How to Reduce Risk
As we gathered for the AFSA convention in Las Vegas, I was reminded of a conversation I had with a client several years ago. He stated that he used to enjoy going to Las Vegas to gamble, but since entering the contracting business he doesn’t enjoy it like he did. His reasoning was that he gambles every day in his business and doesn’t need to create any more opportunities. In many respects, he is correct. Think about the ways we gamble (i.e., take risks) in our businesses. Every time we turn in a bid, have a truck on the road, have crews on a job or bill a customer, we take risks. Fortunately, there are ways we can greatly reduce these risks. Here are a few that I have observed over the years. To clarify, let’s think about it in the following buckets:
• Project Control
• Have a logical incentive-based compensation plan – One of the major trends of the past 10 years is paying average market salaries but adding additional pay for performance. Plans have to be well thought out and consistently followed to be successful.
• Have tenured, proven field superintendents – Simply put, field superintendents have more impact on field profitability than any other group. Make sure you hire, train and retain the best.
• Promote superintendents from within
• “Glorify” the field – We get paid to put work in place, and this only happens in the field. Everything else we do is a support function to the field. Remind the whole organization of this fact on a regular basis.
• Have one person clearly in charge – Construction is not a democracy. Make sure you have the right person leading your organization. As they say, fish rots from the head down.
• Have adequate capital/cash to withstand bad luck – I have never had a client regret having a strong balance sheet in hard times. This is a cyclical business and lean times will return at some point, be ready for them.
• Manage overhead on a “need-to-have” basis – During good times we all have a tendency to increase overhead. Remember that the good times don’t last and manage overhead costs aggressively.
• Have a detailed monthly operating budget and cash flow projection for next 12 months – Good contractors manage their cash and budget for profits. Make sure your division managers are involved in creating the budgets for their profit centers.
• Have an above-average track record of profits – Our founder, Doc Fails, used to always say that profit is not a dirty word. The profits of best-of-class fire protection contractors always exceed the average by a factor of at least four to five times.
• Have superior estimating skills and systems – Quite simply, know your costs, account for overhead in a rational way and add a fair profit. You can’t do that without outstanding estimators and estimating systems.
• Focus strategy on profit, not volume – The old saying that “volume kills and profit thrills” comes to mind.
• Take care of customers at all costs – I read recently that according to a recent study, it costs about seven times as much to acquire a customer as to lose an existing one. I don’t know how accurate this is in our industry, but I do know that profitable firms do a great deal of repeat work with customers. Make sure that everyone in your organization understands the importance of taking care of them.
• Do not accept contracts with questionable terms or with questionable owners – Words have meaning and accepting unreasonable contract terms increases your risk unnecessarily.
• Focus daily on improving productivity – Improving productivity always comes down to controlling field labor costs. Make it a priority. We have yet to see a fire protection contractor who hasn’t been able to cut field labor costs by at least 10 percent by focusing on a few simple strategies.
• Do not have major fluctuations in margins for work in progress – Ask any professional in the bonding industry what they fear and focus on the most, and they will tell you that it is when profit margins start to fade at 75 percent of project completion. This is a sure indication that cost controls are not in place and project managers do not know the status of their projects. Make sure your project managers understand their costs to complete at every state of a job.
• Do not have multiple shareholders without a shareholder’s agreement – Quite simply, a strong buy-sell agreement is essential to avoid real shareholder problems. Make sure the agreement contains a defined method to value company stock.
• Do not put children into management positions if they are not qualified or interested – Putting children in positions in the family business for which they are not qualified nor have an interest in is unfair to everyone including you.
• Do not put anyone into ownership positions unless they are actively involved in management – Construction businesses should be owned and managed by those in the business. When doing estate planning, there are other ways to be fair to children not involved in the business that doesn’t involve stock ownership.
Conclusion We began this discussion by stating that there is plenty of risk in our business. I have listed a few thoughts that can reduce the inherent business risks we all face. My suggestion is to pick out a few that apply to your situation and work on them. The people that depend on your business will be grateful.
ABOUT THE AUTHOR: Randy Stutzman is a managing director of FMI Capital Advisors, Inc., FMI Corporation’s Investment Banking subsidiary. As a specialist in corporate mergers, acquisitions, and strategy development, Randy helps contractors throughout the country develop and implement plans that are uniquely tailored to meet individual needs, including acquire additional business, sell existing business units or ensure that profitable organic growth is achieved. He is a graduate of Indiana University of Pennsylvania, holding a Master of Business Administration.