Is AV in a Race to the Bottom?

Which things can we fix and which are here to stay?

By Tom Stimson CTS

Shrinking margins, unfair competition, price shopping customers, disloyal suppliers, greedy bankers, and a general lack of appreciation for the value of your services…does this about sum it up? Ten or fifteen years ago the industry starting mumbling about AV becoming a commodity. At that time 40-50% equipment margins and an exclusive lock on professional gear made AV dealers quite happy and the AV Industry very attractive to investors. Value-added services like design, programming, and project management were considered overhead costs and what little revenue they represented was just gravy on an already profitable transaction.

In 2010, we are singing a different tune. Hardware margins on integrated projects start at 20% and quickly erode to the low teens. And we find that as an industry we have trained the buyers to undervalue the labor we continue to underestimate. In the end, quality dealers are losing jobs to low margin competitors that can do a convincing job of estimating and are willing to work hard to recover the cost of installation. Customers have become so price-centric that they no longer take the time to consider the value of your “value-added.” And why should they? A tighter scope of work and a willingness to transparently cost a job is what the fringe competitors have to offer. When the veteran AV dealer does actually win a bid job, it’s either because they underestimated the labor or chose to do the work at a loss in order to win the cash flow. Which begs the question, how long can this go on?

The fundamental issue becomes, do you want top line or bottom line growth? Business has been in love with revenue ever since the dot-com boom, where profits were secondary to incredible growth. Entrepreneurs became millionaires without ever making a profit. Today’s successful company is just as elusive, but looks completely different. In the contest of AV CEO’s sitting around the bar jawing about their companies, the winner is the boss that can say, “We shrank by 40% but increased our overall profits.” This guy is buying the drinks, because the next best brag is, “We were flat on revenue but it ate all our profit.” How did anyone increase profits in these dire times? They probably started by defining an acceptable profit then engineered a company that could generate those returns. Profit is not what’s left over; it’s what you planned for.

Put a Stop to Shrinking Margins

In a tight economy, grabbing more market share is tough – especially if you cannot afford to do so on price. The solution therefore is to become smaller AND more efficient. The only way to stop the slide is to give up low profit opportunities (or turn them into high profit). This means giving up what may be a prized position as a BIG company, but that is just one more emotional choice. Becoming a profitable company again is a badge of honor you can get used to.

It is not enough to just set a gross profit threshold and stick to it. First you have to understand your true cost structure. (See Face Reality). Then apply gross margins in increments proportional to the risk of the project. Next, incentivize Account Executives on profit margins not volume. Charge operations with reducing overhead through better processes. And most of all protect the labor estimates made by your design and project management teams. Never fudge hours to win a job – but you can adjust the rates if it makes sense. In addition, examine your efforts on selling Project Management, Maintenance Agreements, and Design Consultation.  Successful companies are selling these services at a premium. When your sales team screams that they can’t win the job at these prices, then it’s time to remind them that order takers win jobs by dropping the price. Sales Professionals win by demonstrating value.

Face Reality

There are two scary practices going out there that affect our perceptions of an acceptable margin. The first is the under-recognition of direct costs in “cost of goods sold”. Job costs for many companies only capture the install and project management time that has been assigned to a specific job. The time not applied to projects drops below the line into overhead expenses. This is a big mistake. All direct labor is cost of goods sold, whether it was used on a job or not. By correctly recognizing direct costs, you will have a better understanding of what a profitable margin should be. You will also learn the true effect of your overhead costs on your business. If you are still following along, when business is down then overhead needs to be reduced. If operating profit is consistently low, then you probably need to outsource more labor instead of maintaining fulltime staff. Learn how to be a smaller company, if that’s what the numbers tell you.

The second scary practice is treating unfavorable outcomes as an exception. We rationalize poor results by citing a problematic job or incident, and vow that it won’t happen again. Then next month there is another incident – a different one – and it gets the same treatment. Problems and mistakes are normal. We can minimize them, but to act like they won’t happen again is just crazy. Mistakes are the cost of doing business and therefore are reflected in cost of goods sold. The average of COGS across all income determine what an acceptable margin should be.

Know When to Walk Away

If you went back and analyzed the business you won the past year, how much of it helped your bottom line and how much hurt? Is your business setup to make money on the kind of work you can win? Or should you be winning different work? The answer is probably a little of both. Many businesses choose to apply job costing to analyze their projects. Not all job-costing methods are accurate and most do not deliver the kind of information we need to make better decisions. The first thing job costing should tell us is whether the proposal budget was realistic. Next it should reveal whether we executed efficiently.

When it comes to writing an accurate budget, firms have to set gross margins in stone otherwise the decision about where to price a project becomes emotional. I.e., first the margin on equipment is whittled down, and then we hack the estimated installation hours to get to the magic number. Messing with labor estimates tricks you into thinking the job can be profitable. At the risk of oversimplifying, labor should be treated as an absolute just like hardware. Change the unit cost of labor, but never fudge the time.  When profit becomes too low, walk away. End of story.