Benchmarking and the Path to Continuous Improvement
Top tier businesses make it a practice to establish performance targets that align with their business strategies and operating plans. These targets serve as “goal posts” toward which every member of the team drives their daily activities. They are a key resource for periodic operational reviews to highlight successes and pinpoint trouble spots. And they’re a means to foster continuous improvement over time. As famed statistician Karl Pearson said: “That which is measured improves. That which is measured and reported improves exponentially.” A few key financial metrics reveal a great deal about the health of a construction firm. They include:
- Total billing, gross profit, and operating income provide high-level indicators of the company’s market position and operational efficiency.
- Underbillings versus overbillings suggest the degree to which invoicing aligns with costs and progress on the project.
- Profit gain or fade from open to closed jobs tracks estimated profits on work in progress against actual profits realized at the finish line.
- Project backlog provides a sense of the company’s ability to sustain or grow the current level of operation.
- Working capital which measures the company’s ability to finance material, equipment purchases, and payroll to support committed projects.
- Working capital and equity turns measure the rate in which the working capital is utilized to generate profits and how the owner’s investment is applied in the company activities.
By setting performance expectations and tracking the numbers over time, management gains a window into the company’s past, present, and future. They get a sense of whether things are moving in a favorable or an unfavorable direction, and they have the wherewithal to take action accordingly. They’ve also got the means to see how they’re doing in comparison to their peers.
Construction-specific benchmarking surveys help leadership teams compares their performance metrics with industry averages and trends. The Construction Financial Management Association (CFMA) has been polling the construction community all across America for decades to assemble this information. Their results are broken down by contractor size, geographic region, and trade, and published in an annual survey. Aldrich uses the CFMA Annual Survey to compare our clients last five years of results against the appropriate industry data producing construction specific ratios to benchmark against peers. Data may also be available from sureties, who collect information on every company they underwrite and can sort aggregated data by contractor size, region, trade, and more.
Keep in mind that benchmarking data is only as good as the quality of information provided by its participants and their relative positions within the market. If you want to count yourself among the “best of the best,” you’ll want comparative data for firms in the top quartile in terms of operational efficiency, profitability and overall financial health.
Setting performance targets, measuring progress and comparing your metrics with others is just the start of any continuous improvement project. You need to have a solid understanding of what the numbers mean and how they relate to your business.
Suppose, for example, that you are continually underbilled on projects and your expenses are outpacing the billings and collections coming in. The constant underbillings on projects are causing cash flow strain and frustration as you can never seem to get ahead. Potential causes of continuous underbillings are poor billing practices, poor project management of cash flow, negotiation of the contract in a manner that allows for underbillings to occur or a potential lack of understanding of the project and customer.
Root cause analysis takes a deep dive behind any number to unearth the operational issues that produce a given result. A robust root cause analysis could reveal personnel issues, critical resource shortages, processes issues that give rise to communications breakdowns, training issues, or perhaps something that is wholly outside your company’s control. If you don’t chase the right cause and invest in the proper course of action, you’ll continue to get the same results and possibly lose valuable staff or business partners along the way.
There’s one other point to consider. Performance metrics and benchmarking data tell you where you are and where you’ve been. They’re a great resource for capturing an operational moment in time and analyzing its relationship to other “snapshots” in history. But they don’t capture where you’re going or what’s possible. It takes a deep understanding of your industry’s best practices to truly assess the degree to which you’ve achieved (or can achieve) your potential. And it takes an ear to the ground of operational and technological developments to make sure that you’re ahead of the power curve when the next “game changer” hits the market.