Clamour for 5% margins makes me uneasy
To grow their business construction companies need to focus on the ways in which they can add value, rather than just chasing higher margins, says Mark Beard.
I have always had a good deal of empathy with trade union leaders who bargained hard for a good pay rise for their members on the back of their efforts raising company productivity and profits. I have far less empathy with trade union leaders who demand a greater share of the cake, with no solid justification.
Over the last six months, we have seen a variety of statements from construction industry leaders, a number who lead companies that earn good margins through adding significant value to the construction process, but also a number who aspire to grow their net margins from 1% to 5% with little outward communication of what extra they will bring to the party. Even in his pomp Arthur Scargill was never quite this ambitious.
If I was an investor in a tier one contractor that was delivering margins of 1%, I would be far happier to hear the chief executive highlighting his plans to move the dial from 1% to 2% and how he would keep the margin at 2% for the full economic cycle, than clamour for 5% margins.
As a part-owner of a medium-sized tier one contractor, it would be very easy for me to join the clamour for 5% margins, but such proclamations make me uneasy, in part because:
- Over the last 20 years, our average net margin at Beard has been just over 2%, which has equated to over 25% annual return on shareholder funds, which I feel is plenty for a cash-generative business;
- If net margins soar to 5%, return on capital will get out of line with the risks we are taking, which is likely to lead to a whole variety of short-term financial investors descending on our industry, creating a bubble, which will of course, in time, burst; and
- Rising profits need to reflect greater added value.
Over the last 20 years, tier one contractors have taken on more design responsibility which clearly warrants higher net margins; conversely the majority of tier one contractors are doing less and less construction work themselves, subcontracting responsibility and margin to tier two and tier three contractors.
This way of working invariably means tier one contractors’ cash flow is significantly improved, to the detriment of tier two and tier three contractors’ cash flow. Exploring in more detail who is and who is not making good margins, it is no surprise to see tier two and tier three contractors doing the best, and rightly so. When I see the effort our supply chain make for us, I often think: “You deserve every pound of profit you make.”
If we focus our efforts and pronouncements on what we can and will do differently to add value for our customers, we are more likely to move the dial towards 5% margins than by simply demanding a greater share of the cake.
Good luck to all those chasing higher margins: anyone who can deliver 5% net margins from tier one contracting for a full economic cycle, without getting overly contractual with their customers or supply chain, will be quite exceptional and will have earned my utmost admiration.
Mark Beard is executive chairman of Beard Construction