Planning for an Uncertain Economy
While we will leave the “recession” question for the economists, academics, and TV commentators, it does appear that we face a great deal more macroeconomic uncertainty than we did six or twelve months ago. What’s the next move for inflation, input costs, margins, and competition? What things do you need to be doing NOW in order to prepare and to make your construction firm less vulnerable to changing macroeconomic conditions?
Please tune in this week as Wayne walks you through two scenarios that seem pretty likely and asks a critical question: CAN YOU COVER OVERHEAD in the event of a reduction in prices (what goes up must come down, right?) and tightening margins? He also gives you a technique all contractors should begin to employ for evaluating your greatest overhead cost. What are your best practices for battling economic uncertainty? Please share with us in the comments.
Don’t forget about The Contractor Business Boot Camp. We are down to the last 10 seats for our upcoming class starting on Feb 9-10, 2023 in Raleigh. If you haven’t yet enrolled your rising NextGen leaders, do it now! Contact Charlotte at ckopp@familybusinessinstitute.com for more information.
Hi everyone, this is Wayne Rivers at FBI, and We Build Better Contractors.
This week, I want to talk about planning for an uncertain economy. Is the US in recession? I don't know. I think we should
probably leave that to the politicians and the academics and all those people. We know the commercial construction is
not in recession. We know commercial construction is 12 to 18 months behind the regular economy. It's a lagging industry,
which is good in a way. Maybe by the time construction feels the pinch of recession, maybe the economy will be on the
way up and we'll have just a little hiccup in construction. But who knows?
Why is this important to you? Well, golly, you've really got to be thinking about, okay, we're going to have a great '22. '23
looks terrific on paper. What's beyond that? So, as we were talking about the construction economy, in our last strategic
planning meeting, Dennis went through three different examples. The first is current day. Let's just use hypothetical
numbers here. Let's just say it's $100 million contractor with a wonderful, beautiful 10% gross margin. That contractor
right now creates $10 million of gross profit. $10 million of gross profit, you can do a lot of things. You can pay some
bonuses, you can contribute to your retirement plans, you can distribute money to the shareholders, you can spend capital
money. I mean, 10% gross margin is wonderful, and that throws off a lot of money. It does a lot of wonderful things for
your people.
The second thing, let's go through this scenario. Now, we had this dramatic spike in input prices. Everything just inflated
at one time. It was unprecedented and ahistorical. Well, Dennis theorizes that the price drops may be probably not as
precipitous but can be quite precipitous. So, let's think about that for a minute. For in particular GCs, where so much of
your revenue's pass-through revenue, if the price of all your inputs drops by 20%, now your 100 million gross volume
might be 85 million. So, let's say it's $85 million, and you can see the example on the screen, and you've still got that
wonderful 10% gross margin, now you're at 8.5 million of gross profit. Okay, that's less, but still pretty healthy.
Now, let's think about this. The economy tightens, and margins get tighter because competition is greater than it was
before. Now that 10% gross margin is pushed down to 7% gross margin. So now you're at 85 million because of the input
price reductions, you're at 7% gross margin because of the increased competition. Now, you're right at around $6 million
of gross profit. You've got to be looking hard at that. Can you cover your overhead? If your gross profit is down from 10
million to 6 million, at that level, can you cover overhead? And if so, do you have a lot of coverage or a little coverage?
How much money are you as the owners willing to put into the company to keep things status quo? You've got to be
thinking about those things.
Now, two-thirds of our members are general contractors, vertical builders. And especially for vertical builders, but also
for other types of contractors, the biggest single cost is people. All right. So, if you're down at a point where maybe you're
not covering gross profit and your biggest cost component is people, you've got to be thinking about, what am I going to
do if we get into a tight economy, serious competition, and this tightness continues for 12 or 15 or 24 months? What am
I going to do? What I'm going to suggest sounds a little harsh, but one of our consultants, John Stump, suggested this in
our strategic planning meeting, and I think it has some merit to it.
He says, "Stack rank your employees." You can look this up, stack ranking. It's a thing Jack Welch created at GE ages ago
in the '80s. It basically puts your employees, you take your top 20% of employees, and it's a curve, top 20%, bottom 10%,
and then the 70% in the middle. And you're always evaluating. Now stack ranking has some pros and cons. Some people
are just absolutely against it. They say, "It creates internal competition. It distracts people from the mission of the company
because they're always looking over their shoulders. Am I going to be ranked higher than that guy across the hall over
there?" And it can hurt morale, especially for the people that think they're going to be here on the rank and they're not.
First of all, I would say this should be a management tool, not something that's shared among your employees. I think
that's the first key.
Now, the pros of stack ranking are, it does emphasize the concept of meritocracy. Construction business is nothing more
than a meritocracy if you look across the entire industry. It's clear, and that's the main thing. If we get into a protracted
economic contraction, you need clarity. Subjectivity is the enemy of leading people. And finally, it can increase morale.
For example, your high achievers, you want to keep them super motivated. So, if they know they're able, because of clear
job descriptions, clear metrics, they're able to do X, Y, and Z, and earn this kind of money, that helps them with morale,
helps them know they're hitting their targets and they're going to be financially rewarded for the targets. You cannot have
subjective evaluations of your people. There's got to be some way to measure them in the jobs that they do. And stack
ranking is one way of doing that.
So, I'd like to know, what are your best practices? We've been through the awful recession of, whatever it was, 2008
through 2012. Whatever you think it was, it seemed to affect us all quite differently. What did you do then? What was
successful? I feel like most of our contractors got caught flat footed. They did not have plans. Because we're a lagging
industry, contractors fooled themselves into thinking, ah, this recession is not going to hit commercial construction. It did.
Most of our members had 40 to 50% volume drops, and most were caught flat footed. They didn't know what to do. They
didn't know where to cut. It was a mess. So, you need to be thinking about those things now, and you need to have a plan
in place, a contingency plan. If competition gets tough, the economy's contracting, margins recede, what are you going to
do to cover your overhead and keep your best people? We'd like to know what works for you. Don't forget about Boot
Camp. That is February 9 and 10. 2023. Get your folks signed up early. This is Wayne Rivers at FBI, and We Build Better
Contractors.
