Your integration company might be capable of being more profitable than you realize. A variable cost structure can add profitability to your business.
More than 20 years ago, I discovered the hidden profit enhancement found in reducing overhead costs and making certain that direct costs were truly variable costs.
My company had acquired a failed roll-up with a national footprint. It had great customers and good revenue for its size, yet the company was losing millions of dollars (even with large depreciation and amortization costs excluded).
The acquired company’s strategy had been twofold:
- Build out a national services offering
- Develop new products for its national customer base
On the surface, these were two great strategies; however, this led to a bloated national field labor force that was underutilized (install and service), bloated fixed costs for R&D, and a centralized service desk, along with the associated administrative and multi-layer executive teams.
Post-acquisition, my company took two actions to turn this loss into a multi-million-dollar profit in the first year.
First, we eliminated all fixed costs that weren’t essential to providing existing customer services.
Second, and even more impactful, we transformed all our “fixed” direct labor costs into truly variable costs. We did this by offering underutilized employees the opportunity to set up their own subcontracting firms where we guaranteed a minimum revenue based on average hours of utilization along with the freedom to offer installation and services in their local markets. With this decision, we turned our direct costs into truly variable costs and ensured that every project or service contract was profitable on its own merit.
Because we no longer had a few profitable customers carrying the weight of other project losses, this action drove up total net profit from our project sales and services revenue. We didn’t stop there; for the next 20 years, we were able to grow profits by greater than 15% annually.
Dollars Saved Equals Profits
You can reduce fixed overhead and variable costs … and grow at the same time!
While the above scenario or solution may not apply directly to your business, the principles of reducing fixed overhead costs and making your direct costs truly variable will unlock a hidden treasure of profitability—with no change to your existing revenue stream.
Here’s how a variable cost structure can add profitability:
- Address seasonality (build fixed costs to lowest expected revenue) and use variable costs for peak demand.
- Address growth, which is typically chunky and not linear. Until it becomes steady state, don’t add fixed costs that are actually variable costs simply because they’re labeled “direct costs.”
- Take on “big” projects that are unlikely to repeat themselves annually, giving yourself the capability to flex growth opportunistically.
- Take on projects that are “out of footprint” but enable you to service a customer whose geographic reach exceeds your own.
- Limit risk on your fixed contracts. Get fixed bids from qualified subcontractors to reduce demand on your internal resources while also locking in project profit.
- Address hiring needs that cannot be filled to your standard in terms of cultural fit and capability in a current market environment.
When I first introduce this principle to a company, the hiring manager always asks, “Why would I pay a subcontractor double or triple what I would have to pay a full-time employee?”
The answer is typically threefold (although I often hear additional excuses to justify hiring only full-time employees):
- You have grossly underestimated your true burden rate. At best, your internal rate when fully utilized is no more than a 20% discount to a subcontractor cost (and often less).
- You do not understand the cumulative profit loss for periods where that resource is not fully utilized.
- You find it “easier” to manage people you can threaten to fire vs. holding a temp or subcontractor to your standard of performance.
As a caveat: If you are staffed below your fully utilized work available (for at least the foreseeable year), then adding full-time qualified staff will be more profitable than hiring temps or subcontractors.
What about your integration business? I’m sure you can add to this list with relevant examples from your own company. Where are you leaking profits by not considering the option of adding truly variable costs to address your company needs?
Joel Harris is COO of North Haven, CT-based integrator HB Communications.