Our guest columnist contributes elements in this article to understand the factors that can differentiate financial results in this industry.
by Eng. Sofanor Alarcón*
A couple of years ago, one of my current clients, who was just starting out with the process of our business consulting for HVAC companies, called me to ask me to examine her company's financial statements. And after reading them, I was puzzled, but not surprised by the fact that this company had had record sales in 2018, but at the same time had made less money than in 2017.
In short, this Latin American company had generated more than US $4 million in turnover, but its net profit was only US $88 thousand, or rather, it had only a 2.2% profit, which is perhaps an acceptable amount for some markets, but not for the HVAC market in the region. Knowing the background of this company, it should have achieved at least 10% EBITDA (net profit before tax or NPBT).
So, the question was simple: Where was more than $300,000 of his winnings?
Upon review, we saw that the income statement combined all of his company's financial figures, but we needed timely details to know what had happened. As an initial solution, we created three types of departments where all the company's services were pigeonholed: Spot Services, Projects and Maintenance Contracts, since it was important to understand in which department or type of services this company was winning, tying or losing money.
We then separate the revenue and direct operating costs from the three types of departments or types of services, if you want to call them that. The result he gave us can be represented by the following example, which is quite similar in proportions (you will understand that I cannot share his real financial statements) of the income statement that we made for this company:
Imagine how surprised and disgusted my client (whom I now consider my friend) was at the huge loss in his Spot Services department, which is represented as "Demand Service" in the example table. Furthermore, I must clarify that my client was actually having a greater loss than the one shown in this example. I can almost tell you that for every $1 her clients paid her for a service, she spent $1.4 on it. You're crazy, aren't you?
As I told you, this was not a surprise to me, as we often see this problem in the Latin market, and not only in the HVAC sector, but in MEP companies as well. Most companies don't departmentalize their income statements, so they don't have a clear idea of where they make money and where they lose it. This is a very dangerous way to run a company, I have personally named it the "Cardboard Box Theory" in honor of my mother, who I consider to this day a true business genius. I hope to talk to you later in more detail about this theory and about it.
The "Spot Services Department" we created for this study is itself the department where most HVAC companies lose money, along with New Projects. These two departments are also the cause of the greatest stress and dissatisfaction for business owners.
Typically, retrofit or remodeling projects offer the highest net gains (<20%) for properly operated HVAC companies. This was the case with my client. But, as always happens, it is not useful to make money on one side if you throw it on the other, as was detected in this case.
The good news for my client is that we now knew about her problem, so it was less difficult to make a quick and dynamic plan to solve these losses in the short term, turning them into profits. Remember that in order to start making money, we must first stop losing it.
Solution Plan: Phase 1
The problem with its Spot Services Department was, simply, that the gross profit was less than 25%, which led to its direct operating costs applied to the service being 75% of the invoiced value, which is clearly crazy for any company. Their labor costs were too high due to the great evil of the Latin world: "Nothing can be finished the first time," with their labor costs being almost 50% of turnover, when this value should not exceed 25% for any reason.
A thorough break-even analysis was performed. We calculated and adjusted their labor and vehicle rates, as well as modified the ownership markups of their spare parts and materials. This immediately impacted the Department's gross profit margins, and profits began to appear.
The latter is very nice, because usually the owners of HVAC companies resist immediately when we suggest increasing their sales prices. This, despite the fact that they know that they themselves subsidize (salaries, profits, equipment, vehicles, etc.) their customers between 20% and 40% of the real price they should pay for their services. Incredible! Having to subsidize customers so that they buy from us and, with it, lose money.
The dispatch of technicians' services was improved to optimize their trips and services, eliminating downtime that killed profits, but above all we detected that more than 40% of service technicians were on the payroll, which was surplus with respect to the services that were performed throughout the company. In addition to this, 75% of the helpers were completely superfluous. This new visibility was possible by using the Desprosoft Contractor Solution (www.desprosoft.com) software, with which it was possible to have data to make tough decisions in less than 3 months. Additionally, with this new tool, rework times and second trips were reduced by almost 70%.
After this initial stage, we scheduled weekly meetings of only 30 minutes to follow up on the processes, which helped to show the results of cost control, services and, above all, review the staff productivity graphs. In addition, this gave us the opportunity to review as a group the procedures that enriched the efficiency of the Operations Department.
Solution Plan: Phase 2
Additionally, the pairs of technicians, which we know as Batman & Robin, were eliminated, leaving only qualified technicians for each of the services, and with a defined variable compensation plan for them, which rewards productivity and the number of services performed by field personnel per week. To reinforce this step, an online training program was implemented for technicians at HVAC University (www.universidadhvac.com), certifying each of them in more than 36 specific trainings in the field. Thus, it helped to reduce service times by more than 40% on average.
Changing Marketing Priorities
We reconverted the priorities of the company, seeking that it all became a sales machine, allowing us to get involved with our technical field staff in the search for Retrofit projects (remodeling and improvements), in order to increase sales through a greater amount of acquisition.
Initially, a 30% increase was achieved in this type of project, which came exclusively from the Spot Services Team, and 20% from maintenance contracts. Likewise, a referencing system was sought which achieved an increase in sales in general of 14%. This radically changed everything, since the sales force was reduced and dedicated to looking for new and good customers, managing to complete more than 36% of sales through transactions with end customers, instead of the classic tenders that were previously 80% of sales.
The sales strategy was aimed at attracting maintenance contracts since, of all the products offered, the annual maintenance contracts are the best of all from a financial and risk point of view, not to mention of course the recurring cash flow it gives to the company.
Conclusion
With what we learned in the financial statements where we found significant losses in the Spot Services segment, it was possible to transform this loss into an important learning to create an action plan, which generated greater control in operations and a significant increase in quality sales, with which our current client has laid the foundations to have a turnover of US $5.3 million today. with an EBITDA gain of 26% and with only 55% of the staff it ever had. It is so much, he no longer goes to the company on Fridays and always enjoys long weekends. Enviable, isn't it?
If you want to review more about this topic or some opportunities for your company, do not hesitate to contact me at my email [email protected].
*Sofanor Alarcón Rojas is co-founder and president of NDL Business Growth. He has also worked as a developer, consultant, advisor and trainer of engineering, construction, service and sales teams in several countries.
