In the first two parts of this series, we looked at the components of profit calculations, including markup and margin, break-even and contribution; no formula or calculation takes the place of strategic thinking, so the underlying foundation for profitable business is the philosophy of management and your ability to plan to be profitable.
Company owners seldom take time to think about profit in a philosophical way. What is profit? It is the definitive measure of the financial success of your company. You use it to do three things:
1. Repay debt
2. Purchase assets to support growth
3. Distribute to owners as a reward for the risk of ownership.
Profit also provides the basis for computing tax rates, as well as the foundation for the owner’s standard of living. This doesn’t just apply to the owner’s salary. Since the company is usually the largest asset in the owner’s estate, its profitability contributes to the level of owner equity on the balance sheet, which eventually determines how well the owner can live during retirement or after selling the company.
So, profit is more than just a number on the income statement. It not only provides the fuel to keep the company growing and moving forward, but it supports the owner’s lifestyle. At the same time, the profit shown on the income statement does not indicate the amount of money the company can potentially earn because of the need to minimize the taxation level. Prudent avoidance of excessive taxation competes with the need to show that you are making money.
How much is enough? Higher profits usually require higher risk tolerance. As with any other investment, the return generally reflects the degree of risk. Since contracting is the second riskiest business (surpassed only by the restaurant industry), your returns should be high. To achieve higher profits, you need to make some difficult decisions in four areas, as follows.
1. Degree of Difficulty: Are you willing to do the jobs other contractors fear? Will you take on the most complicated, difficult, challenging problems? If so, you will probably encounter fewer competitors and be able to demand higher prices that translate to higher profit (if nothing goes drastically wrong). The higher scores in diving, gymnastics and skating go to those who do the riskiest moves. The same is true for you.
2. Specialized Expertise: Is there something you do better than anyone else? Do you provide value-added solutions for healthcare, clean room operations or integrated systems? Whatever niche you choose, make sure you gain a reputation for being the best in that specialty area, and for providing pre-job consultation to design professionals before problems become unsolvable. You earn higher profits when you do your work more efficiently and make your clients more efficient.
3. Service Excellence: Are you willing to provide emergency service at all hours? Is your response time exemplary? Can your customers reach you 24/7? Just as you pay more to be treated at the emergency room of the local hospital within minutes, and less to see your regular physician in a month, the same rates apply to restoring your customers’ power systems and computer networks. Solving problems fast entitles you to higher rates and higher profits.
4. Customer Relations Skill: The old adage is still true—people do business with people they like. They also pay more for comfortable relationships with contractors. If you are skilled at establishing and maintaining great customer relationships, use that talent to “skim the cream”—the most discriminating clients who are willing to pay for the best, most professionally delivered products and services. These are the people for whom the Mercedes is an average vehicle—they are looking for the Ferrari or the Bentley, and the highest price equates with the best quality.
Believe it or not, you have choices that affect profitability. The choices you are willing to make reflect your beliefs and values. Ask yourself some of these questions:
In every market, regardless of the competition, some electrical contractors are more profitable than others, seem to get the best jobs and have fewer customer problems. It’s not a matter of chance but of choice. More than any business practice, your beliefs and values affect your perception of profitability, the decisions you make and the actions you take to meet your established benchmarks. And that is the factor most often overlooked by managers and stakeholders who are trying to change the strategy and operations of an electrical contracting business. In spite of everything you do for stakeholders, one thing is true: ultimately, profitability really is all about you. EC
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached via e-mail at firstname.lastname@example.org.