NICHE MARKETS

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• NICHE MARKETS
• AND
• PROFITABILITY
• Presented by Steven E. Schaefer, P.E.
• Steven Schaefer Associates, Inc.
• 800-542-3302
• www.ssastructural.com

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• PROFIT
• HOW MUCH IS TOO MUCH AND HOW TO MAKE IT

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Profit Margin

• Unless making a 20 profit, close up shop and
  work for someone else!
• Below 20 not operating a business, just
  providing a job
• Not worth the risk under 20

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• 35 years ago before computer expenses and
  escalating Health and Liability Insurance,
  typical firms used a multiplier of 3.0 and had a
  21 profit margin.
• Now to make 20 you need a multiplier greater
  than 3.0.
• Bill Fanning
• PSMJ at ACEC presentation on
• Better Pricing for Better Profit

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Colvin Matheson (Matheson Financial Advisors)

• Says a 30 Profit Margin would be better!
• At a 7 profit he says
• Put the firm out of its misery!

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Mathesons Example 120 Person, 2 Million Net
Revenue Firm7 Profit Margin

• Generates 140,000 profit to split among 20
  people and 2 owners for bonus, 401(k) and Uncle
  Sam
• The firms CPA probably led the Owners to believe
  they were worth 1.0 times revenue
• 140,000 times a valuation multiple of 5 is only
  700,000
• Result
• Employees and Owners sad with the true reality
• Who would WANT to invest?

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Mathesons Example 2Same Firm at 20 Profit
Margin

• 400,000 to split - at a multiple of 5 is worth
  2 million.
• Result
• Owners are worth almost 3 times more and take
  home higher distributions annually
• Much better Total Return (sum of dividend or
  bonus yield and capital appreciation)
• Add on growth value enhancement is even higher

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Benefits of Good Profit MarginA lot more fun
going to work!

• Share some of the profit with the staff
• Bigger bonus (dividend) for you each year
• ?Ownership transition becomes easier
• ?Younger engineers will want to buy stock
• ?Firm value will be based on the profit stream
  not just book value
• ?Higher value sell stock to provide significant
  part of retirement funding

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Comparing Structural Engineers to Other
Professions

• Stock Value
• Structural Firms book value
• Accounting Firms valued at one year of revenue

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Structural Firm

• 1 Total
• Annual Revenue
• Largest asset typically Accounts
• Receivable (A/R) at 100-day collection
  period 27
• Work in Process 1 month 8
• Cash 1 month 8
• Furniture, computers, miscellaneous 7
• Book Value 50 Revenue

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Structural Engineer

• 2/3rds profit to stockholders in form of
  dividends, bonuses or increased book value
• Assume a price to earnings ratio of 6.5
• You need a profit margin of 11.5
• to generate enough profit to buy stock
• at this value.

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Accounting Firm

• Using same 2/3rds of the profit going to the
  stockholders
• Price to earnings ratio of 6.5
• Need a profit margin of 22.5
• to buy stock valued at one years revenue

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• Accounting firms with a selling value of twice a
  typical structural firm need to produce twice the
  level of profits.
• According to Bill Fanning
• Typical Multiplier
• Accounting Firm 4.25
• Engineer 3.0
• Assuming same overhead rates of 1.6
• Profit Margin
• Accountant 39
• Engineer 13

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• Comparing
• Level of Responsibility
• Consequences of Errors
• Education Level
• Structural Engineers deserve an equal, if not,
  higher level of profit compared to accountants

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PSMJ Annual Financial Performance Survey of A/E
Firms

• Results from a very small sample of firms shows a
  median profit of 13.6 overall but 14 for
  sub-consultants
• Upper quartile of sub-consultants profitability
  is 26.5
• Responding firms are probably more profitable
  than the average firm

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Hypothetical 9-Person FirmMost Current Years
Financial Results
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Common Ratios
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Calculate the Required Sales to generate a 20
profit with expenses remaining constant

• Required Sales
• Required Sales
• 1,125,000

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• For 20 Profit Margin with the
• same work volume
• need to charge 1,125,000
• INSTEAD of 1,000,000
• (an increase of 12.5 over
• the original fees)

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Calculate the Required Net Multiplier

• For your sales to be 1,125,000 and with
• Direct Labor of 360,000 the
• Required Net Multiplier 1,125,000 360,000
• 3.125

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• Do not use the Required Net Multiplier to set
  your billing rates.
• Make an adjustment from the Required Net
  Multiplier to get to the Theoretical Multiplier
• you will use
• Compensate for
• Time lost going over budget
• Uncollectible fees

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• Once new rates are set it will probably take TWO
  YEARS to start achieving the NEW profit margin
  goal.
• WHY
• You are still working on projects quoted using
  the prior rates
• There is a delay in collecting accounts
  receivable.

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• To Get Higher Fees
• Do not be a commodity doing the same as every
  other engineer in town
• You need to separate your work from your
  competition.
• You need a specialty or Niche Market

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• NICHE MARKETS
• Something you can do better, faster or more
  efficiently than other firms.
• Steel Connections Retractable Roof
  Stadiums
• Pre-Engineered Metal Temporary Shoring
• Building Foundations Electric
  Communication
• Large Warehouses Towers
• Glass Curtain Wall Masonry Restoration
• Curved Stairways Concrete Restoration
• Greenhouse Tilt-up Concrete
• Pole Barns Feasibility Studies

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• The most profitable Niche Markets use
• VALUE-BASED COMPENSATION

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Cases 1997 PublicationCommentary on
Value-Based Compensation for Structural Engineers

• Typical methods of compensation are cost based
  and derived from a specific scope or services and
  level of effort.
• Typical cost based compensation systems are
• Lump Sum Contracts based on an estimate of
• man-hour effort or a percentage of construction
  cost or Hourly contracts based on multiples of
  labor cost or a fixed rate schedule and
  frequently have an estimated or maximum fee.

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• Value-based compensation refers to compensation
  that is established on the basis of the relative
  worth of the service to the purchaser of the
  service.
• For example..

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• If your design saves a client 100,000 in
  construction costs, negotiate a fee that returns
  a significant part of the savings to YOU.
• Do NOT base your fee on the hours it took
• to complete the design.

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Bill Fanning in his presentation Better Pricing
for Better Profit Fees at the 2000 ACEC
convention

• There are about 58,000 engineering firms in US
• This creates a highly-fragmented market from
  which clients can pick and choose engineers based
  on price.
• To get above this you need to develop special
  skills or NICHE MARKETS.

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According to Fanning, engineers are their own
worst enemy.

• Afraid to ask clients for money
• Look for ways to reduce the price before even
  talking to the client
• Unwilling to say no to a client
• Rather than turn down a project, will lower the
  price
• If client says cant afford you price is
  lowered or scope reduced

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SSA Rate Schedules

• We have two
• Preferred Rate Schedule With a multiplier of 3.0
  for Architectural and Contractor Clients who have
  repeat work for us
• Public Rate Schedule Other clients. Hourly
  rates are 13 higher than on the Preferred Client
  Schedule multiplier of 3.45

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• Entertainment Structures Group, started by one of
  our engineers, is a division of SSA that designs
  theater rigging systems and temporary concert
  stages.
• All work charged at Public Rate plus a 25 to 50
  premium for rushed projects. (Rush Projects
  multiplier 4.3 to 5.2)
• If a building permit is needed in 2 weeks for
  temporary stage for a famous performers concert
  the client usually isnt going to argue the cost!
• Expedited Quality Service often comes with a
  price!

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• Internal Ways to Improve Your Operation to
  Increase Your Profits
• One of the biggest problems is
• SCOPE CREEP

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• Base your fee on the well-defined Scope of
  Services for the project
• Break down the work in manageable steps
• Estimate the time for each step

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• Use a contract that accurately defines the scope
  of what you included in your fee.
• If your building is rectangular say so.
• Include unusual items such as a cupola on the
  roof or clerestory walls.
• Specify that the foundation is simple spread
  footing at minimum depth.
• CASE has standard contracts and a
• commentary on the AIA C 141.
• Make sure your PM knows what is
• included in your scope

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Use Additional Services Orders (ASOs)

• Client wants something NOT included in original
  scope
• State the reason for the additional or changed
  service
• Include cost of doing the work and any change in
  the schedule
• Issue ASO BEFORE you do the work

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To Charge or Not to Charge?

• Okay to do some small items for free but send
  an ASO and mark No Charge
• Lets the client know you are.
• Paying attention to the scope
• Being cooperative
• Generous because you have NOT billed for it
• This documents you did a number for free but now
  it is fair to charge.

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Train Your Staff to Follow Procedures

• Contracts prepared need to define scope in detail
• Use ASOs - Even if there is verbal agreement on
  extra services DO NOT STOP THERE follow up with
  a written ASO! AIA Contract requires it.

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Turn Down Jobs

• If you cannot get the fee you need to make your
  profit margin!
• Let your competition take some of the
• loser projects

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Matheson says Good Project Management can take a
7 Profit to 20

• Keep your staff utilized - 64 minimum on a
  dollar basis
• Sell work at good multipliers (3.25 or higher)
• Control overhead but given that labor is your
  largest cost, if utilization is high, your
  overhead should not be a problem

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Summary

• Need 20 Profit Margin
• Calculate New Rate Schedule
• Develop Niche Markets
• Use Value-Base Compensation
• Improve Internal Operations
• Eliminate Scope Creep
• Monitor Utilization Ratio

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Contact Information

• Bill Fanning, PSMJ Resources, Inc.
• 770-971-7586
• www.psmj.com
• Colvin Matheson, Matheson Financial Advisors
• 703-533-3625
• www.mathesonadvisors.com
• Dave Wahby, Wahby Associates
• 616-977-9756
• www.wahby.com