A focus on revenue is key, but construction firms must not lose control of costs .
You were certain you had done everything right. You won the bids. You generated the sales. Revenue was great, even in this economy. You had dreams of finally taking that vacation. And then, the end-of-year numbers came in—and you actually lost money. You couldn’t believe it. You made the accounting department run the numbers again, but they were right. How could this have happened?
It may sound like a bad dream, but for too many construction companies, it is reality. They seemingly do everything right but just can’t seem to break even or make enough money to justify all their hard work. What happened? Too many companies focus only on the revenue side of the profit equation. True, revenue is very important, but expenses are equally important. When companies fail to accurately track and contain their costs, their hard work can be all for naught.
Offense and Defense
Sports fans know the labels: “He’s an offensive coach,” or “She emphasizes defense above all else.” Fans also know that when teams are weak in one phase of their games, they struggle. The best teams are strong on both offense and defense, even if they only excel at one. Think of the offense as your company’s sales force and bid preparers. These are the folks making the sales calls, exploring new markets, meeting with customers and putting together strong proposals. They’re scoring points and bringing in revenue. Meanwhile, the defense is the folks in charge of reducing costs: purchasers, job site foremen, accounts receivable and other support staff. Like all good defenses, they want to keep their team (expenses) from exceeding revenue.
Good defenses will focus their efforts on two key players: labor costs (including subcontractors) and materials costs. These two costs make up the bulk of most construction companies’ expenses. In fact, these two expense categories can account for as much as 75 to 85 percent of a company’s total expenses, according to the latest data from the Risk Management Association. The remaining 20 percent of costs are nickel-and- dime expenses that don’t have near the impact of labor and materials. If a company loses control of labor and materials costs, it loses control—period.
Labor and materials can be difficult to control for several reasons. First and foremost, the geographic realities of construction make it difficult for a business owner or manager to keep strong tabs on costs. Oftentimes, job sites are far removed from the company’s offices, where managers are also involved with things like estimating, sales calls and advertising. Managers may only occasionally get out to the job site, which may not be often enough to keep laborers on their toes and prevent them from dragging their feet. Adding to the complexity is that unforeseen difficulties with a job may require more labor than budgeted. Conversely, jobs that go faster than anticipated can leave crews idle or stretching out work to fill their days.
Materials are similarly hard to manage. It’s the very nature of construction that the expensive materials stored on site (lumber, sheet rock, copper pipe, fixtures, tools, etc.) can be used elsewhere in other projects, so shrinkage (a polite word for theft) is a problem. Laborers may also “borrow” company tools and equipment for home use or moonlighting, leading to losses. Material costs may fluctuate. While a flat economy and low inflation have been the rule for the past decade, it was not so long ago that building materials and commodities were red hot and increasing in price at several times the rate of inflation. A bid preparer may make his best educated guess on what materials costs will be when he puts in a proposal, but the uncertainties of the marketplace can result in these estimates being far off in a short period of time.
It’s imperative for managers to know exactly what’s being sent out to job sites, both in terms of materials and tools. Managers and foremen should keep accurate inventories, with laborers accountable for their tools. A well-secured job site can help reduce shrinkage, while managers should create and enforce strict policies on the use of company tools on non-company projects. When preparing bids, companies can ask for the ability to add materials price increases into the final cost to help them to recoup unexpected expenses.
Also, purchasers need to make every effort to be as efficient as possible. Buy what is necessary for the job—no more, no less. Poor job planning can result in multiple trips to do-it-yourself stores for tiny quantities of hardware, lumber and other items, resulting in the company paying retail prices rather than contractor or bulk rates. Equally important, purchasers need to shop around for the best prices. With the Internet and globalization opening the door to new suppliers, the local lumberyard may not offer the best prices any longer.
On the other side of the equation, managers need to incentivize salesmen to drive sales and fill excess or idle capacity. Too often, crews stretch out jobs or sit around the shop doing busy work when things are slow. Unbilled labor is a killer, and companies should make every effort to keep crews busy on productive, paying jobs.
Even the most efficient companies implementing all of these best practices can experience trouble in major dips in the business cycle. The worst thing for any company to do is panic or go into denial mode. Cutting staff is simply unproductive, because it’s the people who make the sales and perform the work.
Without people, the company is playing defense without an offense. Further, when employees are laid off, it is difficult to get them back when work picks up. If they do return, their loyalty and morale will be nil. Fortunately, there are several strategies that companies can employ to stay competitive and profitable during economic downturns or even during the off season when new starts are slow and revenue is down. First, reduce overhead, or those costs that go into supporting your profit centers. For example, companies can rent or sublet warehouse space, or farm out services like payroll or accounting.
Another strategy is to identify secondary markets that are similar (but not identical) to the company’s primary line of work. Every company has a ready made list of customers they can target for new products and services. Business management author Eli Goldratt talks about making customers a “godfather offer” (one that can’t be refused because the value is too great). Market your “off season pricing.” Homebuilders may turn to interior remodeling, while HVAC installers might push indoor air-quality improvements or service and maintenance on their systems. Excavators might use their equipment for private and commercial snow removal, or even negotiate contracts with municipalities to do their snow removal as a way for government to save money.
It’s key that companies don’t simply try to perform the same services in the off season or during downturns that they do in-season, but at a lower price. All this does is accelerate sales the company would have made in-season, but at a lower price. Otherwise, as long as the company can make enough to cover its costs and break even, these kinds of jobs are far better than having an idle crew.
A Winning Game Plan
It’s easy to see that companies can achieve great success when they have a game plan that emphasizes strong performances on both sides of the ball. Remember, downturns and off-seasons are opportunities, and they affect every company the same. However, companies are free to choose how to respond to them. Companies that decide to see them as opportunities to expand services and enter new markets —while reducing costs—will reap even greater rewards when times are good. Everyone else will either go away altogether, or continue to muddle along at half efficiency.