Many A&E firms come to me because their profits are too low, not hitting expected targets, and barely enabling the firm to grow. In most cases, their projects are making a profit – just not at the levels expected or needed. The leaders of these firms are frustrated, and want to know – what do we have to do to get to the top 10% of firms in the industry?
By getting to spend quality time with the executive team of over 700 A&E firms over the last 28 years, with confidential access to their key financial indicators (KPIs), I was able to see a huge variation in the profit margins from one to another. While some firms struggle to hit 8% profit, others are sailing along with consistent profit margins over 30%, and in some cases, in excess of 40%!
What Profit Should You Be Making?
While these higher margins are much more expected and targeted in most other professional services industries, the average architecture, engineering, environmental and Geotech consulting firm is targeting 13% to 15%, and lower if 100% of their work is public. In fact, many firms that offer exclusively public work are averaging 6% to 8% – hardly enough to counter the huge risk of these high exposure projects.
It’s All About the Culture
While A&E firms vary in size, geography and services offered, the most significant reasons for why some firms are struggling to make 8% and others are killing it at 30% can be summarized by assessing a firm’s culture. A firm’s culture is the most important factor in determining profitability. The values and vision of the firm’s leaders, and how these values are communicated to employees will drive employee behavior, and affect whether the firm is performing at its highest performance, mediocre performance, or below its capabilities.
The 10 Culture Traps described in Find the Lost Dollars: 6 Steps to Increase Profits in Architecture, Engineering and Environmental Firms lay the groundwork for analyzing and really understanding your firm’s culture and whether it drives accountability, high performance, superior business management and ultimately, high profits.
Here is how the 10 Culture Traps affect profitability, and explain why some firms are more profitable than others:
Trap #1: Quality is everything
Most professionals want to offer the highest quality possible. However, the reality is most clients’ budgets are lower than the level of quality we desire, or they expect. Trying to balance the level of quality with an inadequate budget is a critical yet often poorly mastered component of project management, and most design professionals will over-deliver in order to maintain that quality. Setting realistic expectations from the beginning is critical to a profitable project and happy client.
Trap #2: Keep the client happy at all costs
When you combine Trap One – high quality, with a natural desire to keep clients happy, our employees may engage in practices that threaten the profitability of our projects. They will often give “extras” and favors away in order to avoid conflict or asking for money. It is critical to the success of our company that our employees learn how to set client expectations, communicate often and well, and deal with conflict as it arises during projects.
Trap #3: In slow times it is OK to take projects we know we will lose money on
As a repercussion of the last economic downturn, and competitors that continue to bid lower and lower, we feel the pressure to lower our fees to a level that the firm cannot permanently sustain. As a result, many firms feel compelled to bid on projects at a lower cost than they can do the work, knowing they will lose money. In most cases, the project will be stressful, you will never be able to get a profitable project with the client, and you could get trapped in a long-term vicious cycle of continuing to provide services at a loss. It can also have the negative effect of causing tension between your project managers and the client, as they struggle to keep costs in control and limit the amount of loss that is realized.
Trap #4: All clients are good clients
Most firms have some great clients, some good clients, and some terrible clients. We all know intuitively that all clients are not good clients, yet we continue to work with clients that are cheap, treat our staff badly, and don’t appreciate the work we do for them. And even worse, we jump when the bad clients call to the detriment of our relationships with our best clients. While you may love their projects, and desire the exposure they afford, your employees may be miserable, and your PMs may be frustrated. And studies show that if employees are not happy, they will not perform at their best, which continues to erode profits and client satisfaction, and lowers employee retention.
Trap #5: You can’t lose money on a Time and Materials (T&M) contract
This may seem counter-intuitive but if you do a lot of T&M contracts, it is really important to understand. This is assumed because you are able to bill for every hour that you work, and unless there are write-offs of hours that are not billed, you are making money. The issue with T&M contracts is that in order to make the target profit, the billing rates must be high enough to cover costs plus a profit. If your actual costs to run the business are higher than estimated, the company loses money on every hour your staff works! With increasing salaries and health care costs, many firms have rates that are too low to make an acceptable profit.
Trap #6: We do not share financial data with managers and employees
Sharing financial data with your project managers is a key management decision that can determine how successful they will be in controlling project profitability. In most cases, the more they know, the easier it is for them to react in a timely manner to project issues and overruns. There must be a balance between keeping certain information, such as executive compensation plans, confidential, and giving them the data they need to manage their projects. Managers will feel more empowered and motivated and accountable to help the company succeed if they feel they are trusted, and have a direct impact on the success of the firm.
Trap #7: Our clients do not want us to make a profit
As everyone is under pressure these days to cut costs and streamline budgets, our clients are pushing us harder to lower our fees. This pressure has caused a common myth in the industry that our services are a commodity, and clients do not want us to make money. This trap causes many firms to lower their fees in order to win work. It is critical to our short and long-term success that we strive to find the clients that truly value our work, and understand how important it is to the success of their projects that we make a profit. Operating at a loss causes us to have to cut back on quality, using cheaper people than we recommend, and possibly making critical decisions based only on cost. While this may be the reality in today’s world, it is ultimately a threat to the success of our projects, our firms and our clients.
Trap #8: We can’t make our employees follow our policies
As firms “grow up” they usually find it necessary to start to implement more internal controls, policies and approval processes to effectively manage people, comply with laws, and execute on their project delivery and financial management. However, despite the fact that they put these policies in place, many firms do not enforce compliance with these policies, and many key aspects of firm financial management are compromised. New processes should be based on “the best way to do something” and make your employees’ jobs easier, not more cumbersome.
The reason that many employees fail to comply with company policies and processes is because they either don’t know why they are being asked to do it, or they don’t know how to do it. Your employees are the key to high profitability, and giving them the skills, business understanding and effective structure (processes and systems) to enable them to maximize their performance can be your number one competitive advantage.
Trap #9: Times are tough, so we can’t spend any money
For anyone that has been in business for many years, you have probably lived through a recession or two. Most firms took the necessary steps between 2007 and 2009 to trim back the fat from their overhead, do the painful layoffs that were necessary, and hunker down to weather the storm.
But the truth is that taking this defensive position will not work to grow a firm. With the boom in new technology and changing market conditions, this is the time to take a hard look at your business and see where you can drive real efficiency, and generate bigger margins on your projects. Everything is driven by people, processes and technology, and it is up to your leaders to strategically invest in the right areas to help your company achieve its goals, and remain competitive. The most profitable firms have been investing all along – whether business is slow or booming.
Trap #10: This is how we have always done it
If this is the answer given for the way that you do anything in your company, then it is very likely that your processes are outdated and inefficient. Your business effectiveness and ability to execute your projects to your targeted margins requires that your staff are highly utilized, and projects are well planned and executed by your PMs.
If they are doing these things the same way that they were doing them even a few years ago, then your company is not maximizing their performance and maximizing efficiency. By leveraging new technology that is available for business and project management, you can then risk losing your competitive edge.
Leverage Your People to Succeed
The firms with the highest profits are leveraging their people, effective processes and systems to get every dollar out of their projects that they are entitled to. By getting very intentional about your employees’ mindset and behavior as it relates to your business practices, you can shift your culture to be one of financial guardianship for both you and your clients’ profits.
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RAISE Your Value: 5 Steps for Architecture and Engineering Firms to Uncover Hidden Value, Design a Winning Advantage and Charge More
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