Measuring Up: Contractor Failures
Rags to Riches to Rags
Contractors have always been notorious for having financial problems. How many times have you heard a contractor say, “I grew too large too fast,” or “Everything was OK until the economy turned”? For years I have been talking about new contractors moving from wonder to blunder, and successful contractors moving from thunder and to plunder. Let’s look at some of the fundamental scenarios that can drive a contractor from rags to riches to rags.
The Startup Contractor
Here’s a typical story of a startup contractor: For most of his career, Dan worked as a craftsman for a local contractor. Dan was a hard worker who strived to get ahead and provide for his young family. Unbeknownst to his boss he did side work and brought in quite a bit of extra income. He used his own personal tools and truck, so he had little overhead. His lead source was family, friends and totally word of mouth. Soon his “side jobs” grew to the point where it just made sense to start a business.
Dan’s business grew rapidly because not only did he have little overhead, he was a very productive worker and quality craftsman. When you do good work, at low prices, your business quickly expands. Soon he hired others to help him, borrowed money from his savings or home to buy another truck, and the business grew. Suddenly, he can no longer work in the field himself as he is too busy estimating jobs, picking up material and running errands. He has no job costing because he never used it before. He may even rent a small shop, do some advertising and possibly a friend makes an inexpensive website. The next thing you know, he has two or three jobs going on at once and is so proud and happy.
Then things begin to change. His business excitement and wonder begins to turn into blunder and confusion. Cash is tight but he mistakenly thinks that is because customers owe him for jobs recently completed. All of a sudden his credit card balances start to grow. The next thing you know, he misses a credit card payment and the cards interest rate goes to 20 percent or 30 percent interest. He is COD at the supplier and creditors are calling. Dan’s business is on the brink of failure.
Sadly, all of this might have been prevented with some simple math and a better understanding of overhead and what prices he needed to charge. In the beginning, when Dan was doing the work himself as a field employee, he was basically earning wages. The harder he worked, the more money he made, but as his role shifted from tradesman to non-working owner, all the numbers changed. In addition, employees did not work quite as fast as he did. He had no system for communicating the estimate to the field and ensuring what he sold was exactly what was done. His salary went from earning $40,000 to $50,000 a year as a top rate craftsman in his own company to an overhead expense of a non-working owner.
When he started his business, Dan probably charged a little less than his former boss and all was OK. That worked fine as long as he was earning wages as a field craftsperson. Instead of having one boss, he now has a bunch of bosses called customers. When he stopped working in the field, the numbers changed and he failed to adjust his pricing. Take a $50,000 salary, two trucks with payments, gas and insurance for another $15,000, add $4,000 a year rent, $2,000 for phone, $4,000 for advertising, $3,000 for a bookkeeper and an accountant plus $2,000 for tools and suddenly you have $80,000 or more in overhead. Oh, I forget to mention, not having Dan on the jobs means it will take 15 percent to 20 percent more time to get the jobs done. The math all adds up quickly and Dan is in real trouble. Welcome to the world of a startup contractor going from rags to riches to rags.
Dumb, Fat and Happy
Another common scenario is the dumb, fat and happy contractor of the last 20 years. The last major recession was in 1991 with a little blip in the early 2000s. That’s a lot of years of getting work by merely raising your prices and meeting production demand. This entire era was about getting the work done. As volume grew, so did unit prices. Too many contractors were simply charging what the market would bear and suddenly there is less work in an enabled, mature organization. Some owners became less active and spend time dabbling in real estate or on the golf course. Family members or younger managers take charge. Siblings who have never dealt with a slow market find themselves operating in new territory.
Suddenly, price cutting becomes the norm. Anxiety sets in as you are afraid you will run out of work. The customer who paid you on time in the past is now a slow pay. You see other large companies turn in silly bids with material and labor costs less than your direct cost as absentee owners push for more sales. The market goes to pieces but your business is slow to react. Congratulations, your business has officially moved from thunder to plunder.
For older, more established companies, overhead is the issue. No matter how painful it is, if your sales have dropped 30 percent and margins are tighter, you are going to have to cut overhead; there is no other way to make it. You must react to the marketplace, cut overhead, hold enabled employees accountable and refocus your business for today’s market. Not everyone is losing money.
By the way, we keep accurate financial statistics on our benchmarking customers and most had profit increases in 2010 and again this year. Whether you are a 24-year-old dragon slayer or a 60-year-old “still at it” type of owner, business is not forgiving. It is called capitalism. Yes, we can blame the banks, politics and many other factors, but the reality is no one is coming to help you.
Know what you can control, be willing to change and fight the fight. The good news is we are finally seeing a lot of weak contractors go out of business. Many of these contractors did not follow sound business practices and probably would not have been able to open or stay in business if it were not for a robust economy. Just make sure you are not one of them.
Monroe Porter is president of PROOF Management Consultants, a company specializing in seminars and business consulting for contractors. He is also founder of PROSULT™ Networking Groups developed to help noncompeting contractors. He can be reached at 800-864-0284 or firstname.lastname@example.org.
For more information, visit www.proofman.com.