Business economics can feel very removed from reality, especially when they talk about large corporations and things that seem more theoretical than practical. In fact, business economics uses both economic theory & quantitative methods (which is a fancy way of saying the measurement is by quantity rather than quality) to analyze the health of the business.
There are two ways “Economics” impacts small businesses. The first of two areas we’ll be exploring today is akin to Macroeconomics (the part of economics concerned with large-scale or general economic factors, such as interest rates and national productivity).
1. What is happening vs what will happen
Business involves decision-making. Decision-making means the process of selecting one out of two or more alternative courses of action.
It’s also worth noting that NOT making a decision is a decision. One that I’ve seen over and over again with contractors of all sizes. Burying your head in the sand and pretending everything is ok is not a sound business strategy.
Business Economics is concerned with economic issues & problems related to business organization, business management, and business strategy. It’s a choice that often leads to a business eventually closing its doors.
Keeping an eye on the macroeconomic landscape will enable you to stay ahead of changes.
For example, the Fed, in an effort to tame inflation, is in the process of raising interest rates; on June 15, 2022, they lifted interest rates by 0.75 percentage points, the third hike this year and the largest since 1994. They plan on continuing this over the year.
What does this mean to you? It means that borrowing money is going to get more expensive. The interest rate they are raising, is the rate banks charge for borrowing.
They announced their intention to raise rates months before they did it. Those with an eye on the macroeconomic landscape were able to borrow before rates went up, saving their business money.
2. Understanding per unit pricing: microeconomics
Small business owners most effectively use economics knowledge to the advantage of their business through the lens of unit economics.
What are the per-unit expenses of the business and how do those expenses compare to revenues per unit?
In Construction, this unit cost can be per labor hour or it can also be the square footage cost for installing a product (like flooring).
Square footage is inclusive of knowing your labor rate and production rate. It should not be the industry average, it should be your crew’s average rate. If you consistently use the national average for installing hardwood flooring but your crew does not hit those production numbers, you’ll soon be out of business.
Your labor hour is impacted by your operating cost + labor rate + payroll burden, as well as your debt load. There are a number of variables that can change depending on your circumstance and the economic climate. The better you understand unit economics, the better you’re able to assess opportunities, identify problems, and deal with changes that inevitably occur through time.
If you aren’t able to articulate your operating costs vs your cost of goods/services, reach out to us. Getting a grasp of this is fundamental to understanding your business and making decisions that will enable you to grow.
One of the biggest challenges of any small contractor is to fully understand your per hour operating expenses of bidding, contracting, and completing projects. But the extra effort in understanding the cost that goes into running your company is indispensable.
After you’ve established a more complete understanding of expenses, you’ll be able to do a much better job understanding the labor prices you need to charge for different levels of production and experience.
When opening her company, an iron worker may decide they need a shop. After getting a firm understanding of what it costs to run the facility, adding labor and fabrication expenses, she will have a clearer idea of setting prices for projects, as well as understand the dollar value of contracts needed to make the business profitable.
Keep in mind that your business differs from any other. There are many different electricians in NYC, for example, but the decisions they make about growing and sustaining their company will differ. Because we are all different, with varying wants and needs, our strategies for what we choose to invest in will differ. These investments will impact our operating expenses.
Having an ear and eye open to the economic situations as they unfold is vital for a business to grow, as well as understanding the economics of your own ecosystem (ie your business). Helping contractors get a handle on where they are and where they want to go is what we do. If you are interested in chatting, please reach out to us.