Many of the top construction contractors have a very similar formula to their success, and it comes down to their executive and leadership teams investing in a strategic plan for the business. The plan should outline the company’s vision and future direction to stay profitable and minimize any potential risk that could deteriorate profit.
Below are three key profit improvement areas that contractors should focus on when creating their strategic business plan.
- Focus on pricing and margin instead of volume. Chasing jobs based on volume is not always the best strategy as it can put more risk on the contractor, especially if the job does not go well. Focusing on the right industries and customers is a better allocation of resources that will lead to higher profit margins.
I often ask clients, would it be better to be a $10 million company that has a five percent gross margin with 25 contracts or a $5 million company at a 10 percent gross margin with 15 contracts? You will end up with the same profit margin in the end, but when you manage more volume, your overhead costs will be higher. Your insurance premiums and your people, technology, and risk management costs will all be significantly greater with a higher volume business, which will lead to profit erosion.
Well-run construction companies have a strategic plan in place to identify the type of work they are good at that creates higher margins and better cash flows. They are disciplined enough to stay away from accepting jobs just because of size.
- Evaluate your customers and bidding practices. The biggest mistake we see with construction contractors is their willingness to bid and do work for anyone, anywhere. When this occurs, margins can be easily eroded when disputes or issues arise, especially when there is not a long-term relationship established. There is also a great deal of time wasted when bidding on work that has historically had a low success rate.
Having a strategic process to evaluate and vet your customers is critical to profit improvement. Finding recurring work with returning customers and owners will provide a better opportunity to improve margins on jobs. Customers and owners want to work for someone who is reliable and can get the job done, so they are willing to pay a bit more for this. Also, less competition in the bidding process will lead to more flexibility on charging the appropriate price for the job.
- Segment your business. Accounting can play a pivotal role in a contractor’s profitability, especially if the contractor is performing work in different industries and geographic locations. If you are only receiving a monthly profit and loss statement that shows the total of all of activity across the company, this can be a major mistake. Since it shows averages across the company, it can be hard to tell exactly where you are making and losing money.
Breaking down profitability by customer, geographic location, industry, and project manager can show precisely where the company is making money and provide key information to make management decisions. For example, we worked with a contractor who was extremely busy with a strong, healthy backlog but was still losing money each year. After digging deeper into the numbers and segmenting the business, it was discovered that a poorly run division in a new line of business outside of the contractor’s geographic location was losing significant money. This was offsetting the profitability of the stronger, more established parts of the business. By segmenting the financial information, management was able to evaluate whether to establish process improvements for this troubled line of business or stop bidding on that type of work and concentrate on the stronger, more reliable parts of the business.
The key to implementing these strategies is ensuring that the leadership team is on board, as these are more strategic initiatives that should come from the top. Being disciplined to execute these strategies is just as important. Having the right people in place who understand and can carry out your vision will pave the way to becoming a more profitable contractor.
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