One of the really interesting things about the surety business is you get to look behind the curtain of a ton of contractors’ operations. Daily, we get to hear the opportunities and struggles that our customers face while at the same time seeing how the financial results play out.
A few years ago, our agency took the step to compile the data from our customers’ financial results to determine what market trends we could gain from the information. The trend for the last several years has been consistently upward, and 2018 was no exception. In fact, every area we measure showed continued improvement. Profits and backlogs are up virtually across the board, and based on the numbers coming into 2019, there is reason to believe this year will be strong as well.
What the positive results don’t show is the many challenges and increased risk contractors face including:
- An extremely tight labor market
- Increased environmental and labor compliance regulation
- Greater use by owners of outside construction management and inspection firms to run work
- Subcontractors being stretched thin and not performing
These challenges along with the higher volumes of work have led to an increased occurrence of profit fade on projects and have strained some organizations to the brink of closing their doors.
So, what can contractors do to maximize the good years we have left in this economic cycle? The most important thing is to probably limit growth, as that will only require more highly capable, qualified people which are hard to come by. We’ve seen some of the most profitable contractors focus on the following basics that drive their bottom line.
Raise gross profit margins – When many contractors read this, they will simply dismiss it as not possible. I can tell you firsthand that I’ve seen several contractors try it over the last year and succeed. Not only that, many have maintained their current volume of work. Those that did see a decrease in volume had the higher margins more than make up for it. This is not just because of the higher margins, but because they were able to execute the work they had more effectively at the lower volume.
Stick to work you are best at with owners you are familiar with – Now is the time for contractors to be selective, to focus on jobs where there is a higher probability of success. Taking on new types of work, in new areas, for new owners with new untested staff is a recipe for disaster. One of our customers, did an analysis of all the types of work they’ve performed over the last couple years broken down by market segment and owner type, and they compared the gross profit margins. They found certain types of work to be the most lucrative and have shifted their resources to do a greater proportion of work in those areas. The result, their gross profit margin increased by 6% in 2019 over last year.
Tighten project controls and accounting – As workloads have increased, everyone is getting stretched thin. This doesn’t just include contractors, but construction managers, owners, engineers and architects. As a result, staying on top of change orders and receivables becomes that much more important. We’ve had several clients hire people in their organization with a focus on these tasks to ensure cash flow stays manageable. Growth eats cash and if your pay cycle for receivables and change orders becomes longer at the same time, it will strain your cash flow resources, which is like cutting off oxygen near the top of Everest.
Prequalify and/or bond back subcontractors – This is another area that many contractors will dismiss believing if they put the cost to bond subs in their bid, they won’t get the job. What I can tell you is we have many contractors that do bond their subs, and they make equal to or greater profit margins than those that don’t. These clients don’t necessarily bond all subcontractors such as trades they can self-perform, but they do bond those trades that are critical path, are high risk and/or a large portion of the project.
In the end, bonding subs is very cheap insurance. A couple of our clients have had unbonded subs fail recently, and it cost them each over $500,000 to replace the subs. That money could have paid for a lot of bond premiums and saved a ton of heart ache in time and energy.
In Jim Collins’ book How the Mighty Fall, he outlines five stages that lead companies to failure. Stage 2 is “the undisciplined pursuit of more” and stage 3 is “denial of risk and peril”, which describes perfectly the trap many contractors fall into. But there is hope, Collins suggests, of reversing this fate by focus and discipline on the basics just like the things outlined here. It isn’t glamorous but it is effective.