Contractors that reduce their bid to increase the top line rarely see the additional revenue translate into an increase in bottom line profitability. However, many businesses are using a price reduction strategy to win more bids. They believe what they lose in margin will be made up for in volume. Other than Wal-Mart, has any company made this strategy work?
Unfortunately, slashing prices isn’t enough to increase the bottom line for most companies.
Why not? The short answer is poor operations management. By this point in the economic downturn, most contractors have cut every expense possible. Then, some resort to reducing their price/bid in order to capture more business—only to see the top line grow while the bottom line continues to shrink. This usually happens because of the increase in variable or soft expenses associated with an increase in the top line.
For most contractors, operations represent 75 percent to 85 percent of their expenses. When a company increases its top line revenue, the fixed expenses (e.g., rent, salaries, insurance and loan payments) remain the same, but their variable expenses (e.g., raw materials, hourly wages, overtime, commissions, inventory, utilities and supplies) can increase dramatically. Overtime and poor inventory management are the two biggest profit killers when taking on new business at a reduced price.
Another major factor contributing to a decline in profitability is poor cash flow. As the number of jobs increases due to the reduction in price, so does the cash outflow. As cash outflow increases and credit lines are maxed out, contractors struggle to start and complete jobs on time. As a result, their accounts payable and accounts receivable grow increasingly older. Late fees, interest payments and slow-paying customers contribute to the increase in unforeseen expenses.
As a result, top line growth and profitability don’t always coexist. What contractors need in today’s economy is long-term sustainable growth. There’s no sense in growing the top line if it doesn’t result in a healthier bottom line.
Six Steps to Profitabiilty
An effective and streamlined operations management process will transfer more top line revenue to the bottom line faster than anything else. Here’s a step-by-step plan to accomplish that.
- Assemble a five- to 10-member cross-functional team of current employees.
- Complete a detailed business flow map. Have the team draw out each step involved in the operations process—from receiving the order to getting paid. This must be completed on a very granular level in order to identify how business should flow optimally from start to finish.
- Identify problems, roadblocks and ways to improve profitability from the business flow map. Most companies identify 50 to 100 areas of improvement.
- Narrow the list of problems down to a manageable group. Usually 20 percent of a company’s problems cause 80 percent of the trouble. Identify whether each problem is a causal problem or a symptomatic problem. This step is like killing weeds in the yard. The root must be killed for the weed not to grow back.
- Assess the value of each problem. After narrowing the list, determine the annual cost savings associated with solving each of the problems.
- Start solving each problem, one or two at a time, beginning with the most costly problem first.
The first five steps should take three to four weeks of meeting a maximum of one hour per week so as not to drain time or resources. Step six should take four to six weeks, meeting for about 30 minutes per week, per problem.
Before considering a price cut, contractors should take the time to improve their operations. Simply increasing the top line rarely results in a stronger bottom line. Keeping more of what’s already coming in is much easier than generating new business.