Five factors that can negatively impact contractor profitability
Construction is a high-risk, low-margin business, with some sectors faring better than others. According to Tyler Paré, principal with FMI Corp., a construction-focused consulting and investment banking firm, when barriers to entry are high, margins improve.
Data from Risk Management Associates supports this view. Average profit margin before tax was 6 percent or higher among electrical contractors, highway contractors and utilities in 2019. General contractors had the lowest profit margin before tax of just over 4 percent.
"There are inherent risks in construction work that can negatively impact overall net profitability," says Paré.
Contractors know all too well how labour shortages, supply chain delays, design errors, underutilization of equipment, jobsite accidents and change orders can negatively impact profitability.
Corporate strategy plays an important role in how firms mitigate these risks and improve contractor profit margin. Three industry leaders discuss the reasons for lackluster profits and some profit-boosting strategies below.
1. Companies aren't focused on reducing construction waste
Don Swasing, CEM and COO of site prep firm Schlouch Inc. sees a lot of waste in construction.
"There are plenty of people using a fix-when-fail fleet model, who don't give a thought to the complete cost of equipment ownership," says Swasing. "We run a high-performance fleet model which means I'm trading at the sweet spot prior to major component failure and not wasting dollars on major repairs. It keeps our team in the latest technology and most reliable equipment."
Schlouch tracks equipment utilization very closely and if a machine is underperforming or not meeting utilization targets, it's addressed quickly.
Troy Guevara, a former contractor who is now a construction technologist for Digitek Solutions believes contractors are still using a lot of manual processes for tasks such as accounts payable, project reporting and estimating that can be replaced with technology.
"They are paying people to do things they don't have to do," says Guevara. "You can take those people and put them in other roles."
2. Companies don't have the ideal set of people for the job
"The best contractors have the best people," says Paré. "The best firms are serious about finding, attracting, and retaining the best people. They become a destination employer that attracts highly qualified project managers, superintendents, and craft labour."
Swasing agrees. To retain employees, Schlouch utilizes individual job descriptions, performance feedback and merit increases. They show employees a career path. Employee retention is measured monthly and strategy around retention and employee development is discussed weekly.
When the company experienced a shutdown due to COVID-19 in 2020, they carried healthcare costs for employees. According to Swasing, it's a move that will improve retention and help nurture the culture of trust among its 300 employees.
3. There are no systems in place
"The number one thing that high-performing contractors utilize are systems that hold them and their employees accountable," says Guevara. "Systems help employees avoid mistakes."
Without one complete system for estimating, accounting, project management, inventory and tool tracking, Guevara says contractors are leaving money on the table. "The truth is they don't know what they don't know."
At Schlouch, they understand the importance of getting employees on board with new systems.
"We engage them, listen to their ideas, understand the business problems they want to solve and collaborate on expectations and accountabilities," says Swasing. "It doesn't matter what you are trying to do: improve equipment reliability, safety management, or project management," says Swasing. "If you can't get the people rallied around your idea, where you want to go and what you want to do, you are not going anywhere."
4. There is a lack of real-time visibility
Paré finds that those contractors who have more control over project risk, have better project outcomes.
"Technologically advanced contractors are going to have more clarity and more control relative to key performance indicators," he says. "That should lead to better financial results."
"With today's technology you should have at a minimum daily real-time job costs," says Guevera. He says contractors with real-time job costs can see the trends before they peak and make adjustments.
5. Companies are taking on the wrong clients
According to Paré, high performing contractors are more selective about the jobs they take on and will only go after work they know they will make money on.
"We ask potential clients tough questions about their history, how they select a contractor, ability to pay, their public reputation, and safety," says Swasing. "We are looking for shared values."
"The world of the lowest bidder is not the best place to be," says Guevara. If you do go after low-bid work, it's essential to understand your costs."
Taking the first few steps to improve profitability
Now that we've identified the key areas where you might be leaving money on the table, Swasing suggests taking two steps. The first is to create a clear vision for the business. The second is to look at your business with a fresh set of eyes.
"Allow yourself to see the waste and inefficiencies, the guys who aren't making money, the equipment that chews on your balance sheet and the customers who you can't make money on," says Swasing. "You have to be brutally honest."
For contractors who are behind the curve on understanding the financial aspects of the business, Paré recommends focusing on improving the integrity of field reporting, locating a strong accounting partner and improving financial knowledge with help from associations like the Construction Financial Management Association.
"A good accountant that specializes in construction is worth their weight in gold," says Paré.