The Garrison Report #2007-9

The Future of the Construction Industry - How to Fix a Broken Industry - Part 4:
How to Increase Contractor Profitability

Listen to the audio version of this report here

The past two reports discussed how the construction industry must adapt to the client's and the workforce's demands. This report explains how contractors must adapt to the changing construction environment. The problem for many contractors is they attempt to improve their financial situation by focusing solely on their company, but this actually takes them in the wrong direction. Since the 1950s, business consultant Edwards Deming has explained that suboptimization doesn't work and, in fact, can make the situation worse.

For example, when a contractor attempts to control costs by keeping wages low, it may actually increase its labor costs as a result of poor productivity and mistakes because it doesn't attract the most qualified workers. Another common example occurs when clients beat down the architect's fee to reduce costs but end up with higher project costs as a result of change orders from incomplete drawings.

The Solution

There are no silver bullets and if there were any, I certainly wouldn't be giving them away in a free report. I would be charging a small fortune for each of those bullets. However, there is a magic formula. It's better known as hard work. Unfortunately, hard work alone will not produce the desired results. Instead contractors need a plan that is built on the foundation of proven business practices.

The process starts with differentiation. If a contractor doesn't differentiate itself from the competition, it's forced to compete on price, the lowest form of differentiation. The most profitable contractors learn to compete on issues other than bricks and mortar because that aspect of the project is a commodity and in that situation the contractor is merely following the plans and specifications. In that situation why shouldn't the client take the low bid? It's easy for most contractors to understand the concept of providing additional value through additional services in the non"“low bid environment. But contractors that compete in the low-bid arena argue they have no choice. I disagree.

Peter Drucker in Managing for Results wrote that being indiscriminate about what you sell and who you do business with wastes a business's most valuable resource"”money available for opportunities. In other words, contractors need to take responsibility for the projects they elect to bid on. Even though the contractor selection may be based solely on price, the contractor has the option of bidding on projects only where its differentiation provides a competitive cost advantage without sacrificing its profit margin.

One of the best ways to add value to a project, whether in the competitive bid or negotiated marketplace, is for the contractor to embrace lean construction. Why lean construction? Because that focuses on eliminating wasted expenses and time by making the contractor more efficient and effective. When manufacturing companies incorporate lean production, they double their productivity almost over night. The obvious benefit of increased productivity is you will get things done faster, but in a tight labor market, you can do the work with fewer people. This makes lean construction an essential direction for the construction industry.

The biggest obstacles to implementing lean construction are the roadblocks that companies build into their processes. Some of the symptoms of those roadblocks include "We don't do that here!" "We always do it this way!" and "We've never done that before!"

A discussion of lean construction could focus on the technical aspects of the process, but more important is a discussion of five interrelated business practices that make lean construction possible. They include added value, focus, speed, innovation and collaboration.

Added value

If contractors want to grow their businesses, they must find ways to increase the value they provide clients. It is a better business model to seek out clients who desire additional services and provide those services instead of trying to make a profit working with customers who care about only price. In a low-bid environment, you will be forced to continually lower your price until the business is no longer profitable. This practice helps explain why the construction industry has the second-highest number of business failures of any industry except the restaurant business. If bottled water companies can sell something slightly better than tap water at the extraordinary premium of four to six dollars a gallon because of convenience, don't tell me you can't find options that clients are willing to pay for, such as speed, better quality or greater energy efficiency. Providing different services allows you to earn a premium. One of my general contractor clients asked its clients if there were any additional services it could provide. The contractor received a long list of items. When the contractor said it would need to charge an extra point to perform this work, the clients readily agreed. These extra services added $200,000 in revenue, yet it cost the contractor only $18,000 to provide them. The clients were delighted, yet the contractor added almost one percent to its bottom line. This is remarkable when you consider the average general contractor only makes 1.8 percent net.

Value is not limited to just the external clients. To attract and retain quality workers"”the internal client"”contractors must provide workers what they perceived as better-valued jobs. To learn more about this topic, go back to part 3 of this series on the workforce.

Focus

The most successful contractors have learned that they must focus their energies on what they do best to separate themselves from the competition. Contractors must identify what they are good at and what they can be the best at then zero in on those talents. The reason is simple: it's impossible to be world class at anything unless you have natural talents in that area because those with natural talents will leave you in the dust. Two NFL Hall of Fame players illustrate this point. Walter Payton made a career of avoiding tacklers and John Riggins's career focused on running over people. They both played to their strengths; in Payton's case it was speed and elusiveness, and for Riggins it was brute force. However, if they had tried to reverse their styles, they both would have failed.

Speed is a driving force of success

Speed is a euphemism for efficiency, but to improve performance with speed requires planning, or the effort at speed simply turns into haste with people spinning their wheels. However, speed can be one of the most powerful competitive weapons. In Las Vegas the casino owners aren't as concerned about price as they are about how long the design and construction process will take. The reason is each day a casino opens early produces millions of dollars per day in increased revenue. During the construction of a recent casino, the steel contractor was able to save nearly six months, a time savings that generated enough additional revenue to almost pay for the entire steel contract.

Innovation

Tom Peters has said, "Tomorrow's victories will go to the masters of innovation. Period." New ideas differentiate contractors from their competition. Further, being the first contractor to introduce a new idea is a very powerful marketing position. Therefore, it's in a company's best interest to constantly reassess everything it does. However, a common roadblock many contractors must overcome is the belief that if they just work harder at perfecting things the way they are doing them, they will be fine. The next barrier is the belief that if it isn't broken, don't worry about it. This idea persists because it's easier to believe it's working than to admit it's not. Innovation is about failing faster. In other words, it's about trying new things, exploring what works and what doesn't. Stop worrying about failing because it's better to fail trying new things than to simply resist change and totally fail in the end. Past success is no guarantee of success in the future. Just consider the fact that the average life expectancy of a Fortune 500 company is only 30 years. They simply grow into large dinosaurs and die.

Collaboration

Collaboration may be the most important because none of the above can really be accomplished without collaboration with the other stakeholders. Only by working with clients can the contractor truly understand the clients' needs and work with them to find better and more valuable solutions. The top two motivators for workers are appreciation and a feeling of being in on things. Both factors imply a high level of collaboration with the workforce. Contractors need to recognize that subcontractors are used for their innovative ability, not for lower price. Of course, innovation often results in a lower price, but it's a by-product of innovation. Therefore, contractors must work with their subcontractors to find ways to add value and increase speed to differentiate their team from the competition.

Summary

Throughout this series of reports, the emphasis has been on working together to increase the value received by the entire project team. The industry must avoid a zero-sum game, fighting over a smaller and smaller share of the declining benefits. Instead the industry must learn to collaborate for the benefit of all stakeholders. Any other option is not sustainable. This option is not easy. It will take hard work and commitment by all parties, but failure is worse.

Don't let the process intimidate you. You don't need to change the entire industry. In an industry that domestically makes more than a trillion dollars annually and no contractor has even 1 percent of that volume, there are plenty of opportunities to find other stakeholders that share your perspective. More and more owners are beginning to understand the importance of selecting contractors based on the value delivered, not on a low bid. Contractors that understand it's their responsibility to protect the client are well received by that type of client. When contractors create an environment that workers find challenging and rewarding that also provides opportunity for growth, it will be able to attract a sufficient number of qualified and motivated workers.

I can't make you do anything. I can't even make you accept the facts. Some contractors are dinosaurs, and unfortunately for them, they will die off. On the other hand, there are the gazelles that are already out there, changing and adapting to the new environment. The gazelles will thrive in the future, so unless you want to be left behind, you need to begin adjust to variations in the marketplace. Time is of the essence.

Peter Drucker has stated that the issues facing management don't change from year to year. However, contractors need to change their attitudes. Instead of asking the question "What do I want to do?", contractors need to have the courage to ask the question "What needs to be done?" The willing the to address the later question is the difference between mediocrity and superior performance.

The choice is yours!

 

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