Eight Strategies to Increase Your Profit Margin
Posted March 11th, 2020
Revenue is the lifeblood of your business. Profit supports your goals for growth, but many construction contractors operate on the thinnest of profit margins. Here are eight strategies you can start using today to increase the profit margin on individual jobs, and your company’s overall profit margin.
#1 Know your job numbers.
They say every river leads to the ocean. The same philosophy is true for your profit. The profit of every job adds up to your company’s overall profit. Increasing your profit margin a few percentage points on each job can add up to a significant increase in net profit and free cash flow for your business.
How do you increase your profit margin? It starts with your bid. Accurately estimating profit margin from the beginning can tell you which jobs to pursue, and which aren’t worth the sweat. That means you need accurate bidding, which all comes down to numbers. It feels great to get a job every time, but doing work that is not profitable just to have work will RUIN your business and is one of the leading causes of why construction businesses fail.
Don’t do work if you aren’t going to make money.
Make sure your bid includes ALL job costs, including overhead and cost of capital. It is imperative you add the cost of your general overhead to every job you bid. In order to do that you have to KNOW what your total overhead costs actually are. Overhead, in its most general sense, is the total of all the costs to run your business that are not directly linked to a specific job. That includes all employees that do not work on the job, your rent or mortgage, insurance costs, payroll fees, entertainment, any other debt payments, etc.
The total of all those costs on an annual basis needs to be calculated – that number is your total overhead cost.
The total overhead cost divided by your total revenue is the percent you need to add to all of your bids in order to properly account for overhead in your future estimates.
In order to figure this out add up all the costs from your 2019 income statement that are not related to actual jobs. Then divide that by your total revenue in 2019. Here is an example for you:
- Annual Revenue: $3,000,000
- Annual Expenses:
- Office staff Salaries – $100,000
- Rent – $30,000
- Insurances (GL, workers comp, auto, etc) – $80,000
- Debt Payments – $40,000
- Total: $250,000
- Total Expenses ($250,000) divided by Total Revenue ($3,000,000) = 8.3%
8.3% is your Overhead allocation. This is what you need to add to every estimate just to break even on the job.
If you bid $100,000 on a job and you have $80,000 in labor and materials on the job you make think you are making $20,000 or 20% margin. The reality of that is you are only making $11,700 on that job because there is $8,300 of overhead expense that needs to be paid also.
Dig into historical data to determine if the costs you have estimated in bidding were accurate at the end of the project. If not, it’s time to update your estimate numbers.
Your profit margin needs to be higher than retainage. Waiting to pull a profit from retainage will put you at a huge risk of a cash flow shortage until the job is completed and your retainage is paid out, which can take a long time to be released.
#2 Know your company numbers.
Now that you are keeping track of your overhead, job costs, and profit margin on each individual job, expand that thinking out to your company as a whole. Remember to include all the costs we discussed in #1 like insurance, your fleet, and office supplies. Do you have outstanding debt with interest that is nibbling away at your profitability? You need to know which debt to attack first, and how the entire ecosystem is working for or against your profit.
This macro view of your company’s profitability can be a real eye-opener, but it’s critical to your success. Profit margin is one of the biggest reasons new construction companies fail.
Pro Tip: Hire an accountant. A CPA can help you determine these numbers accurately, identify cost-saving efficiencies, and help you forecast numbers for the future.
#3 Reduce your cost of customer acquisition.
Lead generation is always a hot topic with contractors. The cost of that lead generation, and its outcomes, are two critical pieces of data that impact your profit margin. How many leads is your sales team producing? How many leads have you purchased? And, most important, how many of those leads converted into new business? If you have 100 new leads and 0 new clients, we’re sorry to tell you that you have wasted your money. At the same time, if you have a rock star sales representative who closes a new deal every day, that person is worth their weight in gold.
Track which lead generation channels are delivering the most leads, and the BEST leads. Cut what isn’t working. Spend your marketing dollars where you are seeing the best production to increase your profit margin.
#4 Borrow to GROW.
Borrowing to survive is bad, but borrowing to capitalize on an opportunity for growth is SMART! If you can borrow $500,000 in order to execute a job with a 20% profit margin and you earn $125,000 in profit, then the cost of the financing is worth it.
Every funding option has positives and negatives, and borrowing without a plan is almost always a bad idea. It’s important to view every lending opportunity with this question in mind: Can I borrow this money to grow and make sure I don’t undercut my growth during the payback?
Read more about borrowing to grow:
#5 Stop competing on price.
You are not a commodity. Neither is your business. A strategic price reduction under the right circumstances is one thing, but when you compete on price alone to win business, the message you are sending is that your work is only worth that much. That’s not a great recipe for long-term growth.
Instead, focus on your reputation as a leader, your company’s reputation in the industry, and the quality work your team is executing. Performance and accountability build a great reputation that will last longer and open more doors than a cheap bid.
Go back and read that last sentence again.
This comes back to bidding. Show your numbers and be upfront about how you came to them. You know what it will realistically take to get the job done right, and a good GC does too. Make their lives a little easier with bids that are clear and comprehensive, that answer their questions, erase pain points, and put their minds at ease. Showing them how you are going to fund the job will also help to put them at ease and trust that you can perform the work they contracted you for. That’s a long-term growth strategy that will show up in your profit.
#6 Trim the talent fat.
Take a deep breath, this one is hard.
You need to balance permanent staff and contract workers. Even harder, you need to take a look inside the office. Is your payroll bloated with specialized staff members who do only that one job or don’t do their job well enough? Would you be more profitable if you combined roles or outsourced a few of these duties? If you have people on your payroll that you have to pay whether there is work or not, you need to make sure they are (1) necessary, and (2) helping the business grow. Get lean and efficient to increase profit margins.
Nobody likes to let good people go. It is not a reflection of them or you — it is business. Be the boss they’ll never forget by helping them find their next opportunity. Leverage your network.
#7 Search for efficiencies and lean into them.
You might be surprised where you can find efficiencies that increase productivity and profit margin. Updating your project management software will have a cost, but if it means you can schedule more work faster, it will soon pay for itself. The same goes with basic fleet maintenance. It may be cheaper to repair that old equipment right now, but in the long run how much are you spending on repairs? At some point, it becomes a better investment to retire old members of the fleet and replace them with newer vehicles.
Efficient and effective communication between your field crew and office staff can help you get paid faster. When you get paid faster, you can pay your vendors, suppliers, and lenders faster. All of which means fewer interest payments and an increase in profit margin.
#8 Set goals and track your progress.
To increase the profit margin for your company, assign a goal to each of these tips. Can you increase your average job margin one percentage point this quarter? Can you reduce your cost of customer acquisition from $350 to $100? Set the goals and then track your progress toward them. Monitor the data after every job, at the end of every month, and at the end of the quarter. You do not have to do all of these things at one time – pick one or two and see them through to the end and then pick 2 more until you implement all of them.
Increasing your profit margin gives your company a solid foundation from which to grow. It makes you more attractive to lenders, increasing the odds you will get the funding you need when you need it next. It also gives you more peace of mind and less stress, so you can focus on doing the great work that your business is known for.
Now go out there and get paid.