What Drives 20% Net Operating Level at Any CI Company ... THE GOLD STANDARD
In today’s issue…
Business Model Fundamentals Revealed
598 words, total reading time 3 minutes
The gold standard of profit in CI is 20%. In practice, fewer than 15% of the companies we encounter achieve this level.
20% Net is achieved by generating enough gross margin and by controlling payroll costs. It does not get any simpler to see why a company is falling short.
Thru studying the financial performance of hundreds of CI companies we have learned a direct relationship between top line margin (without labor costs) and payroll. The axiom is this: you must generate $2 of TLM for every $1 of payroll. We have rarely seen a company miss the gold target by having too high OPEX (operating expenses). It is always lost at the pricing or the payroll window.
Another indicator is the relationship of Revenue to Payroll. Using a target TLM of 60%, you must generate 3.3x Revenue for TLM to be 2X each payroll dollar. A higher TLM (>60%) would require a lower revenue multiple (<3.3), and vice-versa.
Let’s take a $2M company with a payroll of $600K. If they have a TLM of 60% (=$1.2M) the math works, and you can solidly bet they are a 20%+ performer. The profit Math would be: Revenue $2M, GM $1.2M, Payroll $600K and OPEX $200K (10%). Of course, margin should not be limited to just 60% we often see 61% to even 70% in some companies.
These are undeniable truths substantiated by hundreds of companies in our industry.
So, what can be changed to meet the gold standard? You must control the 3 M’s: Mark Up, Mix and Margin. Mark up applies principally to Labor. Your billing rate needs to be 4X and preferably 4.5x your average raw wage rate. If billing rate is client sensitive, you will need to make up for it in hours estimated on each project (MIX).
That takes us to MIX. Labor mix needs to be 35% - 40% in most companies and rarely will less than 30% make the math work. Now, an occasional project can be below the target; high ticket equipment with low labor allocation can be winners. The average across projects is the important thing. And always, the goal is to complete the install in less than the estimated hours (margin opportunity). Also, on MIX if you are charging less than 7% for misc. parts you are probably not making enough money on them. Companies charging 2-3% are barely covering their costs. This is why we track them separately in our system.
The MARGIN on equipment is easily calculated from project pricing. Labor margin, though, cannot be known until after production is complete. (Parts margin should only be measured in aggregate, as non-inventory items they are rarely purchased specifically for a job). MIX percentages of project revenues allocated to Labor, and to Parts – are the key pre-production levers that can be pulled to assure a 60%+ TLM.
So, getting 30% to 35% LABOR MIX and 6% to 8% Parts MIX in your proposals is very helpful to maintaining the 20% net operating profit level. At the end of the day achieving 50% Labor Margin will seal the deal if all other levels are being maintained.
The keys again are:
Reviewing each proposal before it goes out the door to meet the standards. Getting your bill rate mark-up in line. Managing Labor Margin to 50%+. Keeping payroll to half of the TLM you are generating.
Do these basic things and your will generate lots of cash and sustainability in your business.