Contractors Must Learn to Compete on Value, Not Price

By Ted Garrison

The author discusses the distinction between competing on value provided, and low cost.

Every time I make the statement that “Contractors must learn to compete on value, not price,” someone responds with, “All the customers care about is price,” or “I’m forced to compete on price in the public sector.” Well, if a contractor believes that, he or she is in trouble. Of course, in some situations contractors must compete totally on price, but that’s the worst market.

Mark Stevens in his book, Managing a Construction Firm, reports that in 1960 there were 800,000 contractors, but in 2003 there were 2.6 million. Worse, the volume of work in 1960 dollars is the same as in 2003. Therefore, too many contractors competing on price has driven profit margins down.

Dr. Ken Sullivan at Performance Based Studies Research Group at Arizona State University reports that the average profit margin for general contractors is 1.8% and 2.3% for subcontractors. Business Week’s 2007 Investment Outlook Report indicates the return on equity for all U.S. industries is 17.9%, while the ROE for the construction industry is a mere 9.7%, despite the recent construction boom. The construction industry is the lowest-rated industry, except for automotive, which lost money in 2006.

The above facts should convince contractors that another approach is needed. Thom Winninger in his book, Price Wars, explains that 17% of people only want value, while another 27% only care about price. The key is the middle 56% that will buy price or value. However, they buy price when they don’t understand value, so it’s the constractor’s responsibility to explain the value.

This condition contributes to a major misperception. The top 17% appears to be invisible, because those projects never hit the street. Since the middle 56% only buys based on value, when it understands the value, too often this group buys based on price. 

We all agree the bottom 27% buys based on price. Therefore, if the middle 56% buys based on price, it appears that everyone buys based on price since we aren’t aware of the top 17%.

However, if we educated the middle 56% to buy based on value and then combine this with the top 17%, 73% of consumers will buy based on value. This is quite a different perception.

If you want to argue that public works projects have no other choice, guess again. I recently spoke at the Design Build Institute of America’s conference of Water and Waste Water Treatment Conference. The owners of these facilities are all public entities. There were a large number of these owners present and advocating the use of design-build to avoid the low-bid environment. These owners understand value.
 
Further, PSBSRG’s studies over the last 13 years indicate that the best value doesn’t cost more. (Obviously, they are focusing on total cost and not only the initial bid.) Surprisingly, as contractors begin to understand the best-value approach, which is built around lean construction, the best value is often the lowest price. The difference is the best-value approach doesn’t allow the contractor to sacrifice quality to lower its price.

If contractors think the consumer doesn’t care about value, think again. Look what has been happening in the automotive industry. Toyota is killing General Motors and Ford because the public understands they get better value from Toyota. If contractors don’t wake up to this fact soon, they will wake up one day to learn they can no longer compete against value-conscious contractors. The reason that the design-build industry is growing so rapidly is because construction clients want greater value.

I’m not suggesting that design-build is the only approach, but my point is that clients do want value. For those in the bid market because they feel they have no other choice, I would suggest that the value proposition works for them, too. One of the best ways to increase value and lower price is to eliminate waste—the goal of lean construction. When contractors eliminate waste, their price comes down. The key is to eliminating everything that doesn’t add value to the client.

For some this may seem to be double talk, but it’s not. There is a big difference from eliminating what doesn’t add value to the client and just cutting costs. In essence, the first is about doing it better; the second is just about doing it cheaper. What may be a surprise is that PBSRG has learned there is no correlation between quality and price. In other words, contractors can lower prices by providing better quality. Therefore, contractors must compete based on value.