Are you putting all of your eggs in one basket?
Having all the resources required to build projects in the current market has implications similar to the last building boom we experienced. If you have an abundance of resources, you may want to consider what the implied value might be before bidding a project.
Implied value is different from your overhead and profit margin because overhead and profit is market driven. Your implied value margin has more to do with the value of your resources, how badly your resources are needed and the percentage of resources you have to commit to a particular job.
The more resources you decide to commit to any single job should cause you to consider implied value if you decide to bid a job in the first place. Again, the more resources you commit to any single job the higher you want the implied value to be.
Implied value is evaluating the potential of earning more than your bid margin in conjunction with the amount of resources you have to commit to a single job. Another way to look at implied value on a particular job is to identify those things that will automatically improve your margin at no additional cost to you.
Things that increase your odds of making more than your estimated margins are:
- Owner’s financial condition
- Quality of documents
- General contractor’s ability to manage
- Your relationship with a general contractor
Although there are other things that can result in earning more than your estimated margin, you should consider how much more based on the resources you have to commit.
We often times underestimate the value of our resources in a hot market or on a particular job. The most valuable resources today are high quality manpower, followed by financial strength, expertise and project management. Committing these resources to a single project isn’t a good idea unless you can earn more than just your bid margin and even then, it’s a bit risky.
If you invest 50 percent of your resources or $100,000 (half your total resources) to earn $25,000 gross, you are only getting 25 cents on each dollar invested. This scenario has more risk associated because you’re committing half your resources to one job. In this situation, since the risk is much higher, there has to be more earning potential to make such a high resource commitment.
If your total resources are $5 million and you commit $100,000 in resources and earn $25,000 on the $100,000 of resources invested, your still only getting 25 cents on each dollar invested. However, you only invested 2 percent of your total resources, leaving you with 98 percent of your resources to invest in projects having higher implied value margins.
(Resources + Implied Value) = Risk Reward
Investing Resources—Think Like a Lender
Is it wise for a bank to loan 100 percent of its deposits to one borrower for a 25 percent return? Spreading resources among many borrowers is far less risky knowing that its very unlikely that one borrower will go broke. The same is true in construction. Spread your resources over many jobs that have a high-implied value is the best use of all your resources.
The higher your resource allocation—the higher your risk, unless your allocations are spread out. The higher your resource allocation to one job, the higher your implied value margin needs to be in order to balance the risk.
If a single job takes up 25 percent of your total resources it means you are putting 25 percent of your total resources into one basket. Is a 10 or 20 percent return adequate for resources you commit? I would suggest that putting up 25 percent of your resources to earn 10 percent or 20 percent isn’t worth it today because resources are far more valuable today than they were several years ago.
If your total resources are $1 million and you commit 100 percent of your resources to 100 jobs, that’s only a commitment of 1 percent per job. However, if you commit the same $1 million to four jobs you’re committing 25 percent of your resources to each job, meaning you have all your eggs in four baskets. Higher risk deserves a higher reward and the question becomes, “How much can I earn if I do these four jobs?”
If you believe you can earn 35-40 percent or more, the implied value is good but if you only expect to earn 10-20 percent return, your implied value is bad because it’s just not worth the resource allocation. Take a look at the chart above and consider adding your own implied value margin to jobs that you know have a low implied value.
The higher allocation of resources (red) the higher the risk, which requires a higher implied value margin between 20 and 25 percent. As resource allocations are spread out over six to 10 jobs, the implied value adjustments adds anywhere from 5-15 percent. Finally, as your total resources are spread over 20 to 100 jobs, the implied odds actually goes up because managing too many jobs creates its own risks; however, overall risk goes down because of this adjustment.
If there were no adjustments for the risk associated with managing many jobs the chart would look similar to the yellow section, which I think is the sweet spot in terms of safe resource allocation.
Committing 10 to 15 percent of your total resources to any one job is reasonable, but I have to say, it’s likely that a goal of between 2.5 percent and 5 percent is where you want to be if you can easily manage between 20 and 40 jobs, which again is not unreasonable. That is the sweet spot with the best-implied value.
Time Equals Resources
Although this article is primarily written for smaller contractors, large contractors are very concerned about over committing their resources on a job that has poor implied value. For the small contractor, let me wrap this up by asking how much sense it makes to buy a life insurance policy when you’re 70 years old. We know it will cost a person dearly. But, if the policy is purchased when you’re in your twenties, it becomes affordable because time is on your side.
All to say, if you’re a small contractor—over time, your financial and labor resources will grow if you don’t put all your eggs in one basket. But then again, there are calculated allocation risks you can choose to grow a little faster. It just depends on what percentage of your total resources you can afford to lose or waste when they could be applied elsewhere with less risk.
Small and large contractors have a limited amount of resources and in this market its more important than ever that you don’t waste your resources on jobs that have a below average earning potential.