When it comes to overhead, truer words may never have been spoken. Today’s “Wild West” online environment has fundamentally changed the way clients research and buy, as well as how contractors do business. More and more in today’s economic climate, “sell-prices” are being squeezed. as clients leverage random information from the web (i.e. “I saw it online, so it must be true”).
Whether it’s parts, materials, or equipment costs, or simply polling peers and contacts on what something should cost, sell-prices are under constantly increasing competitive pressure. As top line revenue drops, without accompanying reductions in direct costs, overall gross margins also start to slip. If gross margins shrink, and overhead isn’t adjusted accordingly, the ultimate impact is to the bottom line.
Often times, most businesses are savvy at being able to do whatever it takes to close sales. Less often, but still pretty common, is their ability to squeeze the down line vendors to reduce direct costs to help recover some of the sacrifice made on the top line. Sometimes, all the margin may not be recoverable, and over time gross margins will slowly start to trend downward.
Overhead exists to support sales and production, period. If any process or expense doesn’t help generate profits to the bottom line, directly or indirectly, they are unnecessary.
While most owners and managers of contracting businesses are adept at sales and production, frequently they take their eye off the ball when it comes to overhead. That’s understandable, since many got their starts in the field turning wrenches, and have no formal business or financial training. It’s easy for overhead to grow unnoticed to the point of potentially getting out of control, or at the very least not decreasing appropriately for the revenue and gross margin reductions.
Start with the PURPOSE of overhead in the first place. Overhead exists to support sales and production, period. If any process or expense doesn’t help generate profits to the bottom line, directly or indirectly, they are unnecessary. Even worse, if they’re not contributing to profitability, they’re most likely draining profits away somehow. Serious consideration should be given to cutting any overhead expense that falls into this category.
Many decisions regarding overhead reductions may be uncomfortable, especially if they involve long-term relationships with vendors and/or employees. An easy first step is to put everything out to bid to ensure all costs are in-line and competitive. Also, leverage peers and industry associations for who they recommend, what they’re experiencing, and what changes they’ve made to improve or reduce.
Organize and review overhead two ways. First, review as a percent of total revenue. Second, review as a percentage of the total overhead itself. This will help you understand the size of the chunks you can target for savings. Reviewed over time or in time batches, patterns may emerge that could be clues to what changed or is trending the wrong direction.
Organize and review overhead two ways. First, review as a percent of total revenue. Second, review as a percentage of the total overhead itself.
Focus on BIG opportunities to save first. One of the primary areas where excess costs can be hiding in plain sight is overhead labor. Typically, non-direct payroll (payroll not directly associated with field work) should be targeted for less than 10 percent of revenue. Target for total company payroll should be less than 30 percent, including overhead staff.
Have you ever noticed that regardless of busy or slow season, the back office overhead staff remains pretty flat? That’s usually an indicator that there’s opportunity to trim excess from overhead. If you use an Ultimate-KPI of revenue per man-day, you will be able to cross-check your right-size staffing to confirm potential issues uncovered with the labor percentages analysis. Then, you can see who’s working on critical stuff supporting sales and production, versus who’s doing “busy-work” to get their hours in each week.
When it comes to overhead management, the saying, “A penny saved is a penny earned” definitely applies. Every dollar of overhead you cut drops directly to the bottom line. Then the real magic is, when your revenue and gross margins increase, you’ve been able to get lean and mean with overhead, so your net profit also grows.
Tom Casey, Jr. is chief quality officer at Climate Partnters Milford, Conn., a multi-generation company in existence sine the early 20th century. He is also chief quality officer at Summit Services, Hilton Head, SC, and Griffin Service Co., St. Johns, Fla. He also operates a contracting consulting business based in Florida. He can be reached by email, at: [email protected]; or by phone: 518-732-JEDI.