complexity of the addition. A simple bump-out or extension will be less expensive than a multi-level addition or one that involves major structural changes. Constructing angled walls is usually more difficult and expensive than straight walls.
- Building codes. Building codes and permits may be required for certain additions depending on the state.
- The cost of the materials used in the addition will also impact the total cost. The number and size of windows and doors can become expensive. High-end finishes such as granite, marble, or stone fireplaces will also increase the price.
- Contractor fees. The contractor’s fees also factor into the cost of the addition. This includes the cost of labor and any design or project management fees.
2. Design
The second major factor affecting a project’s cost is design. The design does not carry nearly as great an impact in a kitchen remodel as when designers can interpret a space’s configuration from scratch. A unique design can increase the cost of remodeling by as much as 50%.
This is not quite true for bathrooms. The vast majority of American bathrooms do not have enough space for creative design. A staged platform for a whirlpool tub, a curved soffit with recessed lighting, or a curved, off-the-floor vanity could increase the overall cost by 5% to 15%.
Of course, even in a small space, designers may plan extra cabinetry for specialty storage. Or extra features like built-in hampers or hidden jewelry safes. Extras like these could increase the overall cost by another 5%-15%.
Another possibility of design in a small bathroom, if there isn’t a second floor, would be to create a vaulted ceiling with a skylight. The enhanced sense of light and space is usually worth the typical $3,000 to $5,000 extra investment.
The best designers engage the prospect in their desires, offering options and solutions within the purview of what the prospect says they want. The act of selling takes a backseat to that of influence. Prospects never pay more than they’re willing to pay for a kitchen or a bathroom, but a designer helps them navigate what they’re willing to pay for.
3. Product
Product is a third important cost factor. Generally speaking, kitchen remodels constitute 60% product – principally cabinets, countertops, plumbing fixtures, appliances, and flooring – and 40% labor. Those percentages are reversed in bathrooms. So, as with design, the product is not as prominent a cost factor in bathrooms as in kitchens.
However, because of the range of quality, the product can have a greater effect on a bathroom project’s final cost than design – particularly in 5’ x 8’ replacement jobs. Take a shower installation, for example. A good quality material would be an acrylic or fiberglass wall surround with a molded stone shower base. A better quality would be a series of solid surface panels with the same shower base. The best quality material might be granite wall panels or designer ceramic tile with a tiled shower base. The consumer’s granite selection could cost up to 300% more than the good options of acrylic or fiberglass.
Vanity cabinets and faucets are two more areas where there can be a wide range of quality. A simple 30” vanity base in the plastic laminate may cost only a few hundred dollars. Filling the same space with a one-of-a-kind reproduction furniture piece in an unusual finish and may add several thousand dollars to the total cost. Likewise, a good quality, single-lever chrome faucet could run in the neighborhood of $150, while a high-end two-lever faucet in polished brass or satin nickel could be another $1,000.
4. Services
The fourth area of influence on a project’s expense is the quality and breadth of a kitchen and bath dealer’s services. That’s because these projects are intangible purchases, totally reliant upon the skill sets of the people who design, order, supervise, and install the hundreds of products and pieces to fit like a glove in one’s home. It becomes a tangible purchase only when the project is substantially completed – and the new room can be used.
Producing such projects is a monumental assignment involving many levels of services, including:
- Educational nature of a dealer’s showroom and sales process
- Quality and range of displays and product samples
- Organization of personnel with specialized skills to service the projects
- The comprehensiveness of the design process
- Completeness of the project specifications
- Systems – both manual and technological – deployed to manage all the details
- Communication protocols through every stage of the project
- Fit and finish of the installation
- Final inspection and evaluation procedures
Indeed, these dealer services function as the critical glue to put the entire project together and elevate the quality of family life for twenty years or more to come. The more these services are factored into every project, the greater the cost. But also the greater level of customer satisfaction with the end results. Historically, kitchen and bath design firm owners have grossly undervalued these services in their pricing model.
How Pricing Formulas Strengthen Business Models And Lead To Bigger Returns
Develop dealer operating budget
The two biggest areas preventing independent kitchen and bath dealers from making substantially more profit in their business are inadequate budgeting and faulty pricing of their products and services. Most dealers don’t realize the logical connection between operational budgeting and creating a price formula: together, they generate a firm foundation to offer better service to prospects and clientele and produce higher gross and net profit margins for the company.
As the most important byproduct of the budgeting process, the price formula system for a kitchen and bath firm should consist of at least three parts:
- Calculation of the production overhead (burden) rate (applicable when sales designers are part of the operational “showroom business model”)
- Calculation of the respective markups for each business mix category (called “price segmentation”)
- Establishment of a service contingency percentage
By developing a singular pricing methodology per market category, dealers can be certain to collect the necessary gross profit dollars to finance a firm’s market-rate salaries, production burden, direct overhead, and desired net profit.
Pricing formulas speed up the time it takes to figure out the price for a job. As mentioned in this white paper, delivering the total cost to the client sooner instills confidence in the buyer and demonstrates the value of the firm. It’s a subtle contribution to professionalism that makes sales designers’ jobs easier. In an industry with so many moving parts, there are many opportunities for things to go wrong. Streamlining one’s business is an opportunity to reduce operationally systemic headaches.
Many dealers use different markups for different categories, such as 1.60 for cabinets, 1.40 for granite countertops, and 1.3 for labor. These numbers are what they are able to get in their local trading area. However, they have little to do with the realities of running a business from a financial management standpoint.
When the aforementioned three elements are followed to arrive at the correct pricing model for a kitchen and bath firm, owners will need to develop a market plan to achieve the revenue and gross profit percentage goals.
Budgeting businesses to the core
Budgeting a business to its core enables owners to make smart overhead-reduction decisions, establish correct pricing formulas, and develop key management tools to successfully steer their operations through rough waters.
A rock-solid budget is a principal tool to determine the minimum amount businesses need to markup products and charge for their services to make the desired pretax net profit. A big mistake kitchen and bath firm owners typically make when budgeting their operations is looking at last year’s P&L statement. Judging that the firm can achieve the same gross profit as last year will prevent the company from reaching the desired net profit for the coming year.
That’s why the recommended process is to reverse engineer the gross profit dollar amount required to fund the necessary overhead and desired net profit. And for greater visibility and maneuverability, produce a three-year budget. What follows is an example of a three-year revenue projection for a “studio” business model where the owner handles all leads and sales with a small support team to assist.
A chart outlining the steps a studio model kitchen and bath business should take to develop a precise budget for its operations for the coming year follows.
Step 1 Project income $1,000,000 100.0%
Step 7 Fill in cost of sales $624,000 62.4%
Step 6 Reverse engineer to gross profit dollars $376,000 37.6%
Step 2 Detail sales expense $163,000 16.3%
Step 3 Detail administrative expenses $138,000 13.8%
Step 4 Detail burden expenses $10,000 (1.0%)
(e.g. rebates and discounts)
Step 5 Select desired net profit $85,000 8.5%
Step 1. Make realistic annual income projections
As an operating budget is a spending document, it’s essential that the owner’s projections are conservative. Overly optimistic numbers can trouble a business, especially in a recession.
Step 2. Detail sales expenses
Like sales designers working for large competitors, studio owners should earn 10% of what they sell. So $1 million in revenue renders a $100,000 salary. Other sales expense accounts for this studio business model include such items as market-rate salaries for design assistant(s), owner’s car expenses (gas, oil, maintenance), marketing tools (cabinet literature, door samples, etc), and advertising. In good times, experts recommend that established businesses invest 3% to 4% of expected income in marketing to keep their brand awareness high. In bad times, they recommend doubling that investment percentage to maintain a continual flow of leads, secure a positive cash flow, and gain significant market share as competitors cut this overhead expense.
Step 3. Detail administrative expense accounts
Administrative expense accounts include office manager salary, rent (should be about 3% of total revenue), utilities, office equipment depreciation, health insurance, owner’s key man and disability insurance, property and liability insurance, retirement, office supplies, dues and subscriptions, and amortization of leasehold improvements.
Step 4. Detail other income and expense accounts
Other income includes cash discounts earned on material purchases, rent from subleased space, buying group rebates, et cetera. These income items should be posted “below the line” on the P&L statement because “top-line income” should be reserved only for project income. Otherwise, a dealer’s gross profit margin gets artificially inflated. Other expenses would include interest from loans and warranty service.
Step 5. Determine the desired net profit
American industry strives for an 8% to 10% pretax net profit: kitchen and bath firm owners can make or surpass that aim. It’s not enough for owners to earn a market-rate salary and perks. That’s nothing more than “buying a job.” There has to be a good return on investment for the blood, sweat, and tears in satisfactorily completing $1,000,000 worth of kitchen and bath projects, as in this sample studio operation. And capital will be needed to fund the 25% growth in year two and 20% in year three. The capital left in the business, called retained earnings, can help to finance that growth.
Step 6: Reverse engineer to gross profit dollars
The last and uncharted step is to add up the totals of steps two through four and post a result on the Pro Forma page under gross profit. This figure represents the total gross profit dollars required to “finance” the sales, administrative, and other expenses – plus the desired net profit. Many owners are shocked that the required gross profit percentage may necessitate a 15% to 20% price increase – or even more.
Step 7. Determine the cost of goods sold
Subcontracting the gross profit from the total project revenue delivers the cost from all vendors – product, and labor. In this case, the total is $624,000.
So the correct price formula for this studio business model in Year 1 would be taking the total of all estimated costs – in either a kitchen or bath project – and dividing it by .624 (the percentage of revenue this expense category represents in the company’s annual operating budget). For example, a kitchen costs out for all products and labor at $50,000. The correct sale price would be $80,128 ($50,000/.624).
Burden Rate Calculation
The labor used to install a kitchen is commonly referred to as a direct labor expense and can be easily posted to a specific job. However, many indirect labor expenses are more difficult to identify and cost to a specific project, such as the project manager’s salary, truck driver’s salary, truck expense, warehousing, workman’s compensation insurance (for production staff), health insurance, retirement, payroll taxes, etc.
How can these indirect costs of production be properly job-costed before paying the sales designer’s percentage share of the gross profit? Indirect production costs must be job-costed before paying any sales designer commissions (typically calculated as a percentage of the gross profit). Otherwise, designers would be overpaid and the firm would under-collect for its overhead.
The solution to accurate burden rate calculation follows two critical steps.
- Creating a production overhead schedule during the budgeting process
- Creating a “burden rate” percentage – in the company’s price formula – to collect these indirect costs of production before adding the correct markup to cover the balance of the company’s sales and administrative overhead and desired net profit
For our hypothetical “studio” operation, when sales designers are added in Year 3, a burden rate of 10% should be added to the cost of sales (including costs of material, use tax, direct labor, and subcontractors) exclusive of appliances. The accuracy of the burden rate should be checked quarterly, and adjustments made up or down, as needed. Failure to use a burden rate in their pricing formula (and commission system) is one major reason why kitchen and bath remodeling business owners fail to make a robust annual net profit.
Develop Price Segmentation Per Target Market
Price segmentation is a strategy intended to finance the collection of sales and administrative expenses, other income and expenses, and the net profit established in the budget. Most dealers with showroom business models (where the owner functions as a general manager to several sales designers) sell to different markets. Based on the expected business mix, different markups will be needed (over the burden rate). Using a hypothetical $3,000,000 showroom operation, a pricing strategy chart below depicts the minimum markups for four market categories.
Market Category Mix % Revenue GP% GP $ Min Markup Min GP
Kitchen – Remodel 70% $2,100,000 43% $903,000 1.79 44.1%
Kitchen – New House 10% $300,000 38% $114,000 1.65 39.4%
Appliances 10% $300,000 25% $75,000 1.34 25.4%
Bathrooms 10% $300,000 46% $138,000 1.92 47.9%
TOTALS 100% $3,000,000 41% $1,230,000
The imperfect nature of the remodeling business, where there can be many sources of human error even with good controls in place, requires an allowance for gross profit slippage. So the minimum markup for kitchen remodeling projects is 1.79 or 44.1%, 1.1% higher than the desired 43% gross profit. Since bathrooms are more difficult to produce, nearly a 2% slippage is built into the 1.92 minimum markups.
It is also suggested that owners give pricing flexibility to their sales designers. For example, the range for the kitchen remodel category might be a minimum markup of 1.79 to a suggested markup of 1.85. Suppose compensation is based upon a percentage of the gross profit of the job. In that case, excellent sales designers seek to achieve the highest markup, particularly if they sense the client will need a lot of hand-holding through both the design and installation stages.
Summary
The most significant challenge of independent kitchen and bath dealers in sustaining the flourishing growth of their firm is to develop the correct formula for pricing their products and services. In closing, the following points enumerate the concepts which support a successful pricing structure.
The most significant challenge for independent kitchen and bath dealers in sustaining the flourishing growth of their firms is to develop the correct formula for pricing their products and services. In closing, the following points enumerate the concepts which support a successful pricing structure.
- The correct pricing formula is the direct byproduct of a company’s annual budget.
- The key step in the business budgeting process is to reverse engineer to the required total of gross profit dollars needed to fund market-rate salaries (including the owner’s), sales and administrative overhead, other income and expenses, as well as desired net profit.
- For studio model operations, the correct price formula for any project would be the inverse of the gross profit percentage. For example, gross profit is budgeted at 37.6%, so all project costs would be divided by .624.
- For “showroom” business models, where sales designers earn a percentage of the gross profit of the jobs they sell, a burden percentage must be factored in prior to the proper markup per market category and service contingency percentage.
- “Pricing segmentation” adjusts markups up or down per market category competitiveness or difficulty of execution. For example, bathrooms are typically on the second floor and are small spaces creating major production challenges. So, it makes sense to target 4% to 5% higher gross profit percentages for bathroom projects than kitchens.
Owners lacking experience or confidence in any of the areas mentioned in this white paper can gain mastery over these subjects at SEN University’s Executive Business School. SEN members receive a discount for attending any SEN-sponsored event. SEN University gives kitchen and bath dealers an opportunity to network with other industry vets and create a stronger, better business for themselves. By being masters of every area of critical operations, owners can expect to achieve their revenue goals and sustain gross profit margins of at least 37%.
