The title of this blog is our theme for 2024. It is too hard to make good money in our industry these days. Contractors risk their own capital taking on enormous and highly complex projects that require expert knowledge and execution and often last for years. But, notwithstanding the enormous effort and expertise it takes to erect the world’s infrastructure, even AI (Artificial Intelligence) has a low opinion of our ability to make money:
Artificial intelligence supposably knows all, and it even sees construction as a “notoriously low-margin business“. That belief is a consensus about the construction industry across the entire internet. If we all believe it is the “natural state of things” then it is assured that we will remain a low-margin business. The average net profit margin for construction companies has been dropping for years and compared to other major industries in the US is a seriously low-margin business. Because the margins deteriorated slowly over a long period of time it was less noticeable and appears to have been accepted as the norm by subsequent generations of industry participants.
This year it is my intention to isolate the factors that contribute to this “low-margin” belief and suggest methods for dramatically increasing net margins to the healthy 15%+ we enjoyed back in the middle of the 20th century.
Low-bid Acquisition
- Because low-bidding was for decades required on all government work (and most private sector projects) this acquisition method has become the construction industry standard. Because buyers of construction services (owners) believe that the smartest and most efficient producer is rightfully the “low-bidder”, it forces most contractors to encourage their estimators and operators to find clever new ways to trim costs to maintain a competitive advantage.
- However, the history of declining profit margins in the construction industry demonstrates the fallacy in this thinking.
- If contractors continue to submit artificially low bids in order to acquire work, we are letting the least efficient operators set the selling prices. This of course is the inverse of what the buyers of our services believe about the low bidder. This is why our profit margins have continued to erode over the past forty years to an unsustainable low level.
Commodity Pricing
Buyers of construction services have come to believe that all contractors are alike and now see construction services as a commodity that they are unwilling to pay premium prices for. This “commodity belief” along with the low-bid format depresses construction pricing. Owners think that one contractor is like any other and, therefore, see no risk in always selecting the low-bidder. We contractors have contributed to this belief by going along with the whole “low-bid” structure of contract acquisition and willingly competing with less efficient and less competent competitors.
Contract Imbalance
Adding insult to injury: With enormous amounts of taxpayer money and political capital at risk, government agencies (and private buyers) began to draw construction contracts that would minimize financial and performance risk to the taxpayer. They claim to be performing a noble task on behalf of the taxpayer but were in fact shifting an unreasonable and inappropriate burden of risks onto the contractor’s shoulders. The environment that we are forced to pursue our business in is fast became toxic. We are assuming almost all the financial and performance risk for enormously complex and long-lasting projects, eroding profit margins and using massive amounts of our own capital.
2024 – A Branching in the Road
Rober Frost wrote:
Two roads diverged in a wood, and I –
I took the one less traveled by,
And that has made all the difference.
In 2024, I am suggesting that we begin to take “the road less traveled “. Forty years have passed since I first began to preach a new focus on making a reasonable profit. Most of my teaching centered on tried-and-true management techniques like proper planning, cash flow management, controlled growth, flexible overhead, etc., etc. We are being forced to recognize that things have changed and not in our favor. We need to reverse this trend and begin to increase profit margins, improve cash flow, and resist some of the risks being forced onto us. We are going to have to reevaluate the very structure of the construction business. Because no one is going to do it for us we are going to have to gradually alter the business model that construction has followed for 100 years and resist the market forces that have squeezed down reasonable profit margins and forced us to accept costly risks that are not rightly ours.
For the next three weeks we will discuss how to begin taking “the road less traveled”.
- We will talk about how to avoid being stuck in the “low-bid” trap by focusing on quality and reputation.
- We will discuss techniques that the entire industry can adopt to alter the “commodity” image of construction services.
- In week three, we will tackle the roadblocks to developing a new set of standards for contract negotiation and interpretation after the work is under way. We must rebalance the risk forced on us by current construction contracts.
For a deeper look into business growht, read more here: GROWTH
For a broader view into managing risk, read more here: RISK MANAGEMENT
To receive the free, weekly Construction Messages, ask questions, or make comments, contact me at research@simplarfoundation.org
Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
