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In a recent article I explained how the construction sector produces one of the highest rates of business failure in Australia. Many complex factors challenge a builder’s survival. The very act of signing a client requires a builder to invest significant time and resources before seeing any cash. This includes finding a lead and converting, as well as the design and quote. Then when a client does commit to a home build, the approval is another complex and intricate process.
The silent killer
Time delays have significant financial implications for builders, leading to financial difficulties and even insolvency. Delays occur due to bad weather, supply chain disruptions or changes to the building design, to name just a few of the causes.
Time delays compromises a builder’s gross profit margin. Time delays lead to increases in material and labour costs. Time delays prolong cash hitting the bank. Time delays make people cranky.
Builders typically have a fixed budget for labour costs based on the planned timeline of a project. If the project takes longer than anticipated, builders will need to pay their workers for the additional time. In turn, that exceeds the allocated budget, erodes the gross profit margin and means lower contributions to meet overhead expenses.
Builders risk increases in material costs if projects are delayed. Again, when builders plan a project, materials are scheduled considering the usual industry lead times. However, if the project is delayed, the cost of materials may increase due to price fluctuations caused by increases in demand due to supply shortages. This has certainly been the case with supply chain disruptions caused by the COVID hangover. Other sleepers include equipment under hirer arrangements such as a construction shed or scaffolding. When the project is delayed, additional hire charges will need to be covered, again hitting the gross margin and resulting in a lower contribution to overheads.
Take time to think about the sub-contractor who comes out on site only to be told by the builder they are not ready. That sub-contractor has now lost a day, possibly more. The implications of this are greater than you think. First, the sub-contractor will not prioritise their work nor fit into the schedule demanded by a builder. Rather they will work for the builder that is consistently ready. Then, when you are ready and in desperate need for that sub-contractor, a specialist tiler, say, supply and demand kicks in and you will be pay more.
In the recent article I explained how one of the main challenges facing builders is management of work in progress. Time delays should be cause for builders to constantly review and update their work in progress to ensure its accuracy.
Most builders grapple with the mark-up and margin dynamic. Ask any retailer and they will tell you the difference in a heartbeat. A builder often confuses to the two. I cannot count the number of times a builder has said to me that their margin is 20 per cent. I am now convinced there is a master apprentice teaching 20 per cent mark-up as a base to almost every builder. Of course, builders are staggered when their accountant tells them their gross margin is 17 per cent, but they are sure they have applied 20 per cent.
The point I am making is that these factors for the time delays and the analysis of the work in progress gets builders to the gross profit line. Gross profit is only part of the battle. You then need to get to the net profit line.
Between the gross and net profit lines are overheads. Time delays will cause overheads to blow out. Overheads are fixed costs incurred to support a builder’s operations regardless of whether there are delays or not. These costs include rent, utilities and insurance to name a few. If a project is delayed there is more time needed to get to the next stage of the build, which pushes out the timing of the next progress claim. The delay in issuing the next progress claim results in the tightening of cash.
There is now a need for the contribution from the gross profit margin to be sufficient to manage the additional overheads caused by the delay. The gross profit margin on a standard residential build of say, 26 weeks, should cover its share of overheads. Delays mean this same gross margin is now looking to cover more than its share of 26 weeks.
The vortex effect
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Time delays impact on quality – “just get the job done” and efficiency – “tools down people, waiting for the trusses to be delivered”. They also mean lost opportunities. If you can’t finish a home, you may not be able to fit another project under your homeowners’ warranty insurance.
Time delays may result in legal issues, including possible liquidated damages. Importantly, delays and legal issues provide interesting client management challenges. Since a large portion of a builder’s leads come by word of mouth, reputational damage and “where is the next job coming from” become the next risks to manage. What will you do to win the next job? Drop your margin or is it mark-up? Rinse and repeat.
The building industry is complex but it can be simplified in this way: builders must do two activities and only two, well.
The first is where and how a builder goes to market to win work. The second is creating an environment of operational excellence where quality, time and systems are paramount. If you are disorganised then business is difficult, extremely difficult; however, getting organised is easy.
The message is simple, if you’re not organised, then business is difficult; getting organised is easy.
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