By Sal Alfano. As volume increases, how much does overhead rise? According to last month's column, which charted the performance of more than 200 remodeling companies over a 10-year period, average overhead (including owner compensation) fluctuates between about 23.2% and 25.4% for remodeling companies up to $5 million in volume. Considering the kind of explosive growth many of these companies experienced in the past five years, a 2.2% variation is remarkably small. It suggests that controlling overhead is critical to managing increased volume.
For a closer look at the relationship between revenue and overhead, we've chosen to chart one company whose response to its marketplace exemplifies the kind of control remodeling companies need to exert over overhead to maintain profits during times of rapid growth. (The data comes from Business Networks, but the identity of the company remains unknown to us.)
Responding to the market
Company A's stable growth through the period reflects a close correspondence between overhead and revenue that few remodeling companies ever achieve. For example, after reaching the $3 million mark in 1995 -- a figure that was nearly double its 1989 volume of $1.8 million -- Company A saw its revenue decrease nearly $200,000 or about 6%. Instead of riding it out, the company immediately cut overhead back almost 4.5%. The result was a less than 1% fluctuation in gross profit.
More important is the way Company A has planned for the rapid growth of the past three years. In 1996, with revenue of about $3 million, overhead was 26.3%. By the time volume reached $4.6 million in 1999, overhead had climbed to 34.4% due to reinvestment of net profits into several new divisions. But gross profit remained strong, and the long-term strategy has paid off. Revenue in 2001 was $5.6 million, with overhead back to 22%. Better still, gross profit had stabilized around 35%, and net profit was an unheard of 13.9%.
Gross Profit %
Net Profit %
Why is overhead so hard to control? Les Cunningham, whose Business Networks consulting company has given him an inside look at more than 200 remodeling companies of all sizes, cites these five reasons:
Complacency. "Owners get comfortable. It's like gaining weight over the years -- it gradually adds on and they never prune it back."
Failure to delegate. "Owners have a low trust level, so they don't delegate. Everything has to come through them, and there's not enough time."
Bull-headedness. Instead of cutting overhead in lean times, many companies try to outlast the downturn. "Companies often make the mistake of taking on jobs they shouldn't just to keep the crew going."
Slow response rate. "It takes 90 days to recognize that you have a problem; 90 days to decide what to do; and another 90 days to do it."
Too big too fast. Companies that grow too fast have the opposite problem. Their overhead doesn't keep up with revenue growth. "They try to handle it with the same staff. Typically, they end up taking larger jobs where profitability isn't as good."