Every contractor’s dream is to maximize construction profits and grow the business. However, there are a lot of factors that affect construction profit margins and make this dream nearly impossible to achieve.
One significant reason for reduced profit margins these days is inflation. Inflation is the gradual increase in pricing for goods and services in an economy. Inflation can either be caused by demand-pull factors or cost-push factors.
Whatever the reason, one thing is clear: the reduction of profit margins needs to be addressed and prevented to ensure that business continues.
Other factors that reduce construction profit margins
Here are some other factors that can reduce profit margins.
In construction, the longer it takes to complete a project, the lower the profit margins. This is because a construction bid only factors in the amount of time a project was expected to last.
For example, if the project is projected to last two years, the contract will only have a budget for two years. If the project lasts two years and six months, then more has been paid for labor and machinery, reducing profit margins.
Inexperienced contractors may assume they can increase their profit margins if they buy equipment rather than rent it. However, a cost-benefit analysis needs to be done to evaluate whether it’s a better decision to buy or purchase equipment.
This is because there are many things to consider before making a purchase, including:
- The cost of maintenance
- The cost of hiring an operator
- The cost of fuel
- Taxes if you’re importing the equipment
- Vehicle mileage
If you’re planning to use a piece of equipment for six months only, then it doesn’t make sense to buy it. Instead, you can rent it for six months.
Another factor affecting the profit margins of construction companies is financing. If a company has the financial capacity to finance a project themselves, then they can better control their profit margins. However, if the company seeks financing from a commercial bank, it must pay interest as negotiated.
If the interest of the commercial loan is 5%, then profit margins will be reduced by a similar factor.
Construction projects are full of risks, so you should always have risk mitigation strategies. However, projects are sometimes affected by problems that contractors don’t initially anticipate. An example of such a problem is when materials are stolen or damaged due to heavy rainfall.
Profit margins can also be reduced by subcontractors who don’t follow guidelines, or subcontractors who declare bankruptcy.
6 strategies to increase construction profit margins
Now that you understand some of the factors that cause profit margins to decrease, it’s now time to discuss practical strategies that you can use to protect these margins.
1. Use technology to increase profits
Since unforeseen risks can reduce your profit margins, it’s recommended to use modern technologies to help you with developing mitigation strategies.
One technology you can use to identify risks is https://www.alicetechnologies.com/solutions/for-infrastructure. This construction optioneering platform is designed for use on complex projects like bridge construction, railway, and tunnels. It uses simulation to optimize essential project resources, calculating how much equipment and material will be required to complete a project on time.
2. Have profit targets in advance
The most common mistake first-time contractors make is assuming that annual profit percentages are assured. You’ll need to identify realistic targets, as well as job costs, overheads, and sales goals.
Job costs represent the amount of contract your company wants to work on, and should include the entire construction budget, including the cost of labor, insurance, equipment, and services offered. Overheads include the cost of setting up an office, and expenses for admin and accounting.
When you do your calculations, try to aim for a reasonable construction profit of 15 to 20%.
3. Negotiate with suppliers
Another strategy to increase your construction profit margins is developing a good relationship with suppliers. If you buy materials in bulk, you may be able to negotiate discounted pricing with a bit of add-on, such as free material transport to the construction site.
It helps to also buy directly from manufacturers, especially if you’re working on a large construction project. Manufacturers (such as cement makers) will gladly sell cement to you at wholesale prices.
4. Rent equipment instead of buying
As mentioned earlier, equipment is expensive to buy and maintain. Therefore, renting is more economical than purchasing, especially if you’re only planning to use it for a short period. Apart from saving you money on initial purchases, you’ll also save on maintenance, fuel, taxes, and staffing.
5. Specialize in profitable niches
You can increase your construction margins by specializing in profitable niches and creating a name for yourself. Target specific construction niches like contemporary home constructions. Other niches you can consider are:
- Restorations of old structures and buildings
- Building of commercial premises
- Factory set-up
- Bridge construction
- Tunnel construction
Before specializing in a niche, you’ll need to ensure that you’re doing a feasibility study of that industry. Determine how much profit margins are realized and if these margins are suitable for your organization.
6. Automate your processes
To increase profit margins, construction companies will need to automate their processes. That way, you’ll be increasing operational efficiency while at the same time reducing overall costs. Some of the things that can be automated are:
- Paying employees
- Conducting background checks
- Inventory management
- Use of robotics in prefabrication
You can also use technology to identify unproductive workers by having an application that tracks milestones and productivity.
Lastly, contractors should try to reduce material waste. The best way to do this is to buy materials based on milestones. If the milestone requires 300 bags of cement, then the project manager should buy only 300 bags.