Solving the Pricing Problem with Stephen King
Pricing is one of the biggest issues that freelancers and small business owners face. The worry that pricing too high will lose sales tends to outweigh the fact that pricing too low is actually worse for your business. Well, Stephen King is here to tell us why the latter will sink you – not the former. And in Build Something More, we’ll talk about how to be prepared for an economic recession – whether it’s this one or the next.
- Stephen King
- Stephen King on Twitter
- Stephen King on Facebook
- Stephen King on Linkedin
- Why Your Business NEEDS Financial Planning to Succeed with Kathy Svetina
- Profit First Book
- Value Pricing by Ron Baker
- Creator Crew
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Hey, everybody, and welcome to Episode 216 of How I Built It, the podcast that offers actionable tech tips for small business owners. Today’s sponsors are TextExpander, Restrict Content Pro, and Mindsize. You’ll hear about them later in the episode. But first, I want to bring in our guest for today. His name is Stephen King. He is the President and CEO of GrowthForce. We’re going to be talking about solving the pricing problem today. Steven, how are you?
Stephen King: I’m great, Joe. Good to be here.
Joe Casabona: Awesome. Thanks so much for joining me. I’ve got to say right off the bat, I’m sure this is the first time you’ve ever heard this, but my wife saw Stephen King on my calendar, and she was like, “What?”
Stephen King: Yeah, it’s the first time today that I heard that.
Joe Casabona: Definitely the first time today. Perfect. Awesome. Thanks so much for joining us today. I’m really excited about this because I’ve been self-employed or freelancing since high school, and pricing has always been such a hard problem to solve. I think a lot of people kind of undersell themselves, probably they’re worried that they’re going to charge too much, and then they’ll lose business and things like that. But we’re going to get into all of that, and lots of cool stuff I have in our notes. But first, why don’t you tell us a little bit about who you are and what you do?
Stephen King: Sure. GrowthForce, we’re an outsourced bookkeeping, accounting, and controller service for companies that use QuickBooks that are worried about getting accurate data to make decisions. They’re frustrated because their financial statements are not on time, they’re not accurate, they’re not meaningful, they’re not actionable, they’re looking backwards, not forward. And they’re frustrated, they’re upset because they work really hard and they’re not making enough profit.
I’m a CPA for 36 years, we do all the traditional things that you would expect, you know, the bookkeeping, accounting, and a controller would do. But what’s different is we do management accounting. We’re trying to help you make data-driven decisions and be able to increase your profits. That’s why it’s called GrowthForce and not Stephen King CPAs. It’s designed to be able to help you live that American dream. We got into business not to just grow the top line, but to rather be able to help build some value and some wealth and spread that wealth in your family, and your workers, and your community.
Joe Casabona: That’s really fantastic. I love that. This episode is serving as a little bit of a financial planning one-two punch. Last week, we had Kathy Svetina on Episode 215. I’ll link that in the show notes over at howibuilt.it/216. So I think with the advice she’s given and then the things that we’re going to talk about today, I think our listeners will be very prepared for improving their financial situation.
Stephen King: Cool.
Joe Casabona: Before we get into the pricing problem, per se, the first thing that I have in my notes in this outline here is a data-driven decision-making. You mentioned that in your intro here. How important is that? Not just in your business necessarily, but when it comes to pricing. I think most people probably look at competitors’ pricing and just use that to start out, or maybe they just make up prices. But how important is the data-driven decision-making? And where does the data come from?
Stephen King: It’s the difference between success and failure. I can’t overstate it more. The time you spend on pricing will do more to increase your profitability than any single other use of time. The numbers are staggering. I’ll answer the second part in a second about where does the data come from? Because that’s where the fun part is. And it’s not hard.
But what’s fascinating to me is—and I this is my third startup, we got 60 employees—this is really the first time that I feel like, “Ah, this is what that American dream feels like.” I don’t have to worry about ‘Can I make payroll?’ I don’t have to work nights and weekends just to be able to get all the work done because I figured out that it starts with getting the right mindset.
Pricing is complex. It comes down to your relationship with money, which is often what your parents’ relationship was with money. It’s also about your own self-worth. You know, I started a CPA firm in the 80s. I left Ernst and Young, I was a manager of accounting system design, and I was billing $175 an hour at age 27. And this is in the 80s, so long time ago. I then started my own CPA firm and I was like, “I’m worth $45 an hour. I think a $45 is fair.” And I was slammed. I was so busy that I had to hire people. And they weren’t as good as me so I billed them out at $35 an hour.
I realized decades later how that was all a function of me not understanding my own value. What I didn’t understand was that a small change in pricing would have had a profound impact on my bottom line. I ended up giving up that firm. I turned it over to one of my college roommates, Danny Collins, and he took it on and did a better job with it than me. But the problem was that I didn’t understand that the impact of discounting my rate had on profitability.
I do a lot of speaking, and one of the things I always ask is, have you ever been in a situation where sales rep comes in and they say, “We’re in a competitive bid here. I need to give 10% discount to be able to help close this deal.” And we’ll make it up in service or parts or referrals. We’ve got people sitting on the bench and “if we can get this job, that’ll improve our cash flow, we’ll keep these people busy, we’ll get the deposit check and everything will be solved.”
And the single biggest mistake that business owners make—and I’ve served thousands of small businesses as a CPA. I just come out of our sixth recession—the single biggest mistake that they make is they think they can sell their way to profits. And there’s only three drivers to profits. You can grow your top line, you can increase your profit margin, or you can reduce your overhead. So the top line, get better at your above the line or control your below the line. And the line is gross profit.
What happens is when somebody comes in and says, “Okay, I need that 10% discount,” and you say yes… and until about a decade ago, I always said yes for all the reasons the sales represent. In particular, let’s get the deposit check, let’s get the cash flow. That discount is what creates cash flow problems. Because all that discount does, that 100% of your discount comes out of the bank account. Because nothing else changes. The cost to serve the client is still the same, your overhead is still the same. So the discount comes out of profits.
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And now let’s get back to it.
Joe Casabona: I think we see it everywhere. We see it in products. We see it in services. I constantly wonder how companies on AppSumo… I don’t know if you’ve ever heard of AppSumo. I’m just like, “What do they do?” They’re just getting users because they’re probably going for venture capital or something. But you’re devaluing your offering and it doesn’t create much benefit for you.
Stephen King: Well, let’s do a sideline on the venture capital world. So I raised 43 million in one of my businesses with a company called Virtual Growth, which was the same business I’m in right now, outsourced accounting over the web. But it was right when Netscape 1.0 came out in 1995. I saw this as a wide area network that I needed to solve the problems I had in my CPA firms. The venture capitalists really only care about growing market share. We were selling business that we had negative margins on, we were losing money on and they were like, “Don’t worry about it. We’ll automate it later. What we need to do now is we need to grow market share. We need to grow top line because you have to have a justification for a higher valuation on the next round and the next round.”
So we raise 10 million on our first round, and then we raise another 10 million, then we raised another 10 million. And as long as you are getting some sales traction, it didn’t matter whether or not you had negative margins, because the VCs want to make sure that we can keep funding the beast. That’s a generalization. They’re not all focused just on… But you can only get an exit if you’re growing valuation of the business.
But if you’re really trying to run a business and actually make money, the impact that discount has is staggering. You know, if you have a 30% margin, if you give a 10% discount, you have to sell 50% more sales at that discounted rate to make the same profit. If you have a 40% margin, you have to sell 33% more sales. It’s hard to do numbers on a podcast but a simple example, if you got $100,000 job and it’s a 40% margin, if you give a 10% discount, well, the job was 100 grand, normally you’d have $60,000 of costs so you can make 40% of gross profit margin. And if you give a 10% discount, that $100,000 then goes down by 10% to $90,000. You still have the $60,000 cost. So now instead of $40,000, you’ve got $30,000 in profit, 33% of the 90 grand.
And I used to think, “Okay, 33% is better than zero.” I’d rather have people busy than have them working at lower margins. But in order to make that $10,000 back up, I got to sell 33% more on that 90 grand. I got to sell $30,000 at that 33% discounted margin to make up the 10 grand. And I’m not suggesting you never give a discount. I don’t want listeners to say, “Okay, wait, they don’t understand.” There’s some good reasons why you want to give a discount. You might be trying to keep a strategic competitor out of a relationship. You might have literally got excess capacity that doesn’t cost you a dime. So you might as well get the 33% margins. And if it doesn’t affect your brand because you’re doing shoddier work, yes, there’s no opportunity costs.
But that’s not what most businesses have. There’s always an opportunity cost. We do service businesses and nonprofits. And service businesses have limited resources. You’ve got people. There’s only so many billable hours in a day. The mindset of thinking that I’m going to take that discounted price because some profit is better than others is what causes you to not hit your profit targets.
Joe Casabona: That’s exactly right. There’s always an opportunity cost. I really like that. I had two thoughts as you were speaking there. Imagine if you as a full-time employee had the discount passed along to your take-home pay? How pissed would you be at that? But as a business owner, you need to think about that. You’re lowering your take-home pay to get work. And maybe that’s not the best place to spend your time. I took on a client pre-pandemic, I gave them a discount to win the business, and then they disappeared for the year basically.
And then they came back and they said, “We’re ready to get started again.” Well, I moved on. I raised my rates. Now I’m working at an even bigger discount. I ended up refunding them almost $2,000 because not having to spend the time on the project was better than me spending time on a project I no longer had the bandwidth to do at a deeply discounted rate when I could have been outselling my Done For You Podcasting Services or recording more episodes and getting sponsors for these shows.
Stephen King: That opportunity cost is really important. To answer your second question about what data do you look at, well, the first thing that we suggest is, and this relates to your take-home pay getting cut example, what the first thing we suggest is you got to start with profits. Put your profits first when you’re trying to make a data-driven decision about pricing.
What most people do is they say, “Okay, my industry averages to make a 50% margin,” just to use a simple example, “and it cost me $100. So I’m going to sell this for $200.” If you’re happy with your profits, if you’re happy with your net income, your bottom line profits, then that works. If it ain’t broke, don’t fix it. But if you’re not living that American dream… You know, well-run companies make 15 to 20% of the bottom line. Most of the businesses that we see, and I speak to thousands of business owners every single year. And what we do in my data-driven decisions is I actually prepare a company scorecard for the people that I’m speaking to. I do Vistage speaking for the members, and I can see what the actual profits are for hundreds of businesses. Most businesses have less than 10% profits, 12% profits.
If you’re in that 5% or 6%, that’s why you have cash flow problems. There’s not enough profit to create free cash flow. And that’s why we suggest you have to start with profits first. There’s a great book by that title. What that means is first thing you want to do is figure out: how much money do we want to make? And do it as a percentage. I’m talking to a company right now. It’s a $6 million business that’s making 2.8% profits. Severe cash flow problems. The COVID hit them really hard.
They deal with corporate clients. They’re doing technology installations, AV systems and automation, and all that kind of stuff. The corporate offices shut down so they pivoted to the high-end residential businesses. And high-end residential home builders are pretty good, but their real challenge was that there wasn’t enough of that to keep their $6 million dollars afloat. So they went into the regular residential, and it’s much more commodity-driven.
So what we said was, “Well, how much profit do you want to make?” They said, “We really want to get to 15% profit.” Then what you do is you say, “Okay, great.” Divide that profit target, in this case, let’s just use a million dollars round number. They’ve got a million dollars profit target for the year. How many units are you going to do in a year? And these guys are doing billable hours? So you got 50 employees, they’re 80% utilized. So that means if there’s 2,000 hours in a year. If they’re 80%, billable, that’s 1600 round number. And of those 50 billable staff, that means there’s 83,000 hours in a year.
Now, what you want to do is divide the target profit by the number of units… And this applies to every business. If you’re in manufacturing, how many widgets are you going to ship? If you got retail, how many skews? If it’s customers, how many jobs? Whatever appears on an invoice is your unit. Whatever your billing your customer for, that’s what a unit is. Divided your target profit by your total number of units for the year. In this example, the 82,000 hours. And it comes up with a profit per unit. In this case, for them to make $1,000,000 in eighty-something thousand hours, you need $12 of profit on each billable hour.
Then you do the same thing with your overhead. They got 3.5 million in overhead, which is why they have less than 5% profit. They got a lot of overhead for a $6 million business. They divide that by the number of units, the overhead divided by the number of hours and they have $42 of overhead per hour. Now you can see I need to have profit margins of $54 per widget, per unit, per job, whatever the widget is, or the unit is. In this case, billable hour. I need a $54 profit margin in order to cover my overhead and to generate a profit on each unit. Because if you don’t have each unit share the overhead and hit your target 15% net profit, you can’t make it up in volume.
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And now let’s get back to it.
Joe Casabona: I think this is really important for people to hear, right? Because you do well, especially in the product business, you say, “I’ll just devalue my product and I’ll sell more products.” My online courses have no overhead except they do because I have to support my students, I have to market the course. If I sell my $200 course for $20, now I am hemorrhaging money because I don’t actively see the cost. The cost isn’t necessarily coming out of my wallet.
Stephen King: Right. And the thing here is that you figure out how to get that price to get your $200 or in this case, they needed to get to $100 an hour because you’re paying somebody 50 bucks an hour, so they got to cover that 52 and overhead and profit, you have to figure out who’s your ideal client. You have to figure out where do you add the most value. And the riches are in the niches. The more narrow the focus the better. You’re marketing guy, right? You know not all clients are created equal.
We do. We focus on project-based service businesses. And that’s our real narrow… it’s not just service businesses. We’re not doing medical practices and we’re not doing a car wash. That’s a service. We’re doing project-based service businesses because that’s where we know that we can help people make more money. And so instead of talking about compliance, you know, bookkeeping to make sure that the bills are paid and as a CPA to make sure the tax return is right, we’re able to have a conversation with the ideal client about increasing your bottom line. And that’s what justifies our value.
What I love is, since we started doing that, we raised our prices because we had limited staff, and we instead of… when you’re about to hire somebody is the time to look at pricing. I have these five decisions that increase profits, and the most important one is pricing.
The second decision after you get pricing right is which clients should you re-price, re-scope, or fire, because not all clients are created equal. And if you’ve got your serving clients, if you can replace your low margin clients with high margin clients, the difference goes right into your bank account. Your costs don’t change.
So it’s the opposite of discount. The impact of discounts is really severe, the impact of price increases. Or sometimes you can increase somebody’s price because their budget is limited, then you can change the scope. When you price the job, you were expecting a certain margin because you had a certain scope. A lot of businesses are really not good at scope creep. I call it time leakage. It’s the time that you’re paying for that you’re not getting paid for. And it happens all the time.
In service businesses, who do we hire? We hire servants. I’m a servant. I love serving small businesses. I’m passionate about it. My employees are passionate about it. That’s why we recruit them. They have those behaviors and core values. But when the client calls up and says, “Hey, can you change the chart of accounts, generate new report? Can you do this?” Yes, I would love to because the thinking is, “If I make you happy, then my boss will be happy. And when my boss is happy, then I’ll get raises, and I’ll get promotions and everybody will be happy.” And that’s absolutely true as long as the company makes money.
And what we see in this AVs company that we’re talking about, we had a call with them yesterday, their challenge is scope creep. They have 25% of their jobs, they’re over hours. Right now they’re looking at Zoho, they can see the hours right now. And what happens is if you go back to those clients and you give them three options… There’s a great book here. Pricing book. I have it on my shelf. I want to give the author credit. Ron Baker. Ron Baker wrote a book on value pricing. And what he said was you give the client three options. You can either increase the fee to reflect the value that you’re currently getting, or I need to reduce my scope based on your budget and I can stay within your budget, or I need to transition you to another service provider.
And the reason you give them options is because then they’re in control. They’re starting to compare you with a higher price or you with a lower scope. And people need three options to feel like they’re in control. And by doing that, we found over 85% of the time the clients are going to stay with you because if you do good work, nobody wants to change service providers. And that extra cash is the difference between living that American dream and struggling to survive.
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Joe Casabona: You’re 100% right with scope creep and value pricing. I read a great book called The Imagineering Way—I’m a big Disney fan—nd they talk about projects. You can either frame them as “No, because”, no, because you’re not paying me enough, which no client wants to hear, or “Yes, if.” So I can do this, yes, I can do this if we can increase the budget, if we can eliminate this part of the project and add this one instead. And have them prioritize. Because you’re right, our time is extremely valuable. You want to surprise and delight your clients but you won’t be able to surprise and delight anybody if you’re not making ends meet.
Stephen King: Yeah. You said it so well. And we started by saying you have to have the right mindset. This is about your own relationship with money, and your security and confidence, and building what you’re worth. And what I have found, and I’ve been doing this for 35 years, what I have found is when you have data, when you can look at profitability by customer, by job, by team, by department, by location, by whatever you’re looking at, what that does is it takes the emotions and the fears out of it.
You now can sit there and say, “Okay, in order for us to hit our target profit, if we want to make a million dollars in profit, and you really want to make that, when you’re faced with a decision about do I give a discount or not, if you have the data to do that, and the sales reps understand we’re going to have to sell 33% more sales to make up that 10 grand of lost profits, they’ll stop giving it away.
I also suggest that your sales commissions should be based on gross profit margin, not top line sales. One of the other mistakes that people make is they reward their salespeople based on sales. It’s in the job description. You have to generate sales. But if your commissions are based on margins, and if the sales rep is able to uncover opportunities for enhanced margin and they make more money, now you’ve got everybody focusing on those single most important number on any income statement, any industry, any size company, any part of the country, gross profit percentage.
And the reason why gross profit is more important than net profit is because gross profit creates net profit. The average person in a company, you know, the service provider working on the client or the sales rep selling the job, or the project manager who’s running the job, they can’t control overhead. They can only control the above-the-line costs. They can only really control the gross profit.
And so, if you sell it right and everybody is aligned around getting the right number, then you’re going to find the behaviors will change. If you take one trade secret away here, gross profit percentage is the single most important number on any statement. Because gross profit creates net profit. It’s why the sharks on Shark Tank always ask: “how much do you sell it for? And how much does it cost you to make?” They’re doing a percentage calculation because they know that gross profit creates net profit.
Joe Casabona: I love that. Gross profit creates net profit. So remember that. Those of you listening, if it takes you nine hours to do something and your hourly rate is $100 an hour, is 900 bucks enough for you to make the profit you want to make? And if someone’s not willing to pay you $100 an hour, they’re probably not worth having as a client. They don’t see the value, you’re not serving the right person.
Stephen King: And they’re not the ideal client. And the way you figure out who your ideal client profile is, look at your job profitability reports. You can go into QuickBooks and add a custom field called industry, job type, customer type, whatever way you want to slice and dice your profitability reporting. And now look at—in this company yesterday—are corporate clients more profitable than residential clients? Okay, yes. If residential client is not as profitable, are all residential clients the same? No. Custom home builders turned out to be better. Okay, let’s put a job type field in there.
So you have an industry, “residential” and then a job type, “home builder,” custom home builder, and start to slice and dice your customer profitability based on the decisions you’re trying to make. I was a manager of accounting system design at Ernst and Young in the 80s. And I learned there that what the big boys do, the wildly successful Fortune 1000 companies do is they start with the decisions you’re trying to make and then work backwards from that field. What are the drivers of the decisions?
And then you figure out what data should come out of your accounting system. And QuickBooks got 88% market share because it’s so powerful. But most business owners only use it to pay bills and make deposits and produce a P&L. But you could customize, this is really easy to do, profit and loss by industry, profit or loss by marketing campaign. Trying to figure out: do I get more leads from podcast, whether or not to our SEO? Put a field in the accounting, so it says “lead source”, and just drop down.
What’s profit or loss by sales rep? We had five sales reps at this company yesterday. One sales rep had hit their 60% profit margin on every job. Only one. Now you study that one. What’s different? How are they selling you as value? The rest are selling as a commodity.
Joe Casabona: Love that. That’s fantastic. Now, we have been chatting for a while we’re coming up on time here. In Build Something More for the members, I do want to ask you about what it was like being a CPA in the multiple recessions, as you mentioned early on. So we’ll get a few extra minutes on that if you’re willing. But before we wrap up here, you gave us a trade secret. Maybe we can do one or two… let’s say someone listening is like, “Man, I really need to change my pricing.” What are the first two steps they should take in changing and optimizing their pricing?
Stephen King: Great question. It’s really easy. You got to allocate your labor costs. Intuit payroll and Insperity payroll, that’s Insperity as outsourced HR company. Those two companies have this fully automated that when you run the payroll, it will allocate the labor costs above the line, direct labor to the customer and the job or below the line to overhead, it will allocate it to departments and profit centers or services and products. And post that back inside QuickBooks. And now you can see profitability by customer, by job, by product and service or department or team.
And you want to study the ones that have the most profits. What’s unique about them? What industry are they in? Why were we able to get the value that we deserve and get the…? Because we got the profit margin we deserve, what we need to hit, then obviously, we’re adding value because people are willing to pay for it. What’s common about those? I’m lousy at golf, but my dad always used to say, “When you hit the ball right, study that swing and forget all the others.” And look at a job profitability report and see which customers are hitting our target profit margins, which customers are covering their fair share of the overhead and generating the 15% profit. And then you can figure out how do I go out and get more that look like that?
Joe Casabona: That’s fantastic. This has been absolutely great. Steven, I really appreciate your time. If people want to learn more about you and what you do, where can they find you?
Stephen King: You can stop by in business virtually on our website, www.growthforce.com. That’s growthforce.com. We have lots of resources and happy to offer helpful advice and answer any questions. We got a chat box on there. You can reach me at email@example.com or LinkedIn I’m Stephen King CPA.
Joe Casabona: All right, I will include all of that and more in the show notes over at howibuilt.it/216. Thanks so much to our sponsors: TextExpander, Restrict Content Pro, and Mindsize. They make the show possible. Thank you, of course to Steven for joining us. I really appreciate it.
Stephen King: Thanks for having me, Joe.
Joe Casabona: If you want to get more of this conversation, you can sign up for the Creator Crew over at buildsomething.club for just five bucks a month. You will get bonus episodes, behind-the-scenes content, access to a community, and so much more. Thank you so much for listening. And until next time, get out there and build something.