There is hope, and that hope lies in an approach seldom used by contractors: Maximizing your “Return on Assets” (ROA), rather than revenue growth.”
ROA is simply how much profit do you generate in relation to the assets applied. Different business models have different asset classes. For most General Contracting and many subcontracting businesses, the asset base consists mostly of people.
Therefore, to make better profits, contractors can first increase their ROA, as opposed to any approach that requires an increase in (human) assets.
There are several ways to increase the bottom line without more people, more revenue or projects – and without raising your prices!
Our research at The Aspire Institute with real contractors in the current economy shows that GC’s consistently fail to retain enough of their revenue after paying the total costs of delivering a job. This is measured as Average Gross Margin (AGM). AGM is simply the percentage of your gross revenue left over after paying all the costs required to deliver a completed job.
Our experience working with many, many contractors is that more than 50% of those profit dollars lost due to low AGM can be recovered without charging any more or cutting costs or overhead! This can be done by plugging profit leaks, improving job mix, and increasing productivity. More can be recovered with some marketing knowledge and a solid marketing plan.
I wish we could tell you it’s one single, magic bullet – but it’s not. It’s about getting a number of things working in concert. No one change is hard to do, but there are quite a few of them, including changes to pricing strategy, understanding more about how contractor marketing can deliver a substantial competitive edge, learning how to track and measure your performance, improving estimating effectiveness, tightening up of change order management and more.
While following an AGM improvement approach may undoubtedly be a road less traveled by contractors, for those that do, it can provide a lifestyle and profit upgrade with a sustainable competitive advantage.
So before trying to break the code on hiring more people to support growth, first focus on AGM improvement to increase bottom line profits while minimizing staffing requirements – in other words, get more benefit from the assets you already have by learning and implementing professional business techniques.
Most contractors can double their bottom line this way without adding incremental staff – it can be a very rewarding path. Here are the keys to focus on first:
1. Tracking your Average Gross Margin (AGM). At the end of each quarter take from your P&L, ask your accountant, or calculate how much of your revenue was retained after accounting for ALL costs expended to deliver each job. That would include benefits and other loads on self-performing and office employees, the part of the owner’s compensation represented by field supervision, fieldwork, and estimating time. Your AGM will change substantially from quarter to quarter, even with no change in your pricing strategy.
2. Identify and fix your profit leaks. ALL GCs have profit leaks. The most popular categories include:
· Hidden profit loss from estimating mistakes (usually 3 to 5 bottom line points).
· Change Order mistakes, including the field not knowing what is contracted. Without this knowledge, your field staff won’t know what is a legitimate change. This leads to not charging correctly (or at all) for the higher cost of change order work (usually 2 to 5 bottom-line profit points).
· Using Professional Service Agreements (PSA). PSAs are pre-contract agreements to cover several classes of work too often given away by the GC. Those categories include: design, estimating, job scope development, and demo/discovery.
· Job Mix management. For a GC, that starts with a thorough analysis of job profitability and then directing more work to the higher-margin project types. GCs sometimes fail to account for the productivity losses that come from work outside their familiar wheelhouse and jobs farther away from their primary base, among other factors.
· Learn some marketing. A few simple marketing processes can increase the quality of your sales leads and provide more leads to allow you to be more selective in the jobs you take. Some marketing efforts can also enable you to charge more by providing a way to communicate your unique value to the right potential customer at the right time.
Let’s compare four models; Model A is a common model, and Model B is the same as Model A, but with a 35% lift in revenue and typical increase in staffing required. Model C holds the original Model A revenue, staffing level and customer pricing but with an 8-point AGM increase from profit leak plugging and job mix management and other changes. Model D retains the original revenue and staffing levels but combines the 8-point AGM lift with another 5-point lift from a price increase based on learning how to use marketing tools to gain a competitive advantage to support better pricing.
|Model A||Model B||Model C||Model D|
|Total Revenue||$ 1,600,000||$ 2,160,000||$ 1,600,000||$ 1,600,000|
|Number of Projects||35||47||35||35|
|Average Gross Profit||14%||14%||22%||27%|
|Gross Profit Dollars||$ 224,000||$ 302,400||$ 352,000||$ 432,000|
|Overhead||$ 172,000||$ 210,000||$ 172,000||$ 172,000|
|Net Operating Profit||$ 52,000||$ 92,400||$ 180,000||$ 260,000|
|Net Profit Margin||3%||4%||11%||16%|
|Incremental Staff Adds||n/a||3||0||0|
As you can see, increasing your AGM is your best path to increase profits without requiring an increase in staff. Also, note the impressive increase in available cash flow between Model A and Model C or D. This incremental cash flow is more than enough to better retain your current team and to give yourself a nice raise.
Yes, contractors can do a lot to increase their hiring and retention effectiveness. We teach this to our clients every day. However, trying only to hire better can, in some situations, be looking for a result that simply isn’t available to you now.
Ken Brookings is a former Fortune 500 business strategist who gave up the corporate grind and founded The Aspire Institute to help residential builders improve their business practices and profitability. For over 20 years Ken has been helping owners and leaders of small businesses achieve new levels of success by helping those who are experts in their craft become equally powerful as professional business operators.
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