Price to Hit Your Velocity Targets

Target Typical Sale price 100.0% 100.0% Cost of sales 70.0% 78.0-85.0% Gross margin 30.0% 15.0-22.0% Indirect construction costs 3.5% 5.0-6.0% Financing expense 4.0% 3.0-7.0% Marketing expense 6.0% 5.0-10.0% General administrative expense 4.5% 4.0-7.0% Total operating expense 18.0% 16.0-22.0% Net profit 12.0% 3.5-5.0%

Here each month, management consultant Chuck Shinn details how builders can hit financial ratios that lead to double-digit net profits. (The targets are in the table, right, with the range Shinn says most builders now achieve.) To reach the first target, a cost-of-sales ratio of 70%, a builder must control land and direct construction costs.

However, Shinn insists we first discuss pricing to a targeted velocity of sales. "You need to understand that the market really sets price as it perceives value," he says. "And it has nothing to do with cost. Builders can only modify pricing, within a tight market-set range, to reach velocity targets."

Many builders do not understand a basic element of pricing: Markup is calculated on costs, margin on price. "To achieve a 30% margin on cost of sales," Shinn says, "you have to mark up costs 42.85%. Profit can't be treated as a residual. Once the market-based sales price is set, you work backward -- deducting targeted profit, land cost at builder retail, operating expenses and a realistic cost-slippage rate (based on historical data). What's left is what you can spend building the house."

Shinn cautions to anticipate cost increases throughout a project by planning price jumps that include the targeted profit margin. "Communicate price rises to salespeople two weeks in advance," he says. "They can use that to push velocity by nudging fence-sitters into an urgency to buy."