Today’s construction market is cyclical. For owners of contracting firms, that presents fundamental challenges. According to the writings of Thomas C. Schleifer, Ph.D., continuous growth in sales as a business model is impractical, high-risk and dangerous. Instead, a concentration on growth in profits rather than sales makes more sense.
In articles he has authored, Schleifer, a retired contracting firm owner and current industry consultant, believes that by concentrating on profitability rather than size, the successful contractor of the future will view the market – and their place in it – through a wholly different lens. Such a firm, says Schleifer, will organize itself internally to conform to current market conditions, and avoid chasing inappropriate work just to maintain volume for its own sake. Under this business model, the firm can still enter new markets, but it will do so with careful attention to how much work it attempts to take on, what the risks are, and whether it can afford the corresponding learning curve.
When growth in profits is the primary focus, adds Schleifer, selection in projects shifts from a desperate need for sales to what the firm does best.
The secret to this strategy is a concept he developed called Flexible Overhead.
Flexible Overhead Overview, Historical Industry Challenges and Implementation Prospects
Like any solution or innovation, the concept of Flexible Overhead was born out of a problem. In articles he has written, Schleifer maintains that overhead in the construction industry is comprised primarily of personnel costs. Since most employees have traditionally been permanent – not temporary – employees, overhead personnel costs, he says, have always represented a “permanent” expense.
No market operates on a straight-line proposition. Market declines occur regularly (see chart below). Yet, most contractors traditionally don’t plan for downturns, so when work slows down in the construction market, overhead is traditionally maintained rather than cut, and contractors leave themselves over-staffed during and after the downturn.
Consequently, those firms are put in the unfavorable position of seeking out additional projects to maintain volume and cover their high overhead costs. This can mean taking on projects outside their comfort zone — i.e., different project types, and even different geographical areas. It can also lead to a fundamental suppression of profits by taking on losses if work cannot be found.
According to Schleifer, a declining market poses risk for a construction organization, but dealing in unfamiliar project types, and in unfamiliar markets actually magnifies the risk. Essentially, maintains Schleifer, firms are confronting risk by taking on more risk.
Schleifer maintains in his writings that a new business model is needed to allow a construction enterprise to easily adjust overhead to available profitable work. “The successful contractor of the future will be profitable in good markets and bad, and the drive for size measured in sales will be replaced with a drive for prosperity measured in profitability,” he wrote in “A Formula for Survival,” a June 9, 2014 article in Engineering News Record (ENR).
What is Flexible Overhead?
According to Schleifer in the June 9, 2014 ENR article, “The flexible overhead concept recommends that 15% to 25% of all overhead costs be engaged in such a way that the overhead costs can be turned off in a week or less and in some cases in a day. In other words, they are not taken on as permanent expenses but as rental, temporary personnel, interim office space, etc.” (Note: The percentage basis differs, according to Schleifer, because no two contracting firms are alike.)
Traditional thinking in the construction field isn’t geared around this premise. In many minds, a temporary worker is half a person; a rented truck is half a truck, and so on. Yet through Flexible Overhead, the contractor of the future can and must reduce overhead at will. Once they become accustomed to the practice, they can even do so practically overnight. Flexible Overhead, says Schleifer, is all about doing only work that is normally profitable for a firm, and avoiding work that is out of the ordinary—and out of that firm’s realm of expertise.
Why is Flexible Overhead Needed?
Since World War II, there have been more growth years than declines here in the U.S. Accordingly, says Schleifer, many contractors have adopted growth as their business model, and in doing so, have continually sought to increase overhead in order to meet the demands of a larger workload. Therefore, overhead costs such as personnel, equipment, machinery, and office and shop space, have been viewed by contractors as permanent—“…a necessary part of the new and larger organization being intentionally built,” he says in the June 9, 2014 ENR article.
Such a business model functions well in a growing market. Yet it yields lower – or negative – margins in a declining market. As the table on page four suggests, this occurs fairly frequently.
What Does Flexible Overhead Accomplish?
With Flexible Overhead, Schleifer says the success of a construction firm won’t be measured solely by the difference between total sales and operating profit, but rather, by factoring in the measure of operating profit to overhead.
When overhead costs are controlled (and minimized to a prudent extent, as per Schleifer’s recommended percentages), sales alone are no longer the key driver of a firm’s success. Instead, that firm can pursue projects that are normally profitable for them—specifically, projects of their desired size, geographic area and type. That firm will do what it does best, expand smartly, and stop chasing atypical, higher-risk work in order to cover overhead expenses.
Considering Flexible Overhead for Your Business
At Skoda Minotti, we embrace new ideas, new technologies, new ways of thinking, and business approaches that create positive outcomes. From our perspective, Flexible Overhead is an intriguing concept with sizeable benefits—and some equally sizeable risks. We see value in presenting it to you, and we encourage you to think about ways in which it could potentially help your enterprise grow intelligently. You may or may not choose to dive head-first into Flexible Overhead. Alternatively, you may find some of Flexible Overhead’s strategic tenets or tactical ideas potentially useful, and perhaps you integrate them into your business over time. In this spirit, we hope you approach the topic with an open mind and judge it objectively on its merits.
In upcoming blogs, we will expand on our coverage of Flexible Overhead through interview excerpts with Roger T. Gingerich, CPA/ABV, CVA, CCA, the partner-in-charge of the Skoda Minotti Real Estate and Construction Group, and David Mustin, MBA, partner and head of Skoda Minotti’s Management Consulting Services Group.
Two additional experts also offer insights that pertain to their respective fields: Heidi Hoyt, managing director of Skoda Minotti’s Professional Staffing Group and a construction industry veteran, discusses potential staffing implications of Flexible Overhead for construction firms; and Lou Colagrossi, Vice President/Producer at Dawson Insurance and an expert in the placement of surety bonds for the construction industry, offers his perspective on how bonding firms might view Flexible Overhead.
To download the full Flexible Overhead e-book, click here.