Direct costs are subtracted from revenue to calculate gross profit. Effective management of these costs directly influences gross margin, ensuring that the business remains profitable. Direct costs are also known as Cost of Sales (COS). If COS is too high, even a company with strong sales will struggle to be profitable. COS includes all costs associated with producing the work in the field, such as materials, field labor, disposal costs, subcontractors, etc.
Below are the direct costs/Cost of Sales (COS) for green industry companies based on our internal data year-to-date (YTD) through the end of July in 2023 vs. 2024:
Install Services:
• YTD to July 2023: 58.5%
• YTD to July 2024: 56.7%
Lawn Care & Maintenance (recurring services):
• YTD to July 2023: 55.1%
• YTD to July 2024: 54.7%
Green Industry Mix of Services (Companies with no more than 75% of install or recurring services):
• YTD to July 2023: 54.8%
• YTD to July 2024: 53.7%
In all three benchmark groups above, it appears that companies this year are experiencing slightly lower direct cost levels. This may be due to more companies now being able to pass through material and direct cost increases from these past few years to customers through price adjustments. A great goal across most green industry service lines is 50%, allowing enough room to cover overhead expenses and maintain a healthy profit margin.
Here are some key points to consider when managing direct costs:
• The top three direct costs for companies are field labor expense, materials expense, and subcontractor expense. Labor is the largest expense but also the largest driver of revenue for a green industry company. We are seeing more companies implement bonuses, pay-for-performance, and variable pay to increase field labor efficiency.
• Direct costs are crucial to manage and track, but one of the biggest issues in the green industry is companies overlooking overhead costs. Our clients are benchmarked to our internal data, allowing us to compare “apples to apples.” Be careful when comparing data or discussing gross margin and COS figures with others in the industry, as they may not fully understand what should and should not be included in COS vs. overhead.
• Each company optimizes and manages its expenses differently. Some companies may have higher direct costs due to more experienced labor, which can lead to lower management oversight and lower overhead expenses. Always consider your company from a full-picture perspective.
• If your direct costs are high but you are confident in your field operations and efficiency, it may be time to adjust pricing. A price increase directly impacts the bottom line—don’t underestimate how much a price increase can benefit your company.
• Managing COS allows the business to understand its operational capacity and scalability. With accurate cost data, the business can plan for growth by identifying the direct costs associated with scaling operations, such as hiring additional labor or purchasing new equipment. You should know how much revenue should be generated per crew to cover direct and indirect costs. Understanding this figure will help you scale in a controlled manner.
• For management overseeing field operations, it’s beneficial to measure and track performance based on gross margin (the result of revenue minus COS). This is also the pool of funds that will be used to pay management team members, making it an excellent metric to hold them accountable for. For some executive-level team members, it may also make sense to hold them accountable for net profit, especially if they oversee overhead and company-wide functions.
• Remember to consider seasonality and the full-year picture when setting your gross margin goal for a month or week. If your yearly goal is 50% and you maintain certain fixed costs year-round with less work during slow months, you will need to aim for a higher than 50% gross margin during the busy season to compensate.
It’s crucial to have a clear view of your direct costs, as this insight shows the effectiveness of your field operations. Efficient field operations will provide the funds necessary to continue growing and scaling your company. Take action today to control your direct costs and drive up gross margin!