5 ways to increase profit margins
Too many construction companies suffer from low margins. They need new strategies to improve their profitability.
Construction firms may be good at winning work, but profit margins in the industry have rarely been
thinner. Indeed, research published earlier this year suggests the 25 largest construction companies in the UK have been operating with an average margin of just 1.2% during 2016. Large numbers of businesses have shifted to a high volume, low margin business model, often unwittingly or against their will. With profits so elusive, many construction businesses are inevitably getting into difficulties. The insolvency adviser Begbies Traynor thinks more than 50,000 construction and real estate firms are now experiencing financial distress, a 17% increase on a year ago.
For construction firms anxious to climb out of such troubles – or to avoid them in the first place – the key is to focus on re-establishing healthy margins. Below, we present 5 possible routes (none of which are mutually exclusive) for doing exactly that.
1. Avoid the commoditisation trap
In a competitive marketplace, it’s easy for construction companies to feel that price is the only basis on which they can win business. But the race to the bottom is a competition that benefits no-one – including the client, who is likely to end up with a shoddy result when its supplier is desperate to protect its paper-thin margin.
Instead, think about what makes your business special, and bid for the projects best suited to your talents. It may well be better to end up with less work, but at higher margins, than high volumes of trade with minimal profitability, because the latter is a much riskier model. Even a minor setback can tip the project into loss.
In part, the challenge here is to sell your business’s skill set effectively. You need a sales team that is able to articulate your unique selling point in potentially profitable niches so that you win business even where your tender isn’t necessarily the cheapest.
Equally, don’t be afraid to pass up on invitations to tender from clients you believe to be overly focused on price at the expense of quality. Firms that are determined to drive down contractors’ prices to the absolute minimum are probably doing the same with their own business. They’re more likely to run projects poorly, hire sub-standard subcontractors and behave badly when you claim payment. All of this will erode your margins even further.
The aim should be to maximise the returns your business makes from its investments in expertise and experience. So, for example, avoid projects where the qualification threshold for bidders is too low, since you’ll end up competing against a large number of rivals where price becomes the differentiator. Instead, focus on winning higher margin business where your specialisation and track record sets you apart from competitors. You may even need to reconsider your business strategy in order to ensure you have specialist offerings that differentiate your firm.
2. Cut out unnecessary costs
Think about cost in the broadest sense of the word. It’s certainly important to ensure your business is operating as leanly as possible, and there will be areas where you can get costs down further. Well-planned waste management, for example, presents opportunities for reuse and recycling – while limiting landfill use – that will produce genuine dividends over time.
It’s important, however, that managers don’t become consumed with chasing every last penny of cost efficiency, because that isn’t the most productive use of their time. Successful construction companies have excellent management information systems, which they use to stay on top of cost control in areas such as labour, plant and materials, but they also organise their businesses so as to optimise long-term profitability.
The aim should be to reduce the possibility of projects being hit by unnecessary costs and delays. Are project timelines realistic and have they been communicated effectively to all those with roles to play in planning and delivery? Does the labour force have the skills and equipment it needs to do the required work at the right moment and in the planned timeframe?
It may even be necessary to speculate to accumulate. Investment in training, for example, will carry an upfront expense but if targeted effectively it will also reduce costs on an ongoing basis over an extended period. Similarly, what’s the best way to acquire the plant you need for particular jobs? Will it be more cost-effective to hire certain types of equipment or is an upfront investment justified?
3. Focus on talent
One common theme cutting across all of these areas is that it is crucial to have the right people in your business as you seek to unlock higher margins. In other words, robust talent management, focused on recruiting and retaining the individuals who will add most value to your business, should be a clear priority for any construction company seeking to improve its profitability.
That’s not necessarily straightforward because there are only so many good people available. A recent study from KPMG confirmed what we already know – that talent shortages have become a real problem for the construction sector. Some 44% of firms struggle to attract qualified labour, while 45% lack planners and project managers.
Construction firms need to be smart about how they approach this issue. What is the right balance between permanent staff and project workers for your business?
How do you market your firm as an attractive employer to new recruits? Might apprenticeships be a good option for entry-level jobs, for example, and what work and experience can you offer more senior potential employees? Focus on retention too – do staff in your business feel you have career development plans in place and that they’re part of your succession strategies? How are you aligning their interests with the interests of the firm itself?
Improving your talent management practices will make a massive difference, over time, to your business’s profitability as you move towards employing an engaged and committed workforce that represents another option for differentiating your business rather than playing the commoditisation game.
4. Promote productivity
Research from the management consultancy firm McKinsey reveals that while productivity in the manufacturing sector has doubled over the past two decades, it has remained flat, or even fallen, in the construction sector. No wonder such businesses are so disappointed by their margins.
How, though, to start improving productivity? McKinsey’s analysis suggests construction companies’ problems most often lie in a relatively small number of key areas. These are where you should start your search for margin gains.
Start by looking at your organisational processes, particularly around how decisions are made – your procurement function is an obvious opportunity to make some quick wins. Part of the challenge is to improve communication, both internally and with third parties such as subcontractors.
Enhancing information flows will reduce delays and deliver collaboration benefits.
Challenging your employees to improve productivity will also be rewarding. Too few construction companies have a rigorous approach to performance management that holds people accountable for their responsibilities – and incentivises them to do better.
How effective is your planning process? Do you have a clear vision of what your business needs to be doing in the very short term, as well as in the medium to long term? If not, people, equipment and materials may not be in the right place at the right time.
Finally, pay more attention to risk management at every stage of the construction process. What are the dangers – in terms of both micro issues and big picture stuff – standing in the way of better productivity and profitability?
5. Exploit new technologies
The way you run your business – that is the processes behind the scene that clients don’t see – will have a major impact on your margins and profitability. The more efficient you are, the more of your resources that can be targeted on doing the work that pays the bills.
New technologies that automate such processes provide a clear opportunity to improve efficiency, taking time-consuming and error-prone manual work out of the business wherever possible.
One good example is solutions that automate the monthly application for payment cycle, where many construction companies are currently spending considerable amounts of time and resources on paper-based procedures that are painful for all concerned. Switching to an automated application for payment solution reduces this wastage, limits the potential for human error, reduces cost and provides a communication platform through which all parties can interact and negotiate quickly.
Such technologies produce more than the immediately visible gains, since they’ll also reduce a number of ‘soft’ costs for your business. For example, your relationships with both suppliers and customers will improve with more convenient payment processes and improved communication. Your accounts department will spend less time dealing with complaints and misunderstandings.
Construction companies sometimes think of new technologies only in the context of their front-line operations. But while investment in, say, machinery and materials can be one way to improve profitability, it is important not to miss out on the gains that process technologies can also deliver.
Click here to read a case study about how Progressclaim.com helped 2Construct improve profitability.