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Profit Margins in Engineering

Profit Margins in Engineering

I was at a cross discipline quiz night last week. At the very start the host attempted to unify the crowd by talking through his career and explaining how he’d worked in each of the diverse fields represented. When he got to construction he said he’d left because he was “tired of failing to survive on a profit margin of just 2.5%”.

It turns out he’s right; attempting to collaborate this statistic, it would seem that heavy construction (lit. civil engineering) has a net profit margin of about 2.3%. To put that into context, the most profitable field was Real Estate Development at 38.7% (one of our clients, in fact), and the average profitability across all industries was 7.3% (or 9.1% if you exclude loss makers).

Although there doesn’t seem to be a definitive source for net profit margins (I’m using a US stocks collection summary), the fact that construction isn’t massively profitable can be seen across any number of sources and articles you dare to name.

So, having established that it’s low, let’s just clarify what Net Profit Margin is. Simply put, it’s profit (after expenses and taxes, etc.) as a percentage of the total revenue. Or, put another way, it’s a measure of how good a company is at converting revenue into profits. It’s also a measure of resilience- industries with higher profit margins can weather harsher conditions.

The weird thing is; construction is a risky business, and traditionally high risk industries operate with high profit so that they can absorb some of the risk. In fact, insurance (by definition, a risky business) runs at 17% net margin. For comparison, low margin industries tend to be high volume- e.g. supermarkets and wholesalers; making a large amount from small profits that are basically guaranteed.

This might explain why the recession tends to decimate our industry and why we have a habit of being so litigious- we can’t afford not to be. The only way to win jobs is to be cheap, and without a buffer anything that damages our meager profit margins cannot be tolerated.

How we got into this position is a bit harder to work out. We’re not the only industry that tenders for work, that relies on a healthy economic state, or that use public money. We are, however, normally judged by price by clients who have typically been slow to learn that you get what you pay for; and this, I believe, is why we take big risks for increasingly small reward.

And why is any of this important? It’s how the construction industry’s pretty much always been; we’ve survived- what else do you want?

The problem with low profit margins is that there’s not much scope for risk. And without risk there is no innovation.

Instead we rely on third parties from other industries (like Software Engineering, profit margin: 13.8%) who take risks to profit from us. And for better or for worse it means that our innovations are indirectly driven.

It also means that innovation has low value. If you work out how to do something cheaper, then the reaction is to lower your bid price so you can win more work (remember volume is the only way to win with a low profit margin). Not long after, everyone emulates your methods and the net result is even smaller net profits for everyone.

The easiest way to survive in a low profit situation is to reduce your costs, which is why engineers are not (as professionals go) paid very well; and why we lean so detrimentally on our supply chain. In a world where STEM capable students are in high demand, it’s not too surprising that our talent pipeline is running dry.

Realistically, it’s hard to work out where we go from here. Without an industry wide (and possibly illegal) agreement to all start to maintain higher profit margins- inevitably we’ll continue down this unsustainable route of risk without reward.

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  1. This is a bit doom and gloom Tom! If property and software developers are making money why aren’t engineering companies moving into this? If the current business plans aren’t working need to try something else. I think the problem is partly where we are in the economic cycle. My company was making ~10% profit before recession.

    • I think 10% would have been out of the norm even pre-recession. Personally I think it has a lot to do with the fact that we compete primarily on cost still. Software profits on innovation, property profits on quality. The construction tender process is pretty unusual- you can be the preliminary designers but have the job taken away; everyone attempts to price what is effectively a fake ‘design’ so that they can be benchmarked on cost, not value; for your average job people don’t even seek out companies based on reputation. This creates an environment (set by our clients, not ourselves) where the cheaper you can deliver a job, the more you win; except, as I hinted, you don’t really- not in the long run.