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    How to Thrive in a Tough Economy

    March 1, 2012
    Practical tips for making money and satisfying the customer during tough economic times

    It’s no secret that times are tough for everyone involved in the construction industry — and have been for some time. Although it’s hard to find a silver lining amid such economic instability, there are still projects to be won, profits to be made, and businesses to grow for electrical contractors. It’s true, the total construction market dropped by more than 40% in recent years, compared with the good old days of 2005 to 2008. However, the good news is — that still leaves 60% of the market available for the taking. To win jobs during an economic downturn, what many people don’t know is they must adjust their operational theory, shifting priorities in support of the following areas: transferring value to the customer; increasing job productivity; reducing error and rework; segregating fixed cost from variable cost; and taking care of your people. Let’s take a look at each of these propositions more closely.

    Transferring Value to the Customer

    Remember in a tough economy your customers are dealing with cash flow problems and reduced profits just like you are. What they want is to start generating revenue again as fast as they can. The construction process is nothing more than a nuisance for many owners and customers. They simply want you to finish the building on time (or earlier) with no punch-list — at or below budget. The sooner you accept and understand your customer’s perspective, the sooner you can deliver the project. This might seem like a monumental undertaking; however, this same need exists whether the economy is good or bad.

    Increasing Job Productivity

    Your focus on productivity has to shift from individual productivity to job productivity. The difference between the two is simple. An individual electrician can be very productive, but if he can’t get to the work to do the installation, he is not producing. In other words, everything you do in the company has to focus on making sure that the skilled trade does one thing and one thing only — installation work. Any other activities, such as handling material, receiving goods, returning items, removing garbage, and cleaning up (Photo), have to be identified and passed on to lower, unskilled labor.

    As you can see in Fig. 1 (click here to see Fig. 1), the majority of an electricians’ time is typically spent on activities other than installation work. If this could be reduced, the electrician’s individual “production rate” could actually slow down, and the job would still be more productive.

    By using prefabrication techniques and asking vendors to place the material when, where, and how it is needed on the job, productivity levels will increase. Planning the job will help reduce the unexpected issues and clarify crew assignments. Our research has shown that every hour spent on planning will help save 17 hours at the end of the job.

    Reducing Errors and Rework

    One of the most important contributors to improved job productivity is the reduction of errors and rework. You can only achieve this goal by knowing what it is that labor is working on at any given time and how you can avoid the obstacles that might present themselves. The main reason for rework and error are miscommunications between supervisors and electricians as well as between the general contractor and subcontractors. By creating a simple and routine communication channel, you can avoid many of these issues.

    One of the tools developed over the last 15 years — short interval scheduling® — has been explained in earlier EC&M articles (“The Secret to Short Interval Scheduling,” February 2009, and “The Agile Construction Advantage,” October 2006). Using this tool will help improve the communication of obstacles. Reducing rework is another means of squeezing dollars out of the project during both good times and bad. During the good times, gaining more-than-anticipated installation time is always a plus. During the bad times, it is a “must,” because the extra buffers are now gone.

    Segregating Fixed Cost from Variable Cost

    This task is much simpler than it sounds. First, you have to realize that during poor economic times, the competitive pressure of the construction market forces contractors to take on projects at lower-than-usual gross margins. This practice has a few disadvantages:

    • Negative impact on cash flow.
    • Reduced net profits.
    • In larger jobs, the more productive labor may be tied up for a longer period of time, making their availability more scarce when the economy comes back on the more profitable jobs.
    • Negative impact on bonding.

    The historical approach to respond to this pressure is based on a cost-based pricing model, which assumes unchangeable labor units for the project completion. In other words, the low margins are achieved by cutting the profit from the top, assuming the labor units cannot be adjusted. Best-case scenario, labor units are cut across-the-board to have a competitive estimate, without any knowledge of where these cuts would come from for the job to actually perform profitably.

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    The alternative approach is based on price-based costing (PBC), coined by management guru Peter Drucker, which focuses on the improvement of elements of the cost drivers, such as labor productivity, cost of money, and cash-flow during these times. PBC will ensure a higher net profit under the tough economic market environment by focusing on the internal and job specific cost drivers. In this model, the selling price is set by the customer and the market, and the expected return in the form of profit is fixed. From here, the cost of operations needed to complete the project is identified and worked on for better-than-estimated profits. See Fig. 2 (click here to see Fig. 2) for a comparison of these two models. If you want to be a profitable and competitive PBC contractor, you need to know the cost drivers of various activities and learn how to manage them.

    A contractor’s bottom line is driven by its negotiation skills and ability to manage and contain costs. You must be able to clearly identify cost drivers and opportunities for their improvement. With this in mind, you must make strategic and tactical decisions on where to make cuts in the estimating and project production phases of the project, all while having confidence that these cuts are feasible and will not arbitrarily require you to give up your gross margins.

    The fixed cost of the company has to be separated from its variable cost. Many contractors believe that if they allocate their fixed cost to the jobs, the jobs will carry them. This can only work if the fixed cost can be reduced accordingly with the reduced revenue payoff.

    For example, let’s say a contractor has an accountant that is fully engaged when the company has annual revenue of $10 million. Naturally, this person’s hours will now be allocated across whatever jobs still remain in the mix. This will drive up the cost of these remaining jobs. This person can only be considered as a variable cost if you can reduce his hours or reduce the portion allocated. Otherwise, he is a fixed cost and needs to be recognized as such.

    Taking Care of Your People

    Typically, the very first thing contractors do when the going gets tough is take away perks from their employees, such as trucks and gas cards. If the fixed and variable costs are segregated correctly, trucks and gas are going to be a smaller part of the overhead cost when the volume drops. However, the people who made the company money during the good times should not be punished during the tough times. A contractor has to have a war chest for the bad economic times to take care of its people.

    The paradox is that this war chest can only be built if, in the good times, the same principles outlined in this article are followed, and the extra profits are stored in this chest. If a contractor made a few million dollars during the good times, for example, a portion of this amount should go into some kind of savings account to make sure its loyal and diligent employees do not suffer during the bad times.

    If everyone else is cutting their cost by getting rid of trucks, can you imagine how proud your labor force will be if they are driving to work with their shiny trucks every day? That is the best marketing and advertising campaign you can ever embark on — by letting your customers know that you will take care of them like you take care of your people.

    By allocating costs correctly, taking care of employees, increasing job productivity, and reducing rework and obstacles on jobs, an electrical contractor can make money in a tough economy and add extra profits to the bottom line in a good one. These practices are not just self serving. They will also prove to your customers that you’re not only business savvy but also cognizant of the value an electrician’s skill and effort brings into a building’s electrical systems. This transfer of value is done most optimally when people are taken care of and the focus is on transferring this value with minimal losses and friction.

    Dr. Perry is president and CEO of MCA, Inc., Flint, Mich. Moore is an associate implementer. They can be reached at: [email protected] and [email protected].

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