An examination in how to return to profitability

By Gregg Schoppman, FMI Corp.

Construction demonstrates the ultimate in extreme comparisons.  Gluttony or starvation.  For what seems like the better part of the last 10-15 years – minus a short COVID holiday – the industry has seen unbridled growth in just about every sector.  Construction organizations seem to have no shortage of opportunities and revenue growth often resembles a runaway train, accelerating ever northward.  Reflecting on previous recessionary times not only creates a sickening feeling in the pit of most leaders’ stomachs, but also seems to have an air of non-strategic desperation. Simultaneously, industry leaders have constantly opined about the lack of talent that the industry is facing.  For over 40 years, there have been countless studies that describe the overall lack of tradespeople, supervision and management personnel.  Coupled with a relatively low nationwide unemployment rate across the board, there is a perfect recipe for the classic construction industry deficit.  Anecdotally, just about every construction leader has had that moment of exasperation when trying to find the right person for their next project.  “Great, we have the project but who is going to run it?”

There are also many correlations that show how a sharp increase in volume often has a deleterious effect on profitability.  For instance, consider the following case study that provides a broad framework of year over year growth when compared with profitability:

The situation illustrated above is extremely common in today’s world.  An organization grows as opportunities arrive across the estimating desk.  Clients are flush with capital expenditure dollars and often supply construction organizations – general contractor and trade contractor alike – with more than enough opportunities to keep them fed.  However, the “governor switch” for many construction firms is the ability to staff projects with the appropriate level of supervision as well as craftspeople.  An interesting phenomenon occurs at this point.  Many contractors will begin to price discriminate by increasing their bids, almost to deter a client from a project.  There is the common belief that if one is honest with a client about capabilities (or lack thereof), there may not be a future opportunity.  “If we say no to them today, they will remove us from their bid lists. Plus, we’ve been chasing (INSERT CLIENT HERE) for X years…”

However, the deterrent fails, leaving the contractor with the dubious challenge of building more, with less resources.

However, it is a bit myopic to examine this case by only looking at the lost profitability.  Below is another illustration of how the firm had addressed the management personnel ranks:

Within this illustration, the organization managed to grow in lockstep, to a point. The team grew as projects were added.  As with any case study, there is the story behind the story. More importantly, it is important to note that this organization did not have a codified set of parameters with which to govern the management and supervision of projects. Put another way, new team members were added as “free agents”, bringing whatever set of best practices they utilized at their previous employer rather than the Brand X Operational Way.  Sure, they had the newer software programs but there was hardly a consistent approach to how those tools were utilized. Additionally, the screening of new personnel was viewed through a lens of “Right Fit Now” versus “Right Fit for the Long-Term.”  Using a sports analogy, personnel are inserted regardless of capabilities, with a “next person up” mentality.

One important delineation is that a sport’s team more than likely has depth. In professional football there are more than likely two other quarterbacks, representing the back-up and possible junior understudy. Comparatively, construction organizations – particularly the representative firm in our example – have zero bench strength. Of course, the first argument is that a professional sports team has a substantial payroll boost compared to most construction organizations, which would be a fair characterization. Additionally, there are most likely support team members that are helping the supervision and management, in the form of project engineers, foremen and assistants. The firm in this case did have a small group of newer team members. However, it is important to note that this junior corps was also hired reactively and immediately dropped on site to fulfill project needs. Consequently, their internal attrition on personnel was high, exacerbating a fragile personnel situation. Some of the common quotes that were used to describe the current state at the firm are as follows:

• “If we lose (INSERT PERSON HERE), we are in trouble.  They were going to run (INSERT PROJECT HERE).”
• “Everyone you work with does it slightly differently, which creates a challenge when we have to shift personnel around. You’ll spend half your time re-learning project management 101 with your manager or superintendent.”
• “We throw people to the fire/wolves/deep end of the pool. Throwing them into the fire doesn’t seem right but we have no choice.”
• “Our client loves (INSERT PERSON HERE).  Unfortunately, we are worried that (INSERT PERSON HERE) is a flight risk. When they leave, so does that revenue.”

Phrases like this are commonplace and they always have to be taken into context of the number of mentions. Simply put, if the organization is not focused on creating a stable environment for its most critical asset, it is simply building on a fragile house of cards. On the other hand, there is a strong argument about how this organization has approached its strategic growth.  For example, consider the following arguments:

• Build internally and then grow – In a classic case of “the tail wagging the dog,” the case study demonstrates a willingness to add volume then add staff, reactively.  Comparatively, what if the firm created a willingness to absorb cost, or at least spread that cost of additional personnel over a longer period of time.  For instance, personnel are added with the intention to grow and the development of those individuals is put first.  Put another way, which might be a better long-term solution – recognizing the cost of a project manager ($100,000) over time while consciously developing that individual or having a new associate parachuted in that could make a costly mistake with a project or critical client, possibly accounting for over $100,000 in expenses?  There are certainly no guarantees.  There are definitely situations where free agency has benefited a firm.  However, there is also a high probability that that misdirected wrong hire will end up costing the firm, with little or nothing to show for it.
• Create discipline around decision making – What if the organization is built with discipline?  For instance, what if the “growth decisions” were predicated on a series of analytical tools that weighed factors such as current backlog, current staffing, profitability probability, etc.  Go-No Go decision making is not meant to become the only mechanism on which a firm decides to chase opportunities.  However, providing fact-based decision making that accounts for internal variables, will provide a mechanism to grow profitably.  Will certain clients or project owners be disappointed that a firm opts out?  Most definitely.  However, they will also express gratitude for not meeting expectations or causing undue stress in the long-term.
• Build the correct firm-wide model of operations – It is imperative that the firm has a consistent and proactive operational model.  This is not to be confused by “personalities” or “management styles” but rather a methodology around pre-construction strategy, resource utilization, change order management structure, financial acumen, project execution at the conclusion of projects, etc.  One of the best ways to determine where a firm stands is to ask the team this question – “How many different meeting agendas do we have for (INSERT MEETING HERE)?”  If you hear, “Well, it depends on who you work with…” it is likely time to consider refining the Operational Playbook.
• Build institutional training and rigor – There has to be a system to introduce and train the “Brand X Way of Doing Things” and there must be discipline around managing that system to drive firm-wide adoption .  This is not only to create internal accountability but also create a vehicle to “catch people doing things correctly.” For instance, firms that create effective on-boarding that is longer than a single day are more likely to create buy-in to the institutional model, creating long-term success.

Ultimately, one great question that every leader should ask themselves is this– if you hired a new team member today, would they simply represent a new project that your firm could take on or do they represent future bench strength?  Put another way, does that posting on social media for a new superintendent backfill an already depleted roster?  Many firms are running a deficit rather than creating an internal surplus of talent.

Consider the example within the case study.  Let’s say that in the last year – the year where they regained profitability – there was an internal movement towards the aforementioned disciple.  Rather than add volume, the firm strategically committed to both less volume and greater operational discipline.  This approach had several benefits that were realized:

• Quality NOT Quantity – Rather than chasing every opportunity, they increased the profitability of the right opportunities
• Risk Profile – Making less money on more volume is a risky proposition.  In a business that is regarded as one of the riskiest industries in the world, making more money on less volume is the only strategic decision.
• The Brand X Way – By establishing a replicable model this organization was able to identify the right “levers of success”, enabling greater control on their projects.  Rather than paper whipping
• Magnet for Talent – Rather than succumbing to the churn of bodies, Brand X was able to reestablish itself within its market as a top employer.  Much better than the people mill it had previously become associated with.
• Client Loyalty – No client likes to be told “no” but this organization was able to creatively sell themselves better for the long-term opportunities rather than resemble a bobble-head doll, accepting everything that came their way, only to under perform.

Finally, the case study simply examined the impact of management and supervisory personnel on overall profitability.  What if this was to also include a component of self-performing labor?  For instance, what if each superintendent was also responsible for 3-5 foremen that may lead crews of labor or fleets of equipment?  This provides an added level of complexity that is illustrated in the graph below:

As the firm’s revenue increased over the six-year span, there was a precipitous drop in overall productivity across the major labor codes that this firm utilizes.  Many organizations would have discounted this as being an estimating error or contributed the decline to some external factor like the weather or permitting. There are often plenty of reasons that must be accounted for but the best summation is an anecdotal example within the organization. A project was bid at an astounding 51% gross margin! The primary factor for the high bid-day margin was the lack of resources to complete the work – there were no crews on staff.  Fast forwarding to the conclusion of the project, the final gross margin was 11.2% with an overhead of 9.5%. The 40%+ write down would end up being attributed to crew shuffling, lack of adequate supervision focus, zero planning, and an inherent belief that they had “enough padding” in their bid. However, what if a catastrophic accident had occurred, all to make a meager 1.5 net margin?  Was it worth it then?  Additionally, what was the impact to customer confidence and satisfaction as they constantly saw underwhelming performance day in, day out?

Certainly, a crystal ball would make this easy. If every firm knew what their revenue would be and if the market participated as planned, this is an easy endeavor in strategic planning and forecasting.  However, returning to profitability may mean a return to realism in strategy, marketing, talent development and operations. Creating bench strength is more than simply having one extra manager on deck. Rather it is a strategic push to develop the correct foundation to build successfully for the long haul.

About the Author: 

Gregg Schoppman specializes in productivity and project management for general and trade contractors across the country. He also facilitates strategic planning and evaluation services focused on organizational transformation. Gregg was named one of the Top 25 Consultants in the World in 2014 according to Consulting Magazine and is also the recipient of the Association of Management Consulting Firms’ “High Five Award” for consulting excellence in 2013.

He leads FMI’s Operations consulting practice as the discipline Leader. Gregg has been a featured instructor in FMI’s Project Manager Academy and regularly trains at all levels of construction from foreman to CEO.