Profit margins have been historically razor-thin in the construction, architecture, and engineering (AEC) industry.
Net margins for the engineering/construction segment, according to data reported by NYU’s Stern School of Business, are a meager 2.16%.
Put this into context with other industries—but particularly known cash-rich industries—and you begin to realize why construction companies face a unique challenge when trying to capture profitability. For example, regional banks enjoy a whopping 30.31% net profit margin. The oil & gas industry, particularly known for being cash-rich (e.g., see coverage in The Guardian, The New Yorker), enjoys a 26.01% net profit margin. The semiconductor industry, a booming segment (see: McKinney article discussing this trillion-dollar industry), enjoys a 22.74% net profit margin. Tobacco, which has had a complicated history (and some particularly morally questionable ad campaigns), enjoys a 23.46% net profit margin. Even publishing/newspapers, a category that has been almost synonymous with layoffs (see: PEW Research report), sees a slightly higher net profit of 2.82%.
What’s more, construction is plagued with other concerns (e.g., rising construction costs, high interest rates, and persistent labor shortages).
A Forbes forecast for the industry, what’s worse, predicts non-residential construction to shrink as the economy is expected to enter what Moody’s is describing as a “slowcession” (Moody’s via CNN Business), combined with those high interest rates we mentioned above. Senior Forbes contributor Bill Conerly summarizes the situation, noting, “The decline won’t be devastating, but it will be significant.”
With all this doom and gloom out of the way, one positive outlook we may offer is to look at lean practices, and how they have transformed the manufacturing industry. There changes have, nonetheless, been difficult-to-implement, long-term infrastructural process changes. However, the adoption of lean manufacturing principles in manufacturing has allowed many companies to increase their margins. These practices helped Apple, on the brink of bankruptcy, reshape and become one of the most valuable brands. The same challenges exist with implementing lean construction, the big infrastructural process changes that will be hard to implement but poised to drive the industry forward.
This all starts with lowering construction overhead, a key metric owners will need to watch closely in order to keep finances in the black. In a 2019 pricing & spending update, the Bureau of Labor Statistics (BLS) stressed the importance of a contractor’s overhead, inextricably linked to profits: “contractors’ overhead and profit percentages are of interest because they can highlight certain market conditions that cannot be isolated by looking only at changes in price.”
While the term overhead should be in the lexicon of any business owner—from retail shop owners to ecommerce entrepreneurs—construction owners in particular will need to manage it even closer to stay financially solvent.
In this article, we’ll break down this important concept and also give some tips for managing construction overhead to maximize profits in construction projects.
Merriam-Webster defines “overhead” (noun: See definition 3) as “business expenses (such as rent, insurance, or heating) not chargeable to a particular part of the work or product.
Jump Ahead:
Shopify, a popular ecommerce platform for online stores and retail point-of-sale systems, defines the term similarly: “expenses and operating costs” which are “associated with running a business [and that] can’t be linked to creating or producing a product or service.” These “overhead costs,” they explain, are the kinds of “expenses the business incurs to stay in business, regardless of its success level.” These expenses, they explain, are representative of “all of the costs on the company’s income statement except for those that are directly related to manufacturing or selling a product, or providing a service.”
Examples Shopify gives for overhead costs include:
Finally, Investopedia offers a few key “takeaways” relevant to overheads:
As Investopedia notes, there are typically three main types of overhead:
Furthermore, other categories of overhead may include:
Based on what we outlined to be generally true across the gamut of business applications, a Construction Overhead Definition might read as such: Business and operating costs associated with running a construction or contracting business and incurred to keep these businesses operational, and not tied to any one specific project.
So, what are overhead costs in construction? The types of overhead we discussed above are equally applicable to construction.
Typical overhead costs in construction you may encounter include:
Pro Tip: Managing construction inventory, which we’ll discuss below, is an important part of keeping overhead costs down. But did you know Milwaukee Tool offers a free inventory app? Learn more about using the ONE-KEY™ inventory app to decrease construction downtime and increase productivity.
Pro Tip #2: You can better manage your equipment maintenance by updating exhaustive service records with virtually limitless documentation in One-Key and can even add tool maintenance reminders at the frequency of your choosing, to ensure you’ll remember to take care of that preventive maintenance and avoid possible breakdowns.
Common questions contractors frequently want to know related to overhead are:
Direct costs ÷ Indirect Costs × 100
The above sentiment about how calculating overhead and profit percentages may vary geographically is also echoed in advice by the BLS:
Some contractors charge different overhead and profit percentages on the cost of materials versus the cost of installation, while others charge a single rate based on the total cost. Still others report separate compounded percentages broken out by overhead first and then profit. These effective markups are then totaled, using the same weights and index structure as the published nonresidential building construction PPIs.
You now know what construction overhead is, as well as how to calculate costs in construction projects.
Here are 7 ways to manage construction overhead and maximize profits:
As previously reported, only 31% of all projects come within 10% of the budget (KPMG via One-Key connectivity blog). What’s worse, as previously reported, construction overruns are experienced in 9 out of 10 (International Journal of Innovation, Management and Technology via One-Key blog).
Construction forecasting plays an important role in keeping overhead down.
Example methods to project accurate construction forecast include:
One process in the toolkit of project managers at large construction companies Construction Job Costing.
What is construction job costing? It’s a process that helps you stay on top of associated costs (labor, materials, and importantly overhead) to, at any given time, give stakeholders a complete picture of a project cost breakdown.
We recently released a job costing, construction overhead management tool for inventory and tool managers, free to use in the One-Key app.
Some of the features helping you manage overhead:
A 2016 PMI survey reported that for every $1 billion invested in the United States, $122 million was wasted due to lacking project performance.
Using collaboration tools (e.g., project management tools like Procore); productivity tools like Microsoft Office 365 and Google Drive; and messaging platforms like Slack or Microsoft Teams can help ensure teams across your organization are communicating and collaborating smoothly and any project issues are quickly addressed.
As an aside, the One-Key app offers the ability to import contacts from your address book, and streamline communication with these collaborators by allowing you to call, text, or email the people you need to, right from the app—so you can be productive and communicative right from your workflow without skipping a beat. What’s more, our multi-user admin allows you to empower your tool team to collaborate with custom permissioning for added organization security.
Want to take your project management game to the next level? Globally, 85% of CEOs believe that AI will “significantly” impact their business in the next five years. 63% agree or strongly agree that AI will make a bigger difference to business than the advent of the internet (Source: PWC global CEO survey).
The world’s your oyster!
A staggering FMI report highlights a key statistic about project data: 95.5% of all data captured goes unused in the E&C industry.
Further, a joint FMI/Autodesk report found only 36% of firms have implemented a process for identifying bad data and repairing it. The same survey found that 14% of all construction rework may have been caused by bad data creating $88.69 billion in avoidable rework globally.
One thing remains clear: Digitizing processes remains crucially important to chipping away at the cumbersome, inefficient processes that kill productivity and drive overruns—how these robust and all-encompassing these digital processes are, importantly, is the ticket because data in a vacuum isn’t particularly useful.
As an example to reinforce this theme, 79% of contractors did report using software to capture data and manage information, an Autodesk/Dodge Data & Analytics survey found—however, the same survey found 41% of contractors to believe that non-standardized data input leads to inconsistent, inaccurate, incomplete, and unusable data.
Example data integrations that may prove critical to your operations:
It’s also worth noting that the earlier FMI/Autodesk report we mentioned above found that 75% of respondents stated an increasing need for rapid decision-making in the field. Consider how useful in-the-field audits, equipment location troubleshooting, and tool lockout may be to prevent theft and keep projects running smoothly.
Pro Tip: You may even consider hiring a full-time construction technologist to help your organization undertake a digital transformation.
Lean construction methods are a great way to minimize waste, reduce expenses, boost productivity, improve quality over time, and increase value for the customer.
Lean construction incorporates offsite construction (see: prefab construction, modular construction) and in some cases 3D printing to offload as much of the upfront assembly, with these components assembled onsite later. Lean construction can help skirt inclement weather conditions and keep project schedules in line while also reducing rework.
Design-build construction methods are growing in popularity, with a 2018 survey reporting 58% of owners had stated they’d used or planned to use design-build.
These processes, as the name suggests, brings design inhouse to save significantly on time it takes to build, and in many cases can cut down on fees. What’s more, it can deliver projects 102% faster than the traditional approach (source: DBIA).
When paired with other innovative approaches like Building Information Modeling (BIM), which can streamline QA, owners can potentially maximize the quality and quantity of projects they deliver.
Sustainable construction, as previously reported by our friend Rose from Renovated, and sustainable building materials can be an economical alternative (both in terms of their environmentally friendliness and their lower cost in comparison to some materials) to materials like lumber that has become expensive to ship.
The green & renewable energy sector has also been an industry that has seen and new jobs (see: solar panel installer and wind turbine technician) and a strong net profit margin 17.77% (as seen in the above-mentioned NYU Stern breakdown).
Construction is an industry that has seen historically razor-thin profit margins, where overhead is even more critical to control.
“If contractors are able to increase their overhead and profit percentages,” the BLS notes,
“it shows that they are confident either that demand is sufficient or that competition is low enough to support the higher markup.”
The above tips should help you manage your construction overhead to drive better profits in 2023!