Benchmarking can improve construction company performance
INSIGHT ARTICLE |
The competitive environment in the construction industry is getting heated.
There is general agreement that infrastructure in the United States—that is, the country’s bridges, highways, airports, rail lines, communication systems and the like—is deteriorating. Politically, there is bipartisan support for addressing the issue.1 For the construction industry, this means there is a potential for significant increases in projects and profits.
Nothing is set in stone, so to speak; no major projects have been defined, prioritized or announced; and nothing is likely to become a reality for several months. But the appetite to build and improve is there—and with it comes increased competition. With the possibility of such growth, construction companies need to manage their margins carefully to ensure they are keeping up with their competitors as well as with changes in the market. It is not only a matter of cutting costs, but also being mindful of profitability.
Benchmarking enables construction companies—whether they focus on heavy highway, specialty trade, industrial, or another category—to keep pace with the rest of the industry and remain competitive.
Why performance benchmarking is essential
Benchmarking—using financial data to compare a company’s performance against industry measures—is not a new methodology. But just like hospitals and hotels, the construction industry—with its wealth of detailed, quantifiable information—makes it quite suitable to taking advantage of what benchmarking has to offer.
Best in class construction companies routinely benchmark their operational and financial performance, but other companies may not feel the need to implement benchmarking measures or their benchmarking efforts may be too narrowly focused for them to be entirely effective. A company that is too complacent to implement a benchmarking process may be missing opportunities for cost savings and margin management.
Benchmarking goes beyond cost-cutting initiatives and comparing a company’s cost structure to industry standards. Management can use benchmarking measures to explore if profits are keeping pace with the rest of the industry. For example, is the company taking the right projects at margins that are appropriate for the current economic climate, or are they bidding like it’s the recession in 2008?
In times of significant change, companies that have easy access to information are often the ones that prosper.
For benchmarking to be effective, management should start by emulating the companies in their sector that are identified as best in class. In its annual financial survey, the Construction Financial Management Association notes that such high-performing companies typically:
- Outperform their peers in a number of key metrics, such as return on assets and return on equity
- Carry less debt
- Show more pronounced gross profit per employee
- Have a higher gross profit margin and net income before taxes2
Management can compare their companies to these best-in-class organizations, starting with two of the most significant management concerns for any construction company: payroll and profit margins. These comparisons can lead to questions in other areas, such as the costs of subcontracting, payroll, overhead and occupancy.
Establishing effective performance benchmarking
Companies should implement benchmarking by following a few guidelines:
- Institute a formal process: This is not a one and done initiative; management needs to make benchmarking a routine part of its operational governance. It may seem like a cumbersome and time-consuming process at first but, once it becomes a part of the company culture, it gets easier.
- Choose appropriate metrics to benchmark: Set up measures on cost structure, profits and margins, as appropriate for the company goals, its region and its annual revenue. Keep it simple, but relevant. In the heavy and highway sector, for example, there are significant equipment costs. Look for any trends to glean there that can help determine if the company should lease or buy. Companies should look at external forces as well, including local occupancy rates, regional shortages in lumber, concrete or other commodities, and any additional elements that can make for fierce competition.
- Track the status of any initiatives that come from benchmarking: Follow the success (or ineffectiveness) of cost-cutting efforts, changing margins and other initiatives that are based on the benchmarking metrics. Assess and re-assess the metrics being used to ensure they are still relevant. As market forces change, management can use the benchmarking data to make informed adjustments to strategic decisions.
Effective benchmarking can play an important role in helping construction companies of all specialties and sizes stay competitive and nimble.
1 Fitzsimmons, E. “What Trump, Clinton and Voters Agreed On: Better Infrastructure” (Nov. 9, 2016) The New York Times
2 CFMA resources