Flexibility = Profitability

I have been talking for years about “Flexible Overhead” as a fundamental management tool in the construction industry.

By Flexible OverheadI mean the ability to expand or contract overhead with the same speed as the construction market expands and contracts.

Construction Company DNA

During market expansion phases, contractors may have to expand home office staff, expand facilities to house them, provide them with a company car to get around in, motivate their performance with health care and bonuses, and buy the newest high-tech equipment to help them keep up with the work. This new “overhead” becomes part of the company’s DNA and will be firmly in placewhen the next market contraction sucks the air out of top line revenues. Many construction enterprises then begin to pile up losses and erode their capital position while frantically trying to find more (and often inappropriate) work to “cover the permanent overhead”in a declining market that has little or no profit to offer.

Profit Margins

According to the Construction Financial Management Association(www.cfma.org), the average pre-tax net profit for general contractors is between 1.4 and 2.4%. For subcontractors it is between 2.2 to 3.5%. Why these margins have become so thin is a discussion for another time. Suffice to say that such thin margins leave little room for error. Each contractor’s overhead footprint must fit snugly into the amount of business it is being asked to produce and service or, with already thin profit margins during the best of times, the company will quickly slip into losses during contractions.

Market Volatility

Your company’s capacity to protect thin profit margins depends on its ability to expand and contract with the market, we can measure the degree of flexibility required year-by-year over the past twenty years.

Many contractors think of the construction market as either going up or down, but most are surprise at the actual volatility when they see the actual data. Let’s take a look at the expansion and contraction of the construction marketplace since the turn of the century.

TOTAL CONSTRUCTION – PUBLIC/PRIVATE – BILLIONS OF DOLLARS

YEAR             PUBLIC          PRIVATE       TOTAL           EXPANSION/CONTRACTION

2000                $181B             $621B             $802B                                     8%

2001                $202B             $638B             $840B                                     5%

2002                $231B             $634B             $865                            3%

2003                $220B             $771B             $991                            11%

2005                $255B             $912B             $1,167                         6%

2007                $289B             $863B             $1,152                         (1%)

2008                $309B             $769B             $1,078                         (6%)

2009                $315B             $592B             $907                            (15%)

2010                $304B             $505B             $809                            (10%)

2011                $286B             $502B             $788                            (3%)

2012                $279B             $571B             $850                            8%

2013                $271B             $638B             $909                            7%

2014                $276B             $731B             $1,007                         10%

2015                $294B             $837B             $1,131                         12%

2016                $297B             $914B             $1,211                         7%

2017                $297B             $969B             $1,266                         5%

2018                $307B             $1,000B          $1,307                         3%

2019                $329B             $977B             $1,306                         0%

A Cautionary Tale

 

Even a casual glance at the table above reveals the volatility of the construction market and tells a cautionary tale about the flexibilityrequired of the contractor who seeks to protect thin profit margins year in and year out. I will talk about how to initiateflexible overheadinto your company in future blogs.