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Business Landscape

Making a Profit in Construction

Deconstructing construction finance to build stronger contractors.

Allon Raiz

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South Africa is readying itself for an infrastructure development boom. On 24 October 2012 the Business Day newspaper reported that at an infrastructure investment conference in Johannesburg, President Zuma had announced that the government was drafting legislation to enable infrastructure development, as well as trying to find funding methods for 18 strategic infrastructure projects.

These projects are estimated to be worth R4 trillion over 15 years.

The huge prospects for companies at all levels of the construction industry that this represents are clear. But whenever huge opportunities like these present themselves to business, they bring with them several dangers.

There are some common mistakes to be avoided by small construction firms when pursuing big projects.

Single project focus

Firstly, many small construction companies spend all their time and energy on bidding for and servicing large projects. This is understandable – on paper the figures attached to these projects look extremely tempting.

However, this single focus leads companies to becoming simply project-based operations, making them highly susceptible to a feast-or-famine situation. When their single big project is finished, many such companies do not have a pool of smaller projects that will sustain them until the next big opportunity arrives.

The single project focus must be avoided by dedicating time to look for new opportunities continually, even when at work on a large project.

Lack of diversity in offerings

A report published in August 2011 by two members of the University of Cape Town’s Department of Construction Economics and Management, Dr Abimbola Windapo and Prof Keith Cattell, indicates that “the ability of a company to grow, improve turnover and gain greater market share is linked to its ability to diversify its services and products.”

Most of the successful companies that were surveyed were “active in at least three types of product/service markets – most commonly in civil engineering contracting, general building contracting, property development and housing development.”

In other words, to ensure the sustainability of their operation, a construction firm should focus not only on having a number of projects at hand, but also on diversifying the range of products and services they offer.

Unclear profitability

Often the profits attached to these projects are not as high as the contractors expected them to be. This is due to a number of factors, chief among which is a lack of experience and understanding in project costing. This leads to the expected profits gradually being eaten away by unplanned-for expenses. The net effect is that profits on big projects are often nominal, if not ultimately negative.

The lower than expected profits are a major cause for concern in the industry. A 2011 report on financial support options published by the Construction Industry Development Board (cidb) states that, between 2007 and 2009, the reason that more than 1 400 construction enterprises failed is “the current lack of profitability in contracting: a measurement of profitability established within the industry has indicated a continual decrease in this regard over the long term.”

Overextending working capital

This is a catch-22 situation that many construction companies find themselves in when they are handling projects. To increase their turnover and improve their cidb ratings, thereby making themselves eligible to bid for even larger projects, these companies overextend themselves in the projects that they take on.

Having taken on projects too big for their own resources to cope with, they find themselves both without the working capital they need to continue with the project, as well as continually having to subcontract various aspects of their projects to other companies – which reduces profits even further.

The lack of working capital and access to finance is a major constraint on contractors at all levels of the industry. In their report, Windapo and Cattell found that the leaders of the successful firms interviewed were unanimous in “acknowledging that the specific strategy responsible for their company’s development, growth and success, was their decision to develop a strong financial base for the company.”

Developing a strong financial base – which is often described as a company having cash reserves of between one and a half and two times its monthly turnover – is not an easy feat, particularly given the low profit margins in the industry. It is made even more of a challenge in the South African context by the extreme delays in payment that are often encountered when projects are undertaken for public sector clients.

Financing mechanisms

To build a strong construction sector, the development of financing mechanisms that take into account the specific needs of upwardly migrating contractors must be promoted. In its 2011 report on financial modelling options, the cidb found that there are “limited options available from banks or other lending institutions to cover [contractors’] large working capital requirements, especially in the absence of sufficient collateral.

The various banks in South Africa have developed and implemented a project finance model but it has not been implemented successfully.”

An aspect of financing that may assist lenders to overcome their reluctance, and which is described as “not fully understood, recognised and exploited” and “a missed opportunity for many companies” in the same cidb publication, is enterprise development.

Enterprise development in the construction sector

Enterprise development programmes offer an opportunity for emerging black-owned construction firms to build their capacity, which will enable them to bid for larger projects, as well as improve their profitability.

The cidb report on financial modelling options lists several benefits of enterprise development programmes for emerging black-owned firms, including recognition by both banks and large construction companies for sub-contracting purposes.

Furthermore, enterprise development is a focused intervention designed to grow emerging businesses with measurable results, which encourages large corporations to support these programmes for the various rating credits they can obtain.

Case study

The impact that an appropriate enterprise development programme can have on an emerging construction firm is dramatic. Among several construction firms in Raizcorp’s ARIZE comprehensive enterprise development programme is Turnkey Group, owned by Khomotso Choma.

Prior to the recession, Ms Choma built Turnkey Group into a recognised name in construction, with a turnover of about R21 million. But then the recession hit. The company struggled to get paid for the work they had done, their suppliers were demanding payment and threatening legal action and a severe cash-flow crisis was looming. Turnover spiralled down to R7 million and the company faced a bleak future.

At that juncture, Ms Choma applied to join the ARIZE comprehensive enterprise development programme run at the BECSA Business Support Centre in eMalahleni. The learning and guidance provided by the programme enabled Turnkey Group rapidly to implement the processes and structures required to turn the company around.

Moreover, the company was able to create a strong platform for future growth in terms of capacity for new work and job creation.

Within a year of Turnkey Group being accepted into the programme, the company’s turnover grew by 114% and they won the Govan Mbeki Housing Award for the Best Informal Settlement Project of the Year 2012.

Conclusion

The cidb’s Business Conditions Survey for the third quarter of 2012 reflects none of the optimism that one would expect in light of the President’s announcement at the infrastructure investment conference. It states that; “Respondents are generally pessimistic about current and expected business conditions, building activity and employment levels are low and profitability is under pressure.” The reason generally given is “inadequate access to credit.”

The imminent infrastructure boom and the opening that this presents for contractors to diversify their offerings, as well as the possibility of using enterprise development programmes to increase capacity and develop business skills, present great opportunity for contractors to lay firm foundations for their companies’ future growth with an entrepreneurial approach.

Allon Raiz is the CEO of Raizcorp, the only privately-owned small business ‘prosperator’ in Allon Raiz is the CEO of Raizcorp. In 2008, Raiz was selected as a Young Global Leader by the World Economic Forum, and in 2011 he was appointed for the first time as a member of the Global Agenda Council on Fostering Entrepreneurship. Following a series of entrepreneurship master classes delivered at Oxford University in April 2014, Raiz has been recognised as the Entrepreneur-in-Residence at the University of Oxford’s Saïd Business School. Follow Allon on Twitter.

Business Landscape

How SMPs Can Support Businesses Looking To Internationalise

Key findings from a new global research report from ACCA suggest Small and Medium Sized Accounting Practices (SMPs) recognise many of the key challenges and opportunities that internationalising SMEs face in today’s global economy. This provides them with an excellent platform towards providing additional value-added support to clients.

ACCA

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Much has been written in recent years about how SMPs are experiencing a growing number of commercial challenges that are disrupting the client services they have traditionally relied upon for revenue.

Equally, many have argued that more SMPs need to consider whether diversification into new advisory services could be the key towards the sector’s future success. However, such change can be difficult when talent flows in the sector are uncertain and competition is fierce.

Whilst not appropriate for everyone, ACCA was therefore interested to explore whether international trade is one area where SMPs’ unique experience and expertise might lead to the development of new service provision.

Our findings suggest that many SMPs are equipped with an excellent platform towards providing additional value-added support to clients. However, despite SMPs stating that most of their clients had been involved in some form of international activity over the last three years, their current provision of relevant support remains highly focused around a small number of limited areas.

The new report, Growing Globally – How SMPs can support international ambitions, also revealed the following about internationalisation and the relevant advice landscape for SMEs. 

Although the research was global, specific findings from five key markets have also been extracted and presented. These markets are Ireland, Malaysia, Nigeria, Singapore and the UK. They were selected on the basis of their representation of markets in various stages of economic development, and their global and regional importance to international trade.

SME internationalisation today

  • Just under half (45%) of SMEs said the main benefit of internationalisation was access to new customers in foreign markets. Increased profitability (35%), faster business growth (33%) and access to new business networks (30%) followed.
  • Both SMEs and SMPs considered ease of doing business and high growth potential as the most important factors when choosing an export destination. Geography was seen as less important, which may be a result of new technologies reducing its significance as a perceived barrier.
  • Both SMEs and SMPs recognised foreign regulations as the most significant barrier to internationalisation. For SMEs, the second most important was competition (27%) though for SMPs it was foreign customs duties.
  • In terms of the future, SMEs’ international ambitions are focused on building the capacity of their business (45%), building networks in foreign markets (45%) and introducing or developing more products and services to market (44%).

Related: Technology In Accounting – Race For Relevance

The advice landscape

  • A wide breadth of professional advice and support is used by internationalising SMEs, who tend to reach out to different sources as they move along their internationalisation journeys. Government or relevant public agencies (39%) are the most widely used source of professional advice, closely followed by lawyers (35%) and then banks (33%).
  • Accountants are most likely to be used by SMEs when looking for support on international tax, regulatory compliance, foreign exchange and accessing external finance.
  • Only 9% of SMPs said they had no clients who had been involved in any international trade activities over the last 3 years. Importing and exporting activities were the most common, as was participating in broader international supply chain networks.
  • SMPs mainly rely on internal and informal resources when advising clients about internationalisation. However, this gradually shifts towards a reliance on more external and formalised resources as practices grow in employee size.
  • Just under half (47%) were not members of any networking organisation, potentially missing out on valuable resources that could enable the development of more effective forms of international support.

Using these findings, ACCA conducted a series of interviews and roundtables with SMPs and SMEs globally. The subsequent insights were used to develop recommendations on how practices can look to develop their international advisory provision.

  • Specialisation is key – For those developing their international advisory provision, it is vital to first identify an area of the market where you believe your practice has the opportunity to effectively develop its expertise, resources and intelligence to best suit the needs of your clients. SMEs’ demands for international advice vary according to sector and size of business. Building a market focus is more likely to make any future expansion of international support more achievable and successful.
  • Adopt a strategic mindset – Identifying where you could best add value in terms of international support requires SMPs to think strategically and embark on initial planning and research. The best place to start is with existing clients rather than prospective ones, as they provide a readily accessible (and more approachable) evidence base to explore where demand is likely to be greatest. Making efforts to understand your clients’ internationalisation needs can then help you shape your wider international advisory offering.
  • Expand your international network – Networks are integral for the development of new professional advisory services but particularly with regards to internationalisation. This is because global value chains often necessitate close and efficient coordination of activities between businesses. SMPs should therefore aspire to become the central referral point for clients looking to find the most appropriate source of professional advice.
  • Invest in professional development – Practices must have highly skilled staff with the appropriate intellectual knowledge for clients to recognise the value in the services offered. Creating a structured programme of learning activities for staff around international trade could be useful for SMPs looking to upscale their international advisory provision. This could involve introducing formal learning activities across more technical areas of international trade (such as tax, compliance and foreign exchange) as well as working with other firms to develop knowledge networks where staff can learn, collaborate and access good practice.

Related: Investing In Value Creation Tools Can Help Your Business Grow

As SMEs continue to seek new ways of engaging in international trade, partly brought about by developments in technology, practices are being presented with opportunities to develop and widen their international advisory provision.

For some SMPs providing additional support to clients involved in international markets will not be feasible or practical. Nonetheless it is important for all practices to continue recognising the changing realities of how SMEs are operating globally.

The key challenge in taking advantage of such opportunities is centred on the risks that inevitably come with the business model optimisation required to provide new and relevant client services.

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Business Landscape

Unlocking Optimism

South African entrepreneurs have one singular advantage that makes them stand out and succeed – optimism.

Howard Feldman

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Game drives. There is a remarkable similarity between the South African on a game drive and the South African entrepreneur. In both cases you’re driving through new territory on the lookout for that ultimate sighting or an opportunity. It’s the endless optimistic belief that around the next corner, after that last stretch of long, hot road, will be that crocodile eating that leopard that’s chasing a caracal. It’s an optimism that’s permeated the very fabric of our culture, our business personalities and the way we face adversity.

South Africans live with adversity every day. We face challenges and issues that our entrepreneurial counterparts in Europe or American don’t even realise exist. Adversity sits on every street corner, hangs out at every robot and reminds us of its presence whenever we stop and look around.

Yet the entrepreneur can take these complexities and harness them to be better at business and more positive in the face of failure. Here are five ways to re-examine what the world has on offer with the eye of the optimistic entrepreneur…

1. The tremendous challenges in our socio-economic and political landscape, from poor sanitation to the unemployment situation, can inspire us to do more and better the world we live in.

Today, many of the most impressive entrepreneurs on the African continent are those who stood up from within adversity and used it to create opportunity. From organisations that ensure children have sanitary pads so they can attend school to non-profit businesses that use the blind to detect breast cancer, optimistic belief in the future is the beating heart of entrepreneurial endeavour.

Related: 6 Of The Most Profitable Small Businesses In South Africa

2. Anyone can succeed

There are people standing at robots across South Africa who are using them as a shop corner, using the captive car audience to sell products and make enough money to get by. Some create works of art, some dance to an invisible beat, and some stand out in their ingenuity. There is a robot in South Africa today where a man stands selling life insurance. That’s the optimistic entrepreneur.

3. We are constantly surprising ourselves

South Africa’s transition from apartheid surprised the world. There wasn’t a bloody revolution, there was a peaceful shift. It was, and still is, imperfect, but it happened with far less brutality than many imagined. The same applied to the World Cup – the stories of doom were ready to be told, but the event was an incredible success. South Africans are capable of surprising themselves and this unexpected brilliance shines through in our ideas and our ventures.

4. Sometimes you just have to laugh

The corruption, the political manhandling, the rage, the insanity on the drive to work, the rising cost of living – the pressures of living in a volatile country take their toll, but South Africans manage to find the humour hidden in the hardness. The adverts that poke fun at the insanity, the ability to laugh at mistakes – this nation’s sense of humour is a very powerful quality that allows the South African entrepreneur to stand up and face each day with a fresh sense of purpose.

Related: 27 Of The Richest People In South Africa

5. We bounce back

The one quality that every entrepreneur needs is resilience. Businesses fail, ideas crash, customers leave and bad times arrive, but through it all self-belief and the ability to see something positive in what’s happened will ensure that lessons are learned and new paths taken. It is perhaps one of the hardest things that any entrepreneur has to learn and yet in South Africa, with its ongoing failure to provide that crocodile-leopard-caracal viewing, has imbued its entrepreneurs with the enviable qualities of patient resilience.

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Business Landscape

Depressed Economy Leading To Business Bust-ups

Palmer looks at the most common causes of business bust-ups and how to avoid them.

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News that our GDP had shrunk by 2.2% in the first quarter of the year, coupled with downward revisions of growth forecasts, are casting a pall on the investment climate. Deals are not only drying up, but there has been an increase in business partnerships bearing the brunt of the economic pressure.

After the initial flush of economic goodwill post the inauguration of President Ramaphosa, we’ve seen a flurry of business owners looking for finance to buy out their business partners.

We have had a number of attorneys and accountants refer dissatisfied partners to us who are looking to exit partnerships. When the economy slows – as we have seen over the last few months – many partnerships begin to show signs of stress. All too often partnerships are seen as tools of necessity and those who rush into these deals without properly exploring the common values between parties will not fare well when things get tough.

What many don’t understand is that undoing a partnership is not as simple as they may think and will come with legal and other costs over and above the finance to buy a partner out.

Related: Government Funding And Grants For Small Businesses

The most common causes of business bust-ups (and how to avoid them) are the following:

1. Misaligned expectations

This occurs when potentials partners don’t share a common vision of where they want to go, how they want to get there and what each wants from the deal.

Misaligned expectations of a business venture will result in disagreements sooner rather than later as they impact every strategic (and even some operational) decisions. It is worth considering a mediated session between partners before the deal is even drafted.

2. Effort Resentment

Another problem creeps in when one partner feels like they are tasked with doing all the work. Resentment around how much effort is put into the success of a venture is not something to be taken lightly – irrespective of it being based on perception or fact. Most contracts will be clear on the value of the equity each partner has, but many ignore the value of sweat equity and how that will be measured and factored into the deal structure.

3. The Golden Rule

Many partnerships are based on one individual who puts in the lion’s share of the capital and another who is committed to doing the day-today work. Effort resentment extends beyond the deal negotiation. When a contract between partners is drafted it reflects a future which is not yet known. As the venture progresses, reality will set in and the division of labour agreed at the outset may not match day-to-day business in year three or four.

It is sometimes useful to draft partnership agreements as you would a lease. Give it a three- or five-year timeframe, with clear deliverables and then, at the end of the period, reassess the partnership and allow for renewals or re-negotiation. Having a sunset clause in your partnership agreement removes the soul-crushing feeling that you are trapped in an unhappy relationship with no chance of escape.

Related: How South African Small Business Owners Can Overcome Economic Uncertainty

4. Honour amongst thieves

Although seldom encountered, there are some partnerships which fall apart because someone is doing something blatantly untoward. Finding out your partner had their hand in the till can be devastating but in tough financial times, such as we are currently experiencing, some people will resort to desperate measures.

5. Absentee landlords

In many cases, a partner may have committed capital to a venture and even agreed to joint expectations. But other work commitments (or a lack of interest) means they disappear from operations for extended periods. No-one wants to work with people who are uninterested in the future of your company. However, the truth of the matter is any breakup has associated costs. Unwinding a partnership can cost more than setting it up and this should be considered before going down that road. Many investors are involved in multiple ventures with the same partners and exiting one deal may result in prejudicing the future of others.

While no-one can predict how long the economic slump may last, minimising the potential for partnerships falling apart requires a meeting of minds. This means agreeing to a common set of values and ethics which will govern how the business is run.

Partners need to agree on how they see the world if they hope to make a success of the business relationship. Thereafter, they should explicitly voice their expectations of how the venture will work, what they want out of it, and how they see their role in achieving that result. In some instances business partners have been together longer than they have been with their spouse. It makes sense to treat the relationship with the same care. More particularly, healthy partnerships will attract more investment and will be a key decision factor when it comes to raising future funding.

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