This post contains affiliate links.
If you have been around construction companies for a while and or you had to engage one before or just want to know how they make money when they have to spend huge upfront capital? Are they even profitable compared to other industries when they spend money on materials, labour, engineering, training and safety?
Construction companies can make a huge profit based on the services they provide. Generally, construction jobs are based on a bidding system where elected companies that do the work offer competitive prices and experience that qualify the contractor to do the work. However, most companies operate on thin profit margins due to the high competition in this industry and the huge overhead cost. Successful companies are the ones that take on a high volume of jobs with an above-average profit margin.
This is why competitive bidding prices combined with contractor experience are essential to bringing profit. The construction industry is quite competitive because it does not change much and has easy market entry. Therefore, some companies will try to win bidding by offering the bare minimum price, bringing the whole industry down in terms of profit and expertise.
This is even more common for low-technical jobs such as plumbing and bricklaying, where expertise becomes a commodity and the cheapest contractor always does the job.
While for highly technical jobs such as project management, design or engineering works, the cost of service might be high, and the overhead might also be high, which means working with a thin profit margin.
Because competition is high, companies will try to do more jobs with low-profit margins. This means the winning formula in construction companies is high job volume and low profit.
How much profit do most construction companies make?
Construction companies operate on a thin profit margin which averages around 15%. However, the profit varies depending on the job type, size, speciality, market demand and competition.
The profit can be high for speciality work such as remediation jobs, which can be as high as 30%, while project management contractors might operate on thin profit margins such as 6-10% for big projects. While small projects and DIY projects, profits differ depending on the competition. It can go as high as 45% for residential jobs.
What is the biggest expense for construction companies?
The biggest expense for construction companies is labour, not engineers, not material and certainly not changes to design.
In general, companies’ overhead is broken down into direct cost (relate directly to the project expense such as labour and materials) and indirect cost (which do not relate to the project, such as administration cost, training and office expenses). The following is a list of the highest expenses in construction, with one being the highest:
- Labour (Direct cost): This is very expensive in most developed countries. For big construction jobs, labour eats away most of the profit.
- Material and equipment hire (Direct Cost): Companies need to buy building materials and hire equipment and machinery to do the work.
- Design and engineering (Direct Cost): Engineering and expertise are actually quite cheap compared to labour and material. Most construction companies will have engineers within the company or subcontract the design work to a specialist, which is also done through open bidding.
- Safety & Training (Indirect cost): While construction is quite dangerous, and most people need to be trained well to do the work, construction companies do not spend many resources on it. This is because most companies train their employees soon after hiring, which means low overhead costs. In addition, many companies adopt online training, which further reduces the safety cost.
- Other expenses (Indirect costs): These are the costs that have nothing to do with the project expenses, such as office equipment, office space rent, human resources, administration, estimation, and accountants. Depending on the company size, those expenses can be quite high, especially for big companies.
What construction business makes the most money?
The following are the most profitable construction business, with one being the highest:
1- Main contractors: Those companies oversee the entire project and subcontract specific areas to special contractors or subcontractors.
2- Specialist contractors: These companies do special work such as plumbing, demolishing, electricians and earth moving. Those companies usually make a profit by taking on a high volume of jobs.
3- Engineering consultants: Those are the engineering firms that bring their design expertise to the jobs and provide recommendations to the main contractor.
4- Remedial contractors: Those companies rectify construction issues on existing buildings and provide solutions to remedy the structural fault.
5- Subcontractors: These are non-specialist contractors with no special expertise other than the resources and manpower to do the work. These are usually unskilled labour, equipment hire and transport companies.
Most companies (except non-specialist subcontractors) require civil engineers and project managers to do the work. To learn more, read: How Hard Is Civil Engineering? 8 Insider Facts U Must Know.
Common ways to maximise profit for construction companies
Winning the bid is just the tip of the iceberg when it comes to making a profit. The following are ways for companies to maximise profit beyond the agreed price on existing jobs:
1- Variations
Variations are changes to the original contract scope of work between the client and the contractor. For example, the client introduces changes to the original design, or the current plan or design is impossible due to some technicality. In this situation, the contractor will have the right to refuse to do the work based on the agreed value and propose a variation sum to the contract based on the changes to the original scope of work.
Variations are quite common in construction because things do not always go as planned, and there will always be a difference between the design and real-life implications. This is the contractor’s chance to make as much profit as possible by proposing an additional fee to do the extra work.
2- Reduce labour
Reducing labour is not always a possible choice, especially if the job requires a specific number of labours. Sometimes, it can be possible due to some work variations, which reducing labour can significantly increase the company’s profit.
4- Reduction in time
The contractor might find a quick solution to do things that might reduce the construction time and increase profit. This can be very rare, but it can save the contractor on huge bills when it happens.
5- Find out cheaper suppliers
When bidding for jobs, the contractor might make assumptions about material costs and other expenses and sometimes ask for quotes from different suppliers. However, when doing the job, the contractor might find cheaper suppliers, thus reducing costs.
However, things do not always work out for the contractor’s benefit.
Construction can be a very unpredictable process in which the contractor spends too much time on certain parts of the project bringing the cost down.
Sometimes the contractor is forced to work extra days due to unforeseen events such as storms, or maybe the contractor has mispriced for the job, which can have devastating consequences and even force the company to work on a negative budget.
This is why the contractor needs to negotiate with the client and ensure that the cost of services does not exceed the expected budget when the project is faced with unforeseen events. On the other hand, providing accurate bidding prices can help ensure that companies can bring profit and not just provide the lowest price to beat the competition.
This is one of the reasons why construction companies spend too much resources on project management. To learn more, read: What Are The Project Manager’s Responsibilities?
How do construction companies get so big?
Construction companies get big by expanding resources and hiring more people. In booming economies, civil and construction jobs are quite high, so more work opportunities become available. Most construction companies increase their size by hiring more workers and engineers to take on more jobs. The higher the volume of jobs construction companies takes, the higher the profit.
