This is the first of our “Case Study” small business series, which GSM will feature on a regular basis.
The Company has been in the fire protection and general plumbing business since the early 1970’s. The current owner took over sole ownership of the business in 1995. Under her management the Company achieved consistent year-to-year profitability, until fiscal 2007. The gross profits in 2005 and 2006 were 29.5% and 31.2%, respectively, exceeding the industry average of 26.5% by a significant margin. However, in 2008 the worsening economic conditions which led to a recession, and foreign competition in the core industries of the region contributed to a drop in revenues of 31.2%. Trying to maintain their market share in a diminished market, competitors drove down the historical margins. The Company’s gross margins plummeted to the 12 – 13% level for three consecutive years thereafter. Unable to make substantial fixed costs adjustment to compensate for the steeply reduced contribution to overhead, net operating profits dropped into the red to the tune of 24% in the last fiscal year. This was expected to improve in the new year, but remain negative.
Where in the past the Company could count on 25-30% of the projects to be directly negotiated with general contractors, the intense competition compelled them to go to an open bid process – forcing a price war. The Company followed suit by reducing the overhead rate on many projects in order to be awarded the bid. At the same time, the pricing model used was inaccurately tied to the Company’s past financial history. The Company thus fell into the classical trap of competing on price alone by not effectively promoting the true value of its fire protection and plumbing services.
The strategic plan sets out to realign the company with its past history of consistent profits, by determining an appropriate marketing mix and sales effectiveness that will drive revenues past the $10.0 million level, at a 31% targeted gross margin. The strategic plan is to be matched by the implementation of a more accountable organization, improved financial and operational controls, and effective communications.
The Company relies on a core group of 40 clients that provided annual sales of $8.60 million in the past year, primarily located within a 100 mile geographic area. Twenty customers contributed 80.% of the total sales. In the top-20, eleven clients are from the core area – contributing 30% of the sales; three were located outside this area – contributing 50%, mainly due to a single large construction company, which accounted for 30% of the total. The approximate population in this area is 2,150,000. The biggest city where the Company is located has the highest population of approximately 900,000, and represents the greatest opportunity for growth.
In order to establish a successful strategy for future growth more definition is required of sales goals per Estimator/Project Manager and per market segment – health care, industrial, commercial, residential, institutional, and per service/product type. This is now in place and provides a starting point for future planning.
With the emerging strength of the economy, the Company is in a good position to grow and gain market share through the development and implementation of the new market strategies, improved sales program, and organizational effectiveness. It is the belief of the management team that a well-established Company with a superior marketing program can outdistance its competitors.
Based on licensing for fire protection and plumbing services, the Company’s territorial reach covers four states. It is difficult to establish market size in the targeted area. The national and regional census on fire protection equipment is mixed in with plumbing under the 1711 Standard Industry Code (SIC). An analysis of the competitors, and an estimate of their relative size in terms of number of employees and revenues is a valid approximation of total sales volume in the active territory.
Estimating the market size will lead to better targeting of market share. The Company’s goals and objectives need to be seen as a percentage of the total market potential. This leads to a more valid assessment of whether the goals are reasonable and attainable. It is insufficient to simply state the objectives in terms of annual growth rates. Seeking to improve market share by 5-10% is much more difficult than a 1.0-2.0% gain. The former calls for the allocation of vast marketing resources; the latter can be achieved with limited resources, but creative marketing mix and sales effectiveness.
Projected sales for the next fiscal year are $10,200,200. This represents a 8.70% share of the available market, within the Company’s territorial reach. The projected growth is $1,600,000, which appears aggressive, but when viewed from the vantage point of market share, it represents an increase of 1.42%. The macro economic conditions are currently conducive to expansion of the market, and well-positioned companies can gain market share through superior marketing mix strategies. The Company’s target markets are new construction, renovation, and retrofits in the commercial/industrial/institutional/health care/residential sectors. Within these broad segments the company is experiencing the fastest growth in health care (41%) in the new year, compared to only 15.6% in the previous year. This dramatic rise is mainly due to the long term contract with its principal client.
The health care segment brings new challenges because the work is generally more structurally complex than the historic industrial and commercial work with its primarily open box structures. Communications between the Construction and Estimating departments must consistently include feedback on the true costs of installation, so that they are pricing for what is achievable in direct labor on these more intricate projects. Although growth projections are rather aggressive in the next three years, care should be taken to avoid over concentration of activity with one single client as was done before.
A breakdown and comparison of sales per segment provides the basis for planning future growth. This must be tied to a definition of relative gross margin contribution from each segment. While this information is nor presently available, it will change with the switch to a new accounting software at the start of the new year.
The market can also be defined by the services and products that are offered by the Company, tied to the needs of the different customer segments. The forecast revenues are separated into four revenue streams, which reflect the different services that the Company provides: from a financial analysis of the previous two years, it is clear that service and inspections work produce an average gross margin of 47%. This compares well to the targeted gross margin for installation work of 26%. In fact, while the company was achieving only 12.0% overall margins in 2007, service and inspection work continued to exceed 44%.
From a service/product mix standpoint these statistics indicate that the Company should become much more proactive in growing the service and inspection work in the future. A good start was made by tracking sales by separate revenue streams. Inspection has recently been placed under an experienced manager, who reports directly to the General Manager.