BUSINESS COUNCIL
The 5% Argument
When no one knows the firm’s net profitability
Ask any member of your team if they know the net profitability of a firm such as yours. The answer may astound you. Having done this exercise over the last 20 years, it is interesting to see values as high as 50% and as low as 1%. So, either your team believes that the executive team runs a massive printing press to push out all of those dollars, or you are barely making enough to cover weekly payroll. Below is a table that represents the last five years of net profitability across the various construction sectors as measured by FMI.
There are a million reasons why one sector is the darling while another is the frog, year over year. Keep in mind that this five-year average also includes a time shortly after the pandemic and firms that may have been recipients of the Paycheck Protection Program (PPP) loan through the federal government, so firms may have received a windfall through the PPP, managing the business well in a crisis, or a combination of both. While it is great for leaders to maintain a strong, healthy knowledge of industry benchmarks, it is more important to go back to the thesis question: Why does your team have such a diverse set of responses when asked about profitability? Additionally, does this diversity also create or drive bad behaviors? For instance, what is your propensity to drive labor productivity when you think the firm is making 50 cents on every dollar that comes into the business?
Reluctance
There are certainly organizations that play it close to the vest when it comes to financial performance. Simply put, most construction organizations are privately held businesses, and sharing such information might feel uncomfortable.
To be clear, this is not to say that to create greater knowledge of financial performance, leaders should leave the income statement in the breakroom next to the coffee maker. But consider an alternative message.
For instance, in Figure 1, the average across all the sectors is 5%. It would be interesting to see the reaction when posed like this: “For every dollar that comes through the front door, we get to keep one nickel. For the risk we take as a business, we get to keep a nickel.” When you put it that way, it doesn’t seem like such a fun party after all. By no means should we be crying into our coffee, but this context provides the right amount of impact.
Figure 1. Net profitability by construction sector, five-year average
Financial Association: Part 1
Consider a civil contractor. This civil contractor — Dirt Movers Inc. — owns 10 excavators of various sizes. The excavators roughly cost around $300,000 each.
Now think about the team that runs said excavators. Doing some quick math with a crew of five for each piece of equipment at $50/hour, burdened, you are looking at $2,000/day. Contextually, it is easy to see how one might make an errant assumption about profitability when doing some scratch pad math. Costs and profit are not the same thing. A little education goes a long way in creating the fight foundation.
Financial Association: Part 2
Costs are a piece of the equation. There is also the top line of this income statement that comes into question. So, Dirt Movers Inc. just landed a $20 million contract. This is in addition to the other four projects they were awards this year totaling $80 million in revenue. To a rank-and-file employee — office and field alike — they hear messaging that sounds a lot like winning the Powerball lottery. In the end, the top line enables us to have jobs, but the bottom line means so much more to the long-term health and well-being of the individual and firm.
Financial Association: Part 3
As an example that builds upon the financial model, ask your team how they would respond to this question: Would you rather be a $100 million contractor generating 5% net or a $50 million contractor generating 10% net? Strategic implications aside as it relates to being larger or smaller, it is amazing how many individuals choose the $100 million in revenue option.
Consider this revision to the previous statement: “You go from $50 million to $100 million but you make the same amount of money, even though you took $50 million worth of additional risk to the business.” Once again, there may be logical, strategic reasons for going to $100 million (i.e., market protection, investment in the team, etc.), but there are also many businesses making bad sales decisions because they think chasing the top line has more sex appeal than the bottom line. However, the bottom line finances the company’s future while the top line represents a promise that may or may not come to pass.
The core arguments for profitability messaging are these:
- Knowledge — Sharing profit goals and performance, whether as a percentage or the actual number, is a good practice to share. Not sharing could lead to bad decision-making based on unrealistic perceptions, and in the worst scenario, spending money they thought existed but never did.
- Strategic decision-making — Control the narrative about how decisions are made whether it is a client, market or even equipment. Left to their own devices, associates make generalizations that may or may not be grounded in facts.
- Training — Educate your team on what great financial performance looks like. This does not mean you are going to create junior certified public accountants, but a little knowledge enhancement goes a long way.
GREGG M. SCHOPPMAN is a partner with FMI Corporation, management consultants and investment bankers for the construction industry. Schoppman specializes in the areas of productivity and project management. He also leads FMI’s project management consulting practice. Prior to joining FMI, Schoppman served as a senior project manager for a general contracting firm in central Florida. He has completed complex construction projects in the medical, pharmaceutical, office, heavy civil, industrial, manufacturing and multifamily markets. He holds a bachelor’s degree and master’s degree in civil engineering, as well as a Master of Business Administration. Schoppman has expertise in numerous contract delivery methods, as well as knowledge of many geographical markets. Contact Schoppman by email at gregg.schoppman@fmicorp.com. Visit fmicorp.com.
Photo Credit: Gregg Schoppman
Photo Credit: Mer_Studio- adobestock.com
