Profitability in construction: Meeting the bottom line

Above: construction worker on construction site Real Estate | 22 Jun |

Construction companies do many things to make sure a project is profitable but at the end of the day the numbers may not add up.

When starting a construction project there are many factors that you must look at in order to meet the bottom line profitability you want in the end. The cost of labor, materials, contractors and other expenses all play a major role in meeting that profit, and this all begins with proper bidding.

Bidding

In construction everything is bid or estimated out. When you’re working on a project the pricing strategy is based off of your cost of materials, labor and your margin. If you’re bidding in an aggressive manner, then your margins are going to be thinner. It doesn’t leave a lot of room for error and even in today’s market of economic growth bidding is competitive.

For example; let’s say a project is bid at $1.5 million. That $1.5 million is probably going to cost you $600, 700 or 800 thousand dollars in materials and labor. You get to this number by calculating total person hours, contractors, materials, permits and all direct costs that went into it. Then you put the appropriate amount of margin on that to cover your overhead, insurance, salary, staff, supervision, etc.

The job costs come down to how you accurately execute the actual hours of the subcontractors and the materials against that estimate. So, if you bid accurately and it is executed accordingly you should generate the gross margin and profit that you anticipated.

John Waters, President & Owner of Waters Business Consulting Group, LLC helps business owners-large and small- Scale up business, improve their cash flow, reduce their costs, and work more efficiently.

Where you lose profit margin and things go wrong, is when factors come into play that you may not have expected. For example, say a project is going to take 90 days to complete. By mapping out the project for 90 days we know that in 30 days your production crews and subcontractors should be one-third completed with that project. This means they should have spent close to one-third of the hourly labor budget or subcontractor’s budget and this would be the same at the 60 day and 75-day marks. If they get to 60 days and have spent 90 percent of the budget on hours and contractors and are only 60 percent complete on the project they are over budget. This is either caused by incorrect bidding or the project has been mismanaged. 

In order to fix an issue like this the project must first be bid correctly then mapped out in a way that will achieve that bid. This means that if you have bid correctly then you have already mapped out the project and know how many hours and materials it will take to complete the project and then all you have to do is execute. At this point all you have to do is stay on pace and you will come in at or under budget.

Kyle Ballew, Partner at Live Forward Ventures, said the best way to stay on budget and having correct bids on projects comes down to the details. 

“The more detail you have up front, we have found, the less cost overruns and delays to the schedule. That also affects profitability, and we have fewer surprises with the detail up front and the bidding process we use,” he said.

When it comes to staying on budget, having a plan for the project from beginning to end and being able to execute that vision on a financially accurate level starts before the project begins the bidding process.

“It starts way before the bidding process,” Ballew said. “When we are in the design phase of everything we have profitability and labor costs in mind from day one. By the time we get to our bidding process we have a ballpark of what we’re going to see back because of the cost per square foot, the type of materials we are using and we try to seek that out before we finish our design so we aren’t on the back end trying to get numbers down.”

Ballew and his team implemented this strategy when developing Verde Park Condominiums in Phoenix, Arizona. 

The communication and the details are the most important part that I’ve experienced in development,” Ballew said. “There are all sorts of general contractors and bidding processes out there but you can never provide enough detail.” 

Contingencies 

Most contractors will put contingencies into a bid, and it will impact the price of the project as far as winning it or not winning it. That’s always the needle to thread. How much in the way of contingencies do you put in on this project to safeguard mismanaging or something that I didn’t take time to look at or missed? Those contingencies will protect against your profitability, but they can also keep you from winning the project. So how do you protect yourself and give yourself the best chance of winning the bid?

The best way to bid a project is to bid the actual hours, the actual materials, the actual contractors, the actual equipment costs and margin to make a respectable profit, and this is where the planning takes effect because you are basically building the project on paper. Once that project is built on paper you know exactly what it’s going to cost to execute that project.

Contingencies are put into bidding contracts because inevitably things can happen on a project. Something was missed or overlooked in the initial bid, the economic conditions, weather conditions and things like that can have an impact. By placing contingencies, you are prepared for these situations, but you still must execute in order to stay on budget and meet the margins of the project. Still, if I do a bid and I feel it’s dialed in and tight, I’m going to put some contingencies in to give me a little bit of margin because inevitably things can happen. 

Fixed Price

Most construction projects are set at a fixed price where you’re bidding your labor and materials with a margin and coming up with that fixed price. It’s up to the contractor to ensure they have all of the right costs in the bid and the margins and that they execute correctly so they can make a profit. 

The risk on a fixed price is on the contractor bidding it. For example; say a contractor is bidding on a project and it’s a one-million-dollar project and they want to walk away with a 25 percent gross margin. Meaning, the resulting margin they get when the project is all said and done. In this case they would have spent 75 percent in costs of materials and labor to build and they walked away with $250,000 in gross margin which covers their operating overhead, insurances, project management salaries, vehicles, etc. and hopefully at the end of that they’re picking up $100,000 plus in net profit, which would be 10 percent of the project. 

What happens is that I’ve seen contractors go in and they bid for those materials, supplies and labor and they put a 25 percent mark-up on those items and that 25 percent mark-up won’t get a 25 percent margin. This typically will only result in about a 20 percent margin. This comes back to making sure you are pricing the project correctly.

The key in all of this to get your maximum bottom line profitability on a construction project is to make sure the bid is done correctly and accurately. Creating the plan on paper and mapping out the project before the ground is even broken has the largest effect on the profitability of any project. Once these items are finished accurately then it is all up to execution.

 

John Waters, President & Owner of Waters Business Consulting Group, LLC helps business owners-large and small- Scale up business, improve their cash flow, reduce their costs, and work more efficiently. John has over three decades of strategic business development experience with proven results. John knows what it’s like to make tough decisions during recessionary cycles which ensure profitability, provide a bedrock of successful survival, and to reinvent businesses in this new economy. 

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