Does size matter?

October 2007 » Columns
Is it possible to remain a small firm and still be highly profitable?
David M. Wahby

Dear Dave,
Perhaps you can provide some insight on a discussion we are having at our firm. As a rule, do firm profits generally increase with the size of the firm? Is it possible to stay small and still be highly profitable? What are some key ingredients to making outsized profits?
C.E., N.C.

Dear C.E.,
In my experience, smaller firms (fewer than 100 employees) generally enjoy higher percentages of profits than larger firms (more than 300 employees). Recent financial performance surveys of engineering and architectural firms show firms of all sizes coming in a few points above or below a median operating profit (before any bonuses or firm-level income taxes) of 15 percent of net revenues. As you might imagine, individual firm performance is all over the board. I have personally seen 30-member firms with 50-percent operating profit margins, and 900-member firms squeaking by at 5 percent.

The short answer is that there is no universal size formula for financial success as a business. Each firm has to find its own profit "sweet-spot." The sweet-spot is that size at which that particular firm is most efficient.

Efficiency is a combination of numerous factors, including the ability of a firm’s management to maintain effective positive control at all times. In smaller firms, managers have a tendency to manage by gut feel. Perhaps that’s OK when you can wander around the office and get a good sense of who’s doing what and where things stand. Project and financial tracking and reporting systems are often basic—if they are even present at all. As firms increase in size and complexity from a single-engine Cessna to a 747, the management process becomes more complicated, and managers need to develop the reporting tools and skills needed to fly by instruments.

Following are common traits of efficient firms:

Overhead is optimized and kept in check. At any given time, firms have no more office space, bookkeepers, equipment, etc., than needed to service the size of the technical staff adequately. On the other hand, they are wisely spending (investing) what is thoughtfully determined as necessary for marketing, training, technology, and other indirect overhead cost to remain current and efficient in the future.

The consistency, level, and nature of the backlog of work available to fuel the operation are maintained at healthy levels. Firms having the head pressure of a large workload pressing down on them at all times have a tendency to push work through their offices more efficiently and more profitably then those that do not.

The firm has access to sufficient numbers of properly trained staff to match work to an appropriately experienced/priced staff person for that particular task. Firms that are top heavy (having too many high-priced people relative to medium- and low-priced staff) have difficulty being profitable. Ideally, you want a graph-like plot of points, representing the payroll cost/experience distribution of a firm’s workforce, to be shaped like a pyramid (fewer at the top, more at the bottom). If your staff plot resembles an upside down pyramid, or even a silo, profits will be hard to come by. Given proper overall management, profit margins are higher at the middle and bottom of a firm’s workforce than at the top.

The firm has developed and uses universal standards, processes, and procedures in design and production of work whenever possible to do so. Routine, repetitive aspects of work are reused, saving time (and fees) for the truly unique aspects of each project, which contributes to higher overall profits.

The firm is not embarrassed to make profitability a part of its culture. Making money is neither immoral nor unprofessional—it is an obligation. A firm that fails to make a sufficient profit to train, to market, to reward its staff, to invest in technology, and to do all other things necessary to remain vibrant and relevant is negligent as an organization.

I have seen numerous cases over the years where firms that were once profitable as smaller firms suffered diminished profitability by becoming bigger. If your sweet spot fails to keep pace with increased size, reduced profits are sure to follow.

For many firms, the path to increased profitability might be to become smaller, not larger. By taking a close look at the profit contribution of particular project types, or individual clients, you’re apt to find some projects or clients that you would be better off without. Either find higher-value replacement projects and clients to support your resources, or work to scale down your resources eventually to a size appropriate for the amount of work opportunities that meet your standards for profit generation.

Never sacrifice staff quality standards when it comes to hiring or retention decisions to take on more work. Compromising your performance expectations seldom achieves lasting increased results. Underperforming staff are highly demoralizing to your best and brightest.

Keep an eye on the average number of hours staff is working. Other than crunch time for periods of a couple of weeks here and there to get a project out, try to stay to a standard work week of not more than 45 hours. Working too many hours over too long a time span results in a loss of productivity for each hour worked, with more hours needed to accomplish a diminishing amount of work. Don’t underestimate the profit generation opportunities by keeping your staff fresh and energetic.

David M. Wahby is president of Wahby & Associates, a management consulting firm serving A/E clients. He can be reached at wahby@wahby.com.


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