When you break it down into the simplest of terms, construction firms have two main goals – to build and to make a profit while doing so. The first is the easy part, but the second seems to be a struggle across the industry.
From a boom period experienced in the early 2010’s, profit margins have been diminishing for the past 5 or 6 years. A study in the Journal of Building Engineering in 2019 found, at that point, a huge 44% of all construction projects would actually result in a loss. Even during the supposed ‘boom period’ earlier in the decade, analysis of 30 large companies by McKinsey Consulting found that 85% had profit margins lower than 10%.
One of the issues within construction is businesses tend to automatically lean towards high volume, low margin business models. In the past, contracts have often been awarded based on price alone, so companies would bid for work with the smallest possible margins. Add to that rising costs, inaccurate estimations, and poor planning, and it is easy to see how so many projects result in little or no profit at all.
It is estimated that only around 20% of construction firms have a truly accurate picture of the cost of their business, and without this, how can they possibly hope to achieve their desired profit margins on the work they bid for? Industry experts believe that the average margins within construction are probably between 1.5% & 2%, a far cry from the 40% operating margins experienced within other industries. But the good news is, according to McKinsey, that contractors could well achieve 20-30% operating margins if they redesign their operations to focus more on profitability.
For companies anxious to improve their situation, and avoid financial problems, we have 5 possible routes (none of which are mutually exclusive) to do just that.
1. Avoid the commoditisation trap
Historically, the construction industry has often seen a race to the bottom when bidding on large projects, which generally doesn’t benefit anyone in the long run. Although many companies feel the price is the only basis on which they can win business, they instead need to look at their unique expertise in order to win profitable contracts. Choose only to bid on those projects that are suited to your talents and learn to sell your business’s skill set effectively. You may well end up with less work, but at higher margins, this will be better than more work with minimal profitability, where minor setbacks can easily tip the project into a loss.
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 determined to drive down contractors’ prices to the absolute minimum are probably doing the same in their own business and are more likely to manage projects poorly and behave badly when you apply for payment.
2. Cut unnecessary costs
If you don’t know what your operating costs are, you have no way of knowing how profitable each job is, never mind increasing your profit margin. It is important to have a good handle on both project costs and your general overhead costs (support staff, payroll, insurances etc) both during the bidding process and once you have won the work. Once you know this, you can then look at ways to operate as leanly as possible and reduce day-to-day costs.
However, it is also important to think about costs in broader terms. Are your managers making the best use of their time or are they getting bogged down in unnecessary tasks? Are project timelines realistic and have they been communicated effectively to all parties to reduce the likelihood of project delays and unnecessary costs?
Successful construction companies often 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 focus on long-term profitability, regularly reviewing if their labour force has the skills and equipment required and pre-empting problems and issues before they arise.
3. Focus on talent
A business is nothing without the people working within it and it is crucial to have the right people in the right roles if you want to unlock those higher profit margins. Recruiting and retaining individuals who will add the most value to your business should always be a priority for any construction company wanting to maximise its profitability. This is often easier said than done, as the industry continues to face an acute skill shortage.
Construction firms need to be smart about how they approach this issue. What is the right balance between permanent staff and project workers? How could apprenticeships help your future strategy and what can you offer more senior workers to attract them to your company for the more immediate requirements?
Improving your talent management practices will make a massive difference, over time, to your business’ profitability as you move towards employing an engaged and committed workforce that can differentiate your business from your competitors’.
4. Promote productivity
Research from McKinsey Consulting reveals that while productivity in the manufacturing sector has doubled over the past two decades, it has remained stagnant in the construction sector. They believe that improvements in a small number of key areas can have a huge impact for construction firms.
Your operational or organisational processes are the first area to consider, with good project management being key. Improving communication and enhancing the flow of information will reduce delays and provide many collaborative benefits. Ensuring your planning and scheduling of work is effective and well managed is essential to ensure the right people and equipment are in the right place at the right time. Challenging your workers to improve productivity will also offer many benefits. Holding people accountable for their actions through effective performance management and incentivising them to improve can be very rewarding for the business as a whole.
And finally, pay more attention to risk management at every stage of the construction process. What are the dangers standing in the way of productivity and profitability?
5. Exploit new technologies
The way you run your business behind the scenes will have a major impact on your margins and profitability. The more efficient you are, the more of your resources can be targeted on doing the work that pays the bills.
It is no secret that the construction sector is often reluctant to embrace new technologies, but those industries that do, such as manufacturing, reap the rewards. Technology that can automate time-consuming processes provides a clear opportunity to improve efficiency and remove the likelihood of errors. Construction companies will often automatically think of new technologies only in the context of their front-line operations, but it is important not to overlook the benefits to be made behind the scenes too.
One example of this is a solution to automate applications for payment, such as Payapps. Many construction companies spend considerable amounts of time and resources on paper-based procedures which are painful for all concerned. Switching to an automated system dramatically reduces the amount of administrative time required, limits the potential for human error, and provides a communication platform that automatically creates a comprehensive audit trail. Alongside these visible gains, businesses also see a reduction in a number of ‘soft’ costs with improved relationships with both customers and suppliers, and improved visibility and communication reducing the time spent dealing with complaints and misunderstandings.
Following the completion of any project, it is always important to analyse the work completed. If you have implemented any new ways of working, now is the time to look in more detail at the impact this made and how it could be improved further in the future. It is also important to remember that this industry, like any other, is ever-changing and in order to create successful businesses now and in the future, you must be willing to continually adapt and evolve.
