Relying on financial statements as the sole basis for making decisions can be dangerous to your business health
There's one thing about financial statements many people forget: Historic relics of your business past, these documents tell you what has already happened, but do little to predict your future. Nevertheless, many electrical contractors continue to obsess over their monthly financial records, using them to squeeze out any form of incremental improvement. Unfortunately, because of the timing and limited content associated with financial statements, they often make ill-advised business decisions and do nothing to exploit the real value of their company.
If this scenario sounds all too familiar, take a second for a little self evaluation. How much revenue is already inherent in your business but not being realized? Are there process inefficiencies that are stealing profits right out from under your nose? Is your mix of products and services optimized, ensuring a steady and predictable flow of revenue — even in an economic downturn? Answers to these questions should form the backbone of how you manage your electrical contracting business.
There are, however, a series of non-financial performance metrics that, once understood, can be used with your financial statements to better guide your business. Let's take a look at how you can help identify your untapped potential.
Metric No. 1: employee retention
A primary indicator of overall corporate health is employee retention. Electrical contracting firms are divided into three primary functions: sales and marketing, operations, and administration. The turnover ratio in each of these areas helps identify potential problems.
High levels of turnover in the sales and marketing area, for example, indicate a business that relies heavily on customer acquisition to sustain corporate health. For electrical contractors, the focus should be on extending existing customer relationships as opposed to relying on significant new customer acquisition efforts. Firms that rely heavily on customer acquisition efforts to remain afloat are often victims of “one-off” sales or an immature product and services portfolio.
An effective sales philosophy bundles together offerings to lead a customer down a predefined path. Energy and power utilization audits lead to implementation projects to resolve outstanding issues. New equipment installation projects are followed up by maintenance agreements that ensure long-term efficient equipment operation.
The alternative, of course, is the lack of any sales philosophy whatsoever. In this reactive environment, salespeople are left to their wits — often selling any service that can result in a commission check. Not only does this approach wreak havoc on your delivery teams, but the process of one-off selling also necessitates that the sales person constantly cultivate new customer contacts — an exhausting condition that eventually burns them out.
High turnover in the operations area indicates that the corporation is too diverse in its product and services focus. Many electrical contractors seeking to be “all things to all people” take on projects that are outside their scope of capability and rely on delivery personnel to magically create the appropriate solution time and time again. As a result, personnel chargeability levels are extraordinarily high, yet productive output is low, which makes profitability suffer.
This condition of diverse project types is most often seen with new inexperienced contractors. Seeking to start their businesses, these contractors bid every opportunity — usually at prices that are far below industry standards. Once a bid is accepted, the inexperienced contractor dispatches himself and his crew to the customer site. Unfortunately, many of these projects are completed at a cost far higher than the original bid — if at all. The crew, dismayed by the level of effort necessary to complete the project, eventually looks for work elsewhere.
Finally, a converse measure is used to assess productivity in the finance and administrative function. When low levels of turnover are found in the non-chargeable areas of an electrical contractor, it's usually a key indicator of an over-sized, somewhat bureaucratic administrative function — one that usually unfairly burdens the profit margin of the delivery function. While high levels of employee turnover in the other areas indicate high levels of ineffective production, low levels of administrative turnover indicate that many of these employees may not be necessary to the operation of a lean and effective electrical contracting business.
If the lowest turnover percentage is assignable to your financial or administrative team, you, as the business owner, should sense a performance problem. In many larger electrical contracting businesses, financial and administrative leaders continue to receive increases in their compensation as a reward for longevity — not for productive and innovative contributions. Just as challenges are established for delivery and sales personnel, similar corporate value challenges should be instituted for non-chargeable individuals.
Metric No. 2: corporate-wide labor utilization
Labor utilization is the amount of time charged for the delivery of sold offerings. For many electrical contractors, labor utilization rates are only calculated for delivery personnel when, in fact, corporate-wide utilization rates provide a much clearer picture of organizational health. Accordingly, it's not unusual to find contractors claiming utilization rates in the 80% to 90% range. When the administrative infrastructure is added in, however, the rates plummet to less than 50% — an inefficient level for any type of business.
Ironically, the biggest culprit is often the owner of the electrical contracting firm. It's not unusual for an owner to spend as much as 6 to 8 hours each day overseeing projects, meeting with customers, and resolving on-site project issues. However, this time is never charged to the customer. What's worse, it's typically never contemplated in the initial pricing of the project. In the end, the customer receives the owner's efforts for free.
What is an ideal corporate-level labor utilization rate? While naming a specific number provides an opportunity for confrontation, an 80% utilization rate is considered by most business gurus to be an admirable level of achievement. Although firms with lower corporate-wide utilization rates will argue vehemently that this rate is inordinately high, it's these very organizations that are invariably top-heavy without a full contingent of lower-level foundation employees.
For those organizations that exceed this 80% utilization rate, while the thought is admirable, such a high rate may be indicative of a firm that is only focused on short-term achievement. Unless the short-term objective is associated with some liquidity event (i.e., acquisition), these over-achieving firms are often best served by allocating a portion of their labor base to some level of corporate reinvestment, such as expanding into new markets.
Metric No. 3: sales effectiveness
Salespeople are optimists — they always believe they can win. While that “mad dog” characteristic is one that serves firms well, the continual barking at opportunities that cannot be won is a trait that must be controlled. Today, there are numerous sales tools that can assist sales teams to qualify opportunities and provide probabilities for win/lose outcomes. Although many businesses use these tools, they continue to override logic in favor of enthusiasm. At the end of the day, however, while the ride was exhilarating, it's nearly always necessary to pay the piper for losing.
Theoretically, new customer acquisition should be a very small part of any firm's success. Electrical contracting firms should only look to generate 10% to 20% of their annual revenues from new customer acquisition and rely on existing customers to provide the majority of the annual revenue dollars. However, every year a substantial number of businesses run to capture new business with a fever that excludes the cultivation of the existing customer base.
It makes little sense, except for new businesses, to aggressively pursue any form of new customer acquisition as a means to satisfy growth. The cost of acquisition and the subsequent fumbling of the customer relationship make this approach archaic and, in turn, forfeit the firm's ability to realize any appreciable level of investment return.
Metric No. 4: reinvestment strategy
Many firms are shortsighted in their efforts to maximize short-term profits and limit any form of reinvestment until corporate results begin to erode. At this point in the corporate evolution, the majority of reinvestment dollars end up going to customer acquisition activities and not to the development of the employee population. The result is usually less-than-desirable investment returns and, presumably, disgruntled employees.
For purposes of evaluating corporate performance, the reinvestment rate is set at 10% to 20% of gross revenue. Assuming the investment criteria of the firm is similar to the expectations of the venture capital community, that investment should provide a ten-fold return in a 3- to 5-year period. Firms that argue a 20% reinvestment factor eliminates any form of corporate profitability have greater issues associated with inflated infrastructure and/or delivery costs.
Where should electrical contracting firms focus their reinvestment dollars? Workforce development continues to be the primary focus for most firms seeking a substantial return on their reinvestment dollars. Likewise, the development of ancillary markets (both horizontally or vertically) provides a ready avenue for new revenue opportunities. In the end, those firms that make a commitment to reinvesting and measuring the out-year results will enjoy long-term growth.
Metric No. 5: hiring for the position
The most common complaint from electrical contracting firms is the lack of individuals inside the organization who are adequately positioned to assume leadership roles as these companies implement growth strategies. For most companies, the hiring strategy focuses on filling immediate technical needs and not finding individuals that can be groomed to be the future leaders of the organization. As the firm grows and the individual assumes greater levels of responsibility, technical knowledge becomes secondary to project management, customer relationship, and pricing skills. The problem is that electrical contracting firms are only hiring for the open position, not for the future.
The resolution is to expand the hiring criteria for new employees. Realize that a competent contractor must possess strong customer relationship skills to be effective in the field. Likewise, an aptitude for project management and financial activities is necessary for any individual to rise in the firm to a position of leadership. Every new hire should be focused on building your firm's leadership suite — where initial contracting skills are necessary but not the only rationale for hire.
Metric No. 6: breaking the 80/20 rule
Ideal customers are those organizations that are able to “purchase” a strong representative sample of all the products and services from a firm's offerings portfolio. However, in many cases, marginal customers are retained as the firm looks to increase periodic revenues or put idle staff resources to work. As a result, electrical contracting firms find that 20% of their active customers are generating 80% of the firm's revenues (the 80/20 rule). The issue is whether all the firm's active customers should remain entrenched in the customer database.
Most firms will attest that at least 20% of their customers should not be customers. The rationale for the comment is usually based on the industry-focus of the customer or size of the entity. Rarely, however, is the primary reason for not being a customer related to any correlation to a customer performance matrix — that is, the correlation of variables that determine long-term customer success. For many electrical contracting firms, customers are simply defined as those entities that pay their bills.
The key is to determine whether underperforming customers have the ability to purchase higher levels of the firm's products and services. In many cases, electrical contractors have opted to only sell their services based on customer requests as opposed to the more aggressive approach of destination selling — the process where you move the customer down a predefined sales path. Conversely, some customers are just too small — unable to use the majority of your products and services. Regardless, the firm should make a concerted effort to effectively increase their overall revenue per customer metric, thereby changing the 80/20 results.
Do non-financial performance metrics matter? You bet. For any underperforming electrical contracting firm, the impact is real and significant.
Dawson is managing director of LTV Dynamics, an international sales management and business-consulting firm located in the suburbs of Washington, D.C.