The Silent Erosion of Your Margins and How to Stop It
"Show me the incentive, and I will show you the outcome."
The reason most contractors underperform is not mysterious. The reason is that they are incentivized, by the structure of their business and by their own habits, to ignore costs that are hiding in plain sight. They focus on revenue because revenue is visible and satisfying. They ignore costs because costs are dispersed, technical, and unpleasant to confront. This incentive mismatch is the source of more business failures than all other causes combined.
I want to describe the costs that contractors typically ignore, not because these costs are invisible, but because the incentive structure of the contracting business trains you not to see them. These costs are not hidden in any meaningful sense.
They are sitting right there in your bank statements, your credit card bills, and your mileage logs. You simply do not look at them because looking at them would require you to make uncomfortable changes. And so you do not look. And so your margins erode. And so you work harder while earning less.
The Vehicle Cost Blindness
Every contractor owns vehicles. Every contractor uses those vehicles every day. Almost no contractor knows what those vehicles actually cost. This is not a criticism. It is an observation about the psychology of vehicle ownership. You buy the truck. You pay for the gas. You pay for the insurance. You pay for the maintenance. You pay for the repairs. You watch the depreciation. But you rarely, if ever, add these numbers together to understand the total cost of vehicle ownership per year. And this total number, if you were to calculate it, would probably surprise you.
Let me give you a framework for calculating vehicle cost that I have found useful. The total annual cost of a vehicle is the sum of depreciation, financing interest, insurance, fuel, maintenance, repairs, registration and licensing, and a reasonable return on the capital you have invested in the vehicle. For a typical contractor truck that is driven thirty thousand miles per year, this total often exceeds twenty thousand dollars annually. Some contractors I know have calculated numbers closer to thirty thousand dollars.
Now consider what this means for your pricing. If you drive ten thousand miles per year for business purposes and your total vehicle cost is twenty thousand dollars per year, your vehicle cost alone is two dollars per mile. Every mile you drive is costing you money that you may not be recovering through your pricing. You may be including fuel in your calculations, but are you including depreciation? Are you including the opportunity cost of the capital tied up in the vehicle? Are you including the increased insurance premiums for business use? Most contractors do not include these items. And this is why most contractors underprice their work.
The solution to this problem is not complex. The solution is to calculate your true vehicle cost per mile and to ensure that your pricing recovers this cost. If you are currently recovering only fifty cents per mile when you should be recovering two dollars per mile, you are losing fifteen hundred dollars per year on vehicle costs alone. This is not a small number. This is a significant erosion of your margins that occurs silently, without your awareness, because you have never done the arithmetic.
The Tool Depreciation Deception
Contractors love tools. They have drawers full of them. They have shelves filled with them. They have toolboxes overflowing with them. They spend significant money on tools every year. But most contractors have never calculated what their tools actually cost them over time. They buy a drill for two hundred dollars. They use it for five years. They do not think about the depreciation. They do not think about the cost of capital. They simply buy the drill and move on. This is a mistake.
Tools are assets that depreciate. A tool that costs two hundred dollars and lasts five years represents a cost of forty dollars per year in straight-line depreciation. But this simple calculation understates the true cost. You also have the cost of capital tied up in the tool, money that could have been invested elsewhere but is instead sitting on your shelf as steel and plastic. You have the cost of storage space. You have the cost of organization and tracking. You have the cost of replacement when tools are lost, stolen, or damaged. These costs add up.
The contractor who owns fifty thousand dollars worth of tools is not spending fifty thousand dollars once. He is spending fifty thousand dollars plus depreciation on that amount every year, spread out over the useful life of the tools. If the tools last an average of seven years, the annual cost of tool ownership is approximately seven thousand dollars in depreciation alone, plus the cost of capital, plus storage, plus replacement. This is not a small overhead item. This is a significant business expense that should be recovered through pricing.
Most contractors do not recover these costs. They include materials in their pricing, but materials are things that get consumed on a specific job. Tools are different. Tools are capital assets that get used across many jobs over many years. The cost of tools should be allocated to jobs based on usage, just as you allocate labor costs based on hours worked. If you are not doing this allocation, you are underpricing your work.
The Unbilled Hour Problem
I want to describe a phenomenon that I call the unbilled hour. This is any hour that you spend on your business that is not directly compensated by billable revenue. Every contractor has unbilled hours. The question is how many, and what they are costing you.
Consider the owner of a small contracting business. He works fifty hours per week. Of those fifty hours, perhaps thirty hours are spent on billable work, actual installation, repair, and service that he can charge for. The other twenty hours are spent on unbilled activities: driving between job sites, ordering materials, managing inventory, doing administrative work, communicating with customers, training employees, managing finances, and a dozen other activities that are necessary for the business but do not generate direct revenue.
Now consider the economics of these unbilled hours. If the contractor's target annual income is eighty thousand dollars and he bills thirty hours per week for forty-eight weeks per year, he must earn approximately fifty-six dollars per billed hour to achieve his target. But this calculation ignores the unbilled hours. If you factor in the unbilled twenty hours per week, the total hours worked are seventy hours per week. The eighty thousand dollars target spread over seventy hours per week is only thirty-four dollars per hour. This is a significant difference, and most contractors have never made this calculation.
The unbilled hour problem is particularly acute for contractors who are growing. As you add employees, your unbilled hours typically increase because you spend more time managing, training, and overseeing. As you add systems and processes, your unbilled hours increase because you spend more time maintaining those systems. As you add customers, your unbilled hours increase because you spend more time on communication and relationship management. Growth, paradoxically, can reduce your effective hourly rate if you do not account for these unbilled hours in your pricing.
The Overhead Allocation Oversight
Most contractors have a vague sense of their overhead costs. They know they pay for shop rent, utilities, phone, insurance, software, and similar items. But when I ask them to calculate their overhead as a percentage of revenue, they typically underestimate significantly. This is not because they are bad at math. It is because overhead costs are dispersed across many categories and never presented to them in a single, unified number.
Let me give you an example that I have observed repeatedly. A contractor doing four hundred thousand dollars per year in revenue has the following overhead items: shop rent at thirty-six thousand dollars per year, utilities at six thousand dollars, insurance at twelve thousand dollars, vehicle expenses not including fuel at eighteen thousand dollars, tools and equipment at eight thousand dollars, software and technology at four thousand dollars, professional services at six thousand dollars, office supplies at two thousand dollars, and a variety of other smaller items totaling perhaps ten thousand dollars. This contractor's total overhead is approximately one hundred two thousand dollars per year, or twenty-five and a half percent of revenue.
This overhead percentage is not unusual. I have seen contractors with overhead ranging from twenty to forty percent of revenue, depending on their business model and efficiency. The point is not that twenty-five percent is the correct number for everyone. The point is that most contractors have never calculated their own number. They have a vague sense that overhead is maybe ten or fifteen percent when the actual number is often twice that.
Understanding your overhead percentage is essential for pricing correctly. If you are pricing jobs with a target margin of twenty percent and your overhead is twenty-five percent, you are losing money on every job. You are pricing as if your overhead is lower than it actually is. You are systematically underpricing your work without realizing it. The solution is to calculate your actual overhead percentage and to price accordingly.
Implementation | A 30-Day Cost Discovery Process
I have described several categories of hidden costs. The question now is how to discover and address these costs in your own business. Here is a practical framework for a thirty-day cost discovery process.
Days One through Ten are the Vehicle and Tool Audit.
Calculate your total annual vehicle cost using the framework I described. Calculate your total tool inventory and estimate annual depreciation and capital cost. These first ten days are about understanding your largest hidden costs, vehicle and equipment expense.
Days Eleven through Twenty are Time Tracking.
Track every hour you spend for ten consecutive business days. Categorize each hour as billable or unbilled. Calculate your effective hourly rate factoring in unbilled hours. This time tracking exercise will reveal how much of your time is actually generating revenue and how much is overhead.
Days Twenty-One through Twenty-Five are Overhead Calculation.
Gather all your monthly and annual expenses. Categorize each expense. Calculate your total overhead and your overhead as a percentage of revenue. This calculation will reveal the true cost of keeping your business running.
Days Twenty-Six through Thirty are Customer Acquisition Analysis.
Review your marketing spend over the past twelve months. Estimate the number of new customers generated by each marketing channel. Calculate the average acquisition cost per customer. Compare this to average customer lifetime value. This analysis will reveal which marketing investments are working and which are not.
After thirty days, you will have a comprehensive understanding of your hidden costs. You will know your true vehicle cost per mile, your true tool cost per year, your effective hourly rate, your overhead percentage, and your customer acquisition costs. You will have the data you need to adjust your pricing and improve your profitability.
A Final Thought on Visibility
I want to end with an observation about visibility. Most contractors focus on visible costs because visible costs are easier to manage. You see the invoice for materials and you pay it. You see the bill for fuel and you pay it. These costs are immediate, concrete, and unavoidable. But the costs I have described in this article are invisible not because they do not exist, but because you have trained yourself not to see them. You have created blind spots in your financial awareness.
The contractors who build profitable businesses are the ones who pierce this invisibility. They force themselves to see the costs that are hiding in plain sight. They do the arithmetic that is uncomfortable. They face the numbers that might discourage them. And then they adjust. They adjust their pricing. They adjust their spending. They adjust their time allocation. They make the changes that are necessary to transform hidden costs into visible, manageable, controllable expenses.
This is not complicated work. It is simple but difficult. It requires discipline and courage. But the contractors who do this work will find themselves in a much better position than those who do not. They will understand their business. They will price appropriately. They will earn what their work is worth. And they will build businesses that sustain them for years to come.