The Garrison Report #2004-5

How to Increase Your Profit Margins

The simple answer to increase your profit margins is to raise your fees.

You might think the author is trying to be smart; however, it’s a legitimate answer. The author hears people saying, “But we can’t raise our fees because of our competition.” Wrong! Does your competitor set your fees, or do you? If you are letting the competition set your fees, you are doomed because there are too many poor businesspeople out there. There is a contractor in Delaware with a sign on the side of his trucks that proclaims he is the most expensive. He has more work than he can handle.

The other day at a presentation, someone said to the author that the recent rapid rise in steel prices might be the best thing that has happened to the construction industry in years. The author was a little surprised to say the least. However, he continued, there are a lot of contractors who haven’t raised their unit prices in years, and as a result, their profit margins have been eroding. Now they will be forced to raise their prices, which is the best thing for them to do. So maybe the correct answer is to just raise your fees.

The reason people are afraid to raise their fees is because they are competing on price. You must learn to compete on value. Peter Senge, author of The Fifth Discipline, said, “Our organizations work the way they work ultimately, because of how we think and how we interact.” Therefore, if we want things to change, we need to change the way we think. Instead of thinking “How can we do it cheaper, cheaper, cheaper?” the question must be “How can we add greater value?” That doesn’t mean we ignore costs; unnecessary costs, whether paid by you or the client, are not good. But focusing only on cost reduction is not the way to grow a business. This is especially true in construction, where we deliver complex products and services that are one of a kind and impossible to really price shop as a commodity.

One of the author’s clients illustrates this concept. At the time, they were a $20 million–a-year general contractor with a net profit in the range of 1.5 percent, or about average. They went back to all their clients and asked if there were additional services they could provide that they weren’t currently providing. They received a long list of desired services. They went back to the clients and said, “If we do all these extras, we will need to charge an extra 1 percent in fee.” The clients all said, “Fine.”

This resulted in an extra $200,000 in income, but the cost to the contractor was only $18,000. How many contractors make a 1,000 percent profit? This contractor had that kind of return on the amount invested on the additional services. The reality is that 17 percent of clients care only about value; they simply want the best. Another 27 percent care only about price, so why should you worry about them? They don’t worry about you. They are never loyal to the contractor or the designer; they are loyal only to the price. Go ahead and send those people to your competitors; maybe you can get a referral fee. Heck, any referral fee might be a larger profit than you will make doing the actual job.

But this leaves 56 percent of the people out there. We must focus on these people because they are the people who care about value and price. They buy based on price when they can’t differentiate between the two contractors. The author often asks contractors to tell him what makes them different from the contractor down the street. Usually, they can’t answer that question, which is a problem. If the contractors can’t differentiate themselves from each other, how do they expect the clients to differentiate them? Thus, the client resorts to the lowest differentiator—price.

 

What’s the purpose of a business?

One of the author’s favorite questions in seminars is, “What’s the purpose of a business?” Someone always responds, “To make money!” He thanks the person because that is the answer he was seeking, but it’s the absolute wrong answer. Why? If you are worried about making money, you tend to make short-term decisions. When you make short-term decisions, you focus on your company, not the client. If no one is worried about your clients, how many will you have? You’re right—none! If you have no clients, you will not make any profit. Therefore, it’s not that you don’t want to make money—after all, that is our personal reason for being in business—but our business focus can’t be on making money. The company must focus on getting and keeping clients.

When clients say your costs are too high, what are they really saying to you? They are telling you that you are not delivering enough value for what you are charging. Look, you make that analysis every day of your life when you go to the store. You ask yourself, Would I rather have the money or the item? Depending on your perceived value of the item, you make a purchase decision. Your clients are no different.

 

Dialogue is the answer

There are two major issues that must have greater dialogue. The first is you must do a better job of educating your clients about the value you deliver. You need to educate them about the problems of deleting jobsite personnel to save money, which results in mistakes that are more costly to fix than the savings in personnel. You need to inform the client that cutting design fees is a mistake because it results in higher construction costs. The reality is that the general contractor’s fee and the architect’s fee represent about 10 percent of construction costs. But construction costs represent only about 10 percent of the total lifetime cost of a building. Therefore, the general contractors and architect’s fees represent only about 1 percent of the total lifetime cost of a building. Yet misguided owners focus on this 1 percent in the hope of saving money. When they do this, often the remaining 99 percent in costs goes wild. Therefore, we need to communicate the concept that it’s more important to select the “right contractor and designer” than to select the cheapest. We must educate clients to focus on the idea that the right team can create significant savings in the area of the other 99 percent of costs.

Another important issue in delivering greater value is to understand what the client really needs. This occurs only when there is an open dialogue with them. Just as with the earlier example, when services are provided that the client places a high value on, it’s often possible to increase profit margins while at the same time serving the client better.

In subsequent issues of The Garrison Report, we will explore some specific actions that contractors and designers can perform to substantially increase the value they deliver to their clients, thus eliminating competition and increasing profit margins at the same time. In fact, the author encourages contractors and architects to provide examples of their success. He’s happy to include these responses in The Garrison Report with or without your company name—your choice.

 

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