Masonry Magazine December 1988 Page. 8
Overhead/Volume Relationships
Once you have decided how much you are willing to spend for overhead investment, the next step in the planning process is to determine how much volume the investment is capable of producing in a given year.
Generally speaking, we can say that the greater the investment in overhead, the greater the capacity of your company to generate volume, the second variable of the CDS Model. For example, if you are willing to invest $1,000,000 a year to support the operations of your company, you should have a greater capacity to generate volume than if you invest only $500,000 a year.
This is not to suggest that the relationship between overhead and volume is constant. Each added dollar of overhead investment does not necessarily produce a corresponding dollar increase in the volume. If that were so, planning for growth would be a snap.
In reality, you must make a choice. You can position your company at a certain level of volume, and capitalize upon the economies of scale by developing a very efficient system to process work at that level of volume. Or, you can choose to change the scale of your operation by taking the steps necessary to fund your capacity to handle greater volume.
Your decision will have a profound effect upon the profitability of your company, both in terms of the nature of the overhead investments you will be required to make, as well as the efficiency with which your company will be able to serve your customers.
One way to illustrate the impact of the change in relationship between overhead and volume is by considering the typical evolution of a masonry contracting company.
Take the example of a ten year old firm that grows in volume from $750,000 after its first year, to $3 million after its fourth year, and to $10 million after its tenth year of operation. For the company to move from one level of volume to another, it has to make incremental investments in overhead including buying more equipment, hiring additional estimators and project managers and expanding its office operations. The overhead investment is necessary to "power" the growth of the company from one level of volume to another.
As the company grows, its volume will grow at a faster rate than its overhead. Thus, the proportion of overhead (as a percentage of sales) required to produce the volume will actually fall. However, the ratio of overhead to volume will not fall to zero, unless the company chooses to go out of business.
Similarly, there is a limit on how much growth the company will achieve on any given dollar of overhead investment. Thus, as the company moves to the next level of volume, it must be prepared to lose some of the efficiency of operation which it developed at one level of volume before it will achieve comparable efficiency at the new, higher levels of volume.
These limits set "equilibrium points" at which the company will operate at maximum efficiency. This illustrates the very fundamental point that the weight of the overhead becomes "lighter" as the company begins to benefit from the economies of scale and the efficiencies of its operation. This trend is shown in Figure 1.
Although the shape of the curve and the location of the equilibrium points differ for each type of construction trade contractor, they represent critical breakthroughs in the growth, development and evolution of the company. In each case, the transition from one point of equilibrium to another can and often does create a period of marked instability in the internal operations of the company. Thus, the company may find itself in a position where its overhead investment is too "heavy" relative to the volume which
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8 MASONRY-NOVEMBER/DECEMBER, 1988