The Economics of a Construction Business

Construction businesses are characterized by three things. Low margins, high risk, and long payment cycles. A construction business can hit 10, 20, or even $30 million of revenue within a year or two. That same amount of revenue for a software company would probably take 10 years, but you end up keeping very little of it, and it is

attached to huge amounts of risk. So, in this video, I'm going to talk about the economics of the construction industry and give you a bit of an overview of the numbers that matter and define it. A good friend of mine is in the final stages of securing a $10 million contract. So, what does a $10 million

contract actually mean in construction? Well, it means he'll probably need around $2.8 million of cash in his account to finance it. His business will be lucky to keep $500,000. And if somebody makes a mistake across the 3,000 man hours of work to deliver the project, he could potentially go broke. So while in any other industry $10

million sounds like a lot of money, in construction you actually get to keep very little of it. So now I want to dive into the numbers of a $10 million contract. And the reason I want to start with this is I'm going to talk about these really three ideas of profitability, risk, and cash flow. And

then I'm going to go expand on them a bit more later. But to start with, when we say a $10 million project, what we mean is that the client is paying us $10 million to deliver a project for them. Whether that's build a house, build a bridge, upgrade an electrical plant, they're paying a fixed fee to deliver a

fixed scope. The only way that $10 million payment varies is if the scope of works associated with it varies. In construction, we refer to this as a variation or a change order. Now, this is going to matter a lot more later when we talk about how contractors make money. But the important concept to