Subject: Quality over quantity
Never Ask a Texan…

…the size of his spread. It’s not polite. I made that mistake while touring a Texas cattle ranch with the owner many years ago. The rest of the tour was spent in comparative silence. When we got back to the headquarters I asked one of the hands about the rancher’s response.

“Oh…no…no…Sénor. This…it is not done. It is insulting.”

 It seems that a Texas rancher does not measure success by the number acres or number of cattle on his ranch, but rather by the quality of his beef.

Another Tour

Many years later I was riding to a job with a big city contractor as he proudly pointed out all the big buildings his company built.  Ironically, I happened to be there to “work out” for his bonding company his most recent projects because he was in financial distress and in the hands of his creditors. Suddenly, the contrasting irony of the Texas cattle rancher came back to me.

It’s not what we build that matters…it’s the quality of earnings.

Measure of Success

 In my experience, contractors measure success by total sales and the size of the projects they have built. The bigger the better. However, this be very dangerous. It can take our eye off the earnings ball. Our industry is cyclical—available work has always gone up and down. In cyclical markets, an attachment to volume can be a deadly trap. I often contractors say:

“I can’t operate with 10% or 20% less work. I have a ‘drop-dead’ volume I have to maintain to be viable.”

My response to that belief is: “As you grew your business from $5 and $10 million on your way to $15 million were you profitable at $5 and $10 million?” The answer is usually: “Yes.” Therefore you can do it again.

The point is, if you have to go back to one of those reduced volumes, you should be able to re-size and re-configure your organization to what it looked like at that size and it can be profitable again with the reduction in sales. This will include cutting overhead and perhaps reducing equipment resources by selling some — or mothballing if a sale is not practical. In any case, expenses must be minimized or eliminated.

Earnings…Always Earnings

In cyclical markets the volume of business shrinks and expands in response to market forces outside of your control. When there are fewer projects in any market competition intensifies and prices and potential profits diminish. We cannot control the market, but we can control our response to it and our research reveals that there are two opposite responses:

1. Contractors devoted to the belief in size tend to load up on “cheap work”. They temporarily ignore profit margins to maintain a volume that can support their existing overhead structure. Trying to maintain volume in a declining market is an attempt to increase market share and an increase in market share is universally “bought” at a cost. If you retain overhead waiting for an upturn, you may drain your resources to the extent that you will be unable to finance the growth that comes in the upturn. Too many firms have struggled to maintain size through years of market downturn only to falter just when the market begins to offer salvation. Many are encountering this phenomenon in this current market recovery following the Great Recession of 2009.
2. On the other hand, contractors focused on the quality of earnings rather than the size of revenues, find ways to adjust overhead to diminished sales. They realize that profit, measured as a percent of sales, is possible during a down market.

Profit in a down market is difficult, in some cases impossible, to achieve without a corresponding and proportional reduction in overhead. Because capturing, training, and retaining good people had been a major accomplishment during the good years, we are obviously resistant to even a temporary dismantling of the organization we put in place. However because the most substantial element of overhead is payroll and while it may be counter-intuitive, it is exactly what maintaining profitability requires. It is the only effective survival strategy.

A New Paradigm

Learning to manage a successful construction organization in cyclical markets is not easy. It demands that the overhead structure in both up and down markets become “flexible overhead.” To develop the art of a flexible organization management must begin with the belief that earnings, not revenues, are the only enduring measurement of success. Only after a we have experienced this paradigm shift can we begin to craft an organization that can be managed profitably in both up and down markets. (Read more about flexible overhead)