Competing Against a Shop That Does Not Know Its Own Costs

Why this matters

The competitor that hurts a small shop most is not the best one in town. A well-run rival prices near where you do, because they have run the same arithmetic on the same wages, the same trucks and the same insurance. The dangerous one is the shop that has never run it: prices below cost without knowing, takes work on that price for two to four years, resets what customers in your market believe the work costs, and then closes - leaving the expectation behind and taking none of the damage with it. That is why "they will go out of business eventually" is simultaneously true and useless. The damage is done by then and it is not billed to them.

This article derives the mechanism. Every other card in this group that touches an underpriced rival points here rather than re-deriving it.

Where the hole actually is

A shop prices below cost in four specific places, and they are not equally large. Three of them share a feature that makes them invisible: the money has already been spent, so nothing about this month's bank balance objects.

• Hours that are paid but not billed. The largest by a distance. Drive time, shop time, warranty returns, restocking, the hour lost to a supply house. A rate divided across paid hours rather than billed hours is wrong by the entire gap between them.
• The owner's own labour treated as free. An owner on the tools full time is a technician's worth of production that carries no wage line. It shows up as margin.
• No allowance for callbacks or rework. Real and usually small. Worth counting, not worth leading with.
• Equipment and vehicle replacement not reserved for. A van bought outright is free for six years and then is not.

Only the first two are large enough to explain a big price gap. If you are trying to work out how a rival can quote where they do, start there and stop worrying about whether they buy better than you.

Rebuilding their rate from the outside

Say their quote on a job type you both do lands consistently at about three quarters of yours, and you want to know whether that is efficiency or arithmetic. You cannot see their books. You can bound the answer from your own.

Step one, the billable-hour error. Take a technician paid for 2,080 hours in a year, which is 40 hours across 52 weeks. Your own measured billable hours for that tech are 1,200. Use your number here, not a benchmark; a residential service shop that actually measures it usually lands somewhere between 55 and 70 percent of paid hours, and nothing in this example depends on where in that range you sit.

A rate built by spreading wage and overhead across 2,080 hours instead of 1,200 recovers 1,200 / 2,080 = 0.577 of what it needs to. That rate is 58 percent of correct, which is to say 42 percent light, on every hour sold. Note what that means against the gap you were trying to explain: this single error is bigger than the 25 percent difference you can see. You do not need a theory in which they are 25 percent more efficient than you. You need one error, made once, in a spreadsheet nobody re-checked.

Step two, the owner's hours. Their crew is the owner plus two technicians. The technicians bill 1,200 hours each, 2,400 between them; the owner bills 1,000 himself. Total delivered hours are 3,400, and 1,000 / 3,400 = 29 percent of them carry no wage at all. That does not reduce the rate by 29 percent - it removes roughly 29 percent of the labour line only, which is one component of the rate.

Do not multiply those two together. The first is an error on the whole rate; the second touches only the labour component. They run the same direction and either one alone is larger than the gap you observed, which is all the conclusion you need.

Step three, what is genuinely small. If 1 job in 12 comes back and the return visit runs about a third of the original on-site hours, the true hours per completed job are 1 + (1/12 x 1/3) = 1.028, about 2.8 percent over. Drive time is not a separate addition on top of this, because it is already excluded inside the 1,200-hour billable figure - counting it twice is the most common error people make when they first run this.

Step four, the timer. The van is on its seventh year. Whatever is wrong with the rate, it does not present as a problem until that van is replaced.

Why it is not irrational from the inside

From inside that shop nothing looks broken. Revenue arrives every week. The bank balance grows in season. The phone rings more than it did last year, which reads as a verdict on the price. The three costs missing from the rate do not send an invoice: the owner's own labour has no payee, the callback is absorbed as a Saturday, and the truck already runs.

This matters for how you respond, because it means the rival is not bluffing and cannot be reasoned out of it. There is no moment where they look at a number and stop. They will stop when something forces cash out of the business faster than it comes in.

The failure is usually triggered by growth

The intuition is that an underpriced shop dies in a slow quarter. More often it dies in a good one, and the mechanism is worth knowing because it tells you roughly when.

Growth is what converts free inputs into billed ones. The owner who bills 1,000 hours himself stops doing that the day he has three crews to run, and the labour that was free becomes a hire at market wage. The van that was paid for becomes a second van financed. The customer count that one person could schedule becomes a dispatcher. Every one of those conversions lands on a rate that never had room for it.

So the timeline is two to four years in most cases, and the trigger event is usually the first hire made to keep up with demand the low price created. Watch for the hire, not for the quiet season.

The damage outlives the shop

Here is the part that makes this worth an article rather than a shrug. When they close, their price does not.

A customer who replaced a system at three quarters of your number three years ago carries that figure as their reference price. Reference prices move down instantly on one exposure and upward slowly across several, which means the customer who calls you after the cheap shop folds is not neutral - they are anchored, and their anchor is a number nobody could deliver at. You will meet that anchor on quotes for years, and in referral conversations from customers who never used the failed shop but heard the figure.

That is the real cost, and it is why waiting is not a strategy. Waiting is correct about the outcome and wrong about the invoice.

What actually works, and it is not matching

Matching loses money indefinitely against a price that was never viable, and it validates the anchor. Three responses work, and none of them is a price move. The Pricing shelf owns how to hold and defend a price - see related below - so what follows is what is specific to this rival.

Make the comparison non-comparable. A customer comparing two numbers will take the lower one. The move is to change what is being compared: what is included, who carries the risk, and what happens afterwards. Scope stated line by line, so the customer can see the two quotes are not the same job. Terms that transfer a risk - a written labour warranty with a stated duration, a stated response commitment. Evidence the other quote cannot produce: a licence number, a certificate of insurance, photographs of the last three of these you did.

Compete on the things their arithmetic cannot fund. A shop underpricing by a wide margin cannot afford a second visit, cannot afford to stock the part, and cannot afford to be wrong. Response time, stocked inventory and the willingness to make a failure right are all funded out of margin, and they are what the customer is actually buying on a repeat basis.

Say the quiet part to the customer once, in their terms, not yours. Not "our costs are higher" - nobody buys that. "Here is what is in ours that I can see is not in theirs, and here is what happens if it turns out to be needed." Then stop. Repeating it moves you from informative to bitter, and customers hear the difference immediately.

Which segments to concede on purpose

You will not hold everything, and trying to is how a shop ends up matching a price it cannot carry across its whole book.

Concede where the customer is buying on price alone and there is no repeat value behind the job: one-off transactional work, jobs in the bottom size band, customers who have shopped you every time for three years. Hold where the decision has a second criterion in it - anything with a relationship, a schedule commitment, a warranty that matters, a site you know. Concede deliberately, in writing, as a decision with a date on it, rather than by losing quotes and calling it a market.

The trap is conceding the segment that feeds the others. Maintenance agreements look small and low margin and they are the intake for replacement work three years out. Losing them is not a concession, it is a supply decision.

The patience question

Two to four years is a long time to hold a price while a rival takes visible share, and the honest answer is that it is survivable only if you know your own numbers well enough to be sure you are the one pricing correctly. That is the condition on everything above. A shop that has not measured its own billable hours cannot tell whether it is the disciplined one in this story or the other one.

So before you decide to wait them out, run step one on yourself. Divide your own overhead and wage base across your own measured billable hours, not your paid hours. If that produces a rate above what you currently charge, the rival is not your immediate problem.

How to know you read this right

You have diagnosed this correctly when you can name which of the four holes explains the gap, and the one you named is large enough to actually produce it. The failure mode is the owner who concludes "they must be buying cheaper" - purchase pricing on equipment at small-shop volumes moves a total by a few points, not by a quarter, so it cannot explain a gap of that size and pointing at it stops the analysis in the wrong place.

The second failure mode is diagnosing this when it is not what is happening. A rival with lower overhead, a different labour model, or genuine scale in buying has a sustainable price and will not fail - and the response to that is completely different. See related: A New Competitor Undercuts You Sharply, which forks on exactly that question.

References

• See related: Why Pricing Against Your Competition Is a Trap, Competitive Positioning, Knowing Which Competitor You Are Actually Competing With
• See related: A New Competitor Undercuts You Sharply, The Price War and Why the Second Mover Loses More
• U.S. Small Business Administration, pricing and cost-of-goods guidance for service businesses