Minimum Bottom Line Profit Should Be > 7%!
After Income Taxes Are Paid!
Restoration contractors face a different set of business dynamics than the traditional new home builder or remodeler. Unlike the builder and remodeler, restoration companies deal with a third party in their contract negotiations and performance. The new home builder uses the market to determine the value of their product, whereas the restoration contractor is forced to perform services based on pricing models set by insurance underwriters.
The key dynamic is the insurance company. They are paying for the services. They want the maximum value for the lowest price and often use aged pricing models to determine the value of the services the restoration contractor will perform. Worse, most use an overhead and profit markup of ten and ten to determine the total value of the services. The ten percent overhead and ten percent profit are carry overs from the 70’s. In the last fifty years, governmental compliance, risk management and human resources requirements have increased overhead costs to well in excess of twenty percent of the hard costs to perform services.
How can a restoration contractor make a reasonable profit and still cover their overhead costs? There are several tools available to the restoration contractor to make this happen. This article will identify existing business dynamics and processes/systems needed to be a successful restoration contractor. To explain this, the typical pricing model used by insurance companies to pay for a claim is explained, next the types of services restoration contractors provide is covered along with the best mix.
The final section will illustrate the best mix to maximize margins and profits in this industry.
Most insurance companies utilize Xactimate software within the Xactware software line of products. This software has built in pricing models for materials and labor. Xactware has a team of individuals solely responsible to update the pricing database related to materials and adjust for labor pricing. The current version of Xactimate 28 converted the labor concept from a base rate to a minimum’s rate. This change slightly increases the labor value for smaller projects and levels out with larger projects. The software has improved over time, when I first used this software back in the early 2000’s, estimates had a large disparity for the same project when written by different estimators. Today, the dispersion is less and thus better for the restoration contractor.
The key to success is the estimator. Better estimators will spend hours pricing out a job in order to ensure thorough work. The more details covered, the more revenue earned from the project to offset the costs associated with that job.
Although a good software, it isn’t perfect. Xactimate doesn’t use prices from your local hardware store or lumber yard. They utilize a broader based pricing model sourced from industry price schedules. The same is true for labor and its nuances. Thus, the end result of the estimate doesn’t truly reflect local costs and this is where the restoration contractor can get into trouble.
Overall, the job costing software is the most important tool in the restoration contractor’s business model. The more accurate and detailed the estimate, the more likely the company will achieve financial success.
Restoration contractors utilize two groups of services. The first is referred to as emergency services and the second is referred to as remediation. Within each group are several different services. The following describe the two groups and their various services.
Emergency Services – Services provided within 72 hours of the incident.
- Security/Containment – This service consists of preventing further damage or access to the actual damage. Examples include boarding up openings to the home, utilizing temporary fencing to prevent unauthorized entry to the site and using tarps to shield the property from weather (this is most commonly done with tarping roofs to prevent further rain damage).
- Extraction – This service is common with water damage. Its goal is to extract water from the home to minimize overall damage and to accelerate the drying out of the home.
- Drying – Here, the goal is to reduce the overall humidity and moisture level within the home to normal. Tools used include air movers, dehumidifiers and desiccant dryers.
Remediation – Services to restore the damaged property back to its state prior to the incident.
- Fire – After a fire, the home has two types of required services. The first is the clean-up and removal of smoke (the scent along with stains) from furnishings, fixtures and of course the personal effects of the owners. The second type of service relates to the actual damaged caused by the fire. If structural, the work involved is broad and often there are hidden issues.
- Water – More common than fire damage, but water based accidents are less costly overall to the insurance company. Common causes include frozen pipes, aged water heaters and plumbing issues. Here, the key is the mitigation step above in getting the residence dried out including the personal items. Any damage to the home is more superficial and generally involves flooring replacement. Sometimes, cabinets must be replaced.
- Storm Damage – A third type of remediation is caused by storm (wind) damage. Mostly exterior work is performed when storm damage is involved. Obviously, roofing is the most common form of repair. Others include siding replacement. However, when large storms such as hurricanes and tornadoes are involved, the damage is often more extensive as trees fall on homes causing internal damage and structural issues.
The above two groupings and their respective services are customarily performed by restoration contractors. For the restoration contractor, there are some historical business dynamics related to each type of service as I note below.
Each of the services a restoration contractor provides has its own set of business dynamics. Allow me to elaborate:
To effectively render this service a contractor must train a crew of employees that are willing to go out at night to do this kind of work. The better restoration contractors have an enclosed trailer with all the necessary tools and materials to effectively perform these services. The trailer contains light systems, tools, plywood and other materials to get the job done. The employees are trained to address safety issues and proper protocols to set up and perform the work.
Similar to security and containment there are tools involved to perform this service. The number one tool is an industrial water vacuum. Larger restoration contractors use a truck mounted system to suck up the water (both fire and water damage jobs require water removal). Others use portable systems. Other extraction work includes debris removal and even the use of cranes to remove trees from the top of houses.
Drying is now a science. Tools include air movers and desiccants for drying the home. Many restoration contractors have a trailer loaded with the necessary gear. Some even have electrical power generators to augment or replace turned off power to the residence. Many contractors have specialty trained employees to perform this service.
This is the most complex of the restoration service spectrum. Typical skill sets include carpentry, engineering, wiring, plumbing and exterior siding work. Often, masonry work is required due to heat cracking the mortar joints. In addition, to put out the fire, water is used causing additional damage and additional emergency services. Most jobs are complex in nature and demand the services of cleaning companies (for clothing, furniture and fixtures). Most jobs exceed $50,000 in services.
Unlike fire remediation, water damage is no where near as severe as fire damage. Since water can be immediately extracted and the home and its contents dried quickly, the actual damaged sustained is normally not as severe as fire damage. Every now and then, a water damage is a result of Class 3 water (sewage, pathogens and other highly contaminated sourced water). Class 3 projects require more diligence on behalf of the contractor to remedy and typically add $10,000 to the value of the job. Most water remediation jobs are less than $25,000 in total cost to the insurance underwriter.
Most storm damage jobs are exterior in function, sometimes the interior is affected if a tree falls on the home. Storm damage jobs can get costly especially if the tree falls and breaks through trusses or damages a load bearing wall. Most storm damage jobs are roofing repairs or siding repairs.
Best Mix for a Restoration Contractor
The number one failure for most restoration contractors is the belief that revenue volume, i.e. the prices paid for jobs, is the most critical aspect of business. They want to earn as much revenue as possible to take advantage of economy of scale. Smaller restoration contractors will need revenues greater than $1.5M per year to generate bottom line profits.
IT IS THE WRONG APPROACH TOWARDS BUSINESS.
The reality is that business is about profit, bottom line profit. I did work as a controller for two different restoration contractors and as the CPA for three others. I couldn’t convince either owner to focus on profit and not revenue. Even after modifying the accounting software to report financial information based on the service spectrum and at the job level, they still refused to see the obvious. They were only interested in revenue, they wanted to be able to tell their business colleagues how much money they generated each year.
With one of the restoration contractors, we had $3.2M in sales in my 2nd year there and still lost $240,000. Why? It was the mix of jobs. The owner wanted fire jobs because they paid more overall. However, the costs to get the job done were significantly greater per dollar of revenue than any other type of job. It made sense to me. The skill levels required were higher thus payroll per dollar of revenue was higher. There was more compliance with the local county inspectors (because fire jobs traditionally exposed code violations or aged out code requirements, the county often required the home to be brought up to the current code). Furthermore, the jobs took longer from start to finish per dollar of revenue to get done. This aspect was driven by codes compliance and the need to incorporate additional trades to get the work done and in accordance to the code.
A water based job was much simpler in nature and rarely required high skills from the employees. Over half of the work was flooring related most often to carpet replacement. Those involved in flooring are traditionally paid two thirds of what the highly skilled employees were paid. In addition, water jobs were fast; rarely did a water based job take longer than three weeks and only one or two per year required county inspections.
I posted over 280 jobs in that year for the one restoration contractor I was the controller with discussed above. About 140 of them were water jobs totaling less than $1.7M in revenue. The margins from them exceeded 27%. I posted about 40 fire related jobs which averaged margins around 4%. It was blatantly obvious that fire jobs could not cover their respective share of overhead (front and back office costs).
The key is the mix. Rule number one: STAY AWAY FROM FIRE JOBS. Fire based jobs require an extended learning curve to acquire knowledge with how to achieve margins of 27% or higher. If you want to do fire jobs, keep them at a minimum and be selective. Ensure estimates are detailed and cover all aspects of the work.
Rule number two: GEAR THE COMPANY TOWARDS EMERGENCY SERVICES and away from restoration services. Emergency services are by far more lucrative and profitable than restoration work. The problem is that it is rare to have a consistent flow of work. Catastrophes such as storms, hurricanes and flooding do have an annual pattern. Thus, it isn’t continuous work. However, if the company staffs properly and learns how to use part timers, the company can be quite profitable on a year to year basis. Naturally, you are not going to have revenues in the multi millions of dollars per year, but your profits will be greater than 20%.
Use job costing to constantly stay abreast of your performance especially in the respective mix of services. Use class accounting to assist you too.
By using the above rules, you can indeed do very well financially in the restoration industry and make good profits. You will not be the number one guy in terms of volume of work (revenue) but I can assure you, you will be one of the most profitable. And isn’t profit what it’s about? ACT ON KNOWLEDGE.