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Don’t Go Off the Overhead Diet Yet

Don’t Go Off the Overhead Diet Yet

“If ‘x’ is the number of contractor failures that happen when the market is on the way down, then it is ‘3x’ when the market starts to go back up,” says construction industry expert and author Dr. Thomas Schleifer, who admits feeling like the industry is still in limbo. “Dollars put in place I’d hoped to see by August 2012 are not there; now I’m looking to the first quarter of 2013.”

Schleifer often cites the 12- to 18-month lag time for the construction industry after the rest of the economy starts to recover, but his “second lag” lesson is the one to watch now. Schleifer’s timeline for the recovery looks like this:

  • June 2009: Economic recovery begins.
  • January 2011: Official end of the first lag; beginning of the second lag (i.e., the margin recovery).
  • July 2012: Margin recovery should be over, with put-in-place dollars back to 2008 levels.
  • August 2012: Rate of recovery is not happening as it has in the past.

“What we need to get back to is $1.1 trillion put-in-place, which was the level in 2008. That will signal margin recovery,” he says. “But in August 2012, we were still sitting at $900 billion.”

Schleifer’s research includes a look at the seven largest economic downturns since World War II. In three of those downturns, “the failure rate was worse when the economy was on the way back up,” he says. “Contractors load up on too much work and too much overhead too soon. They don’t factor in things like wage inflation and materials inflation when they bid, and then find out mid-job it’s unprofitable work.”

Following is Schleifer’s list of what causes most contractor failures.

  1. Traveling too far for work.
  2. Taking on bigger jobs than they can handle.
  3. Trying to do unfamiliar types of work.
  4. Forming joint ventures to accomplish the first three.

Schleifer cautions contractors about news stories that claim things aren’t as bad as predicted and that report consumers are spending again. “They don’t explain that the recession we just had was worse than the depression and that spending is up in remaining stores because many other stores closed,” he says.

The situation demands business planning for contractors that takes the timing of the margin recovery into account. Since margin recovery is still months or more away, Schleifer’s advice for a bulletproof 2013 strategy includes resisting aggressive pricing and bidding, conservatively projecting likely sales for two years and reducing overhead to fit likely sales.

“That’s the tough part,” he says. “When you’re growing, additional overhead should trail your sales, but when you’re in a decline, trimming overhead should precede your sales. I call it the overhead paradox, and having the discipline to get lean and stay lean until margins recover is the key.”

Contractors are surviving by taking the advice of experts like Schleifer, construction accountants and professional surety advisors. Because they made necessary cuts before it was too late and remained credit- and bond-worthy, they are positioned for growth when the construction lag finally ends.

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