The P&L of the Construction Industry

July 3, 2024

Discover why the traditional SaaS model doesn't always work (at first) in construction. We dive into the industry's P&L, revealing why services trump software and how startups can tap into a market 50 times larger.

Discover why the traditional SaaS model doesn't always work in construction. We dive into the industry's P&L, revealing why services trump software and how startups can tap into a market 50 times larger. Learn how to build trust, deliver outcomes, and succeed in the unique world of AEC. Essential listening for founders and VCs in the construction tech space.

(01:13) The herd heuristic: SAAS

(02:37) The 1st principle: AECS = outcome business

(04:14) Services address 50x more market than SaaS

(04:33) The P&L of the industry

(06:23) IT Budgets in AEC(S)

(07:46) What it means for founders

If you ever tried to raise venture capital for your construction-tech venture, you must have noticed that generic VCs are pushing SaaS models across sectors, acting like it's the holy grail of business models. But something doesn't sit right with me. After years of investing in this space, I've learned that the traditional VC playbook often falls short when it comes to AECS (Architecture, Engineering, Construction, and Supply Chain). Let's dive into the numbers and unpack why the standard approach might be leaving money on the table.

The herd heuristic: Software-as-a-service

For the past 15 years, Software-as-a-Service (SaaS) has been the darling of the VC world, especially in enterprise tech. And it's easy to see why. SaaS offers predictable recurring revenue, scalability, and often juicy profit margins once you get past the initial customer acquisition costs.

VCs love SaaS because it's a model they understand. Many have been software users themselves or even former IT managers. They're comfortable with the idea of selling software on a subscription basis. The math seems straightforward: high upfront costs to acquire customers, then a steady stream of recurring revenue that eventually leads to strong cash flows.

This love affair with SaaS has led to a sort of herd mentality. VCs push it, founders pitch it, and even incumbent players feel pressure to adopt it. But here's the thing: construction isn't your typical enterprise market. Not by a long shot.

The first principle: AECS is an outcome business

To understand why SaaS isn't always the answer in construction, we need to look at the fundamental nature of the industry. AECS is, at its core, a project business. This isn't like selling software to a manufacturing plant with continuous operations. Construction projects have hard deadlines, strict quality requirements, and serious consequences for failure.

Miss a deadline or deliver subpar work? You're looking at penalties that can wipe out your profit margin (and then some). This creates a culture hyper-focused on guaranteed outcomes. General contractors, subcontractors, and other service providers live and die by their ability to deliver results on time and on budget.

This outcome-driven mindset permeates every level of the industry. When a general contractor is considering a subcontractor or a new technology, their primary concern isn't fancy features or a slick UI. They want to know: "Can you guarantee this will help me deliver my project successfully?"

The vertical singularity: Services address 50x more market than SaaS in AECS

Now we're getting to the really juicy part. Here's a statistic that should make every construction tech founder and investor sit up and take notice: in AECS, services represent a market 50 times larger than SaaS.

Let that sink in for a moment. We're not talking about a 50% difference or even double the market size. We're talking about a market that's 50 times bigger. This isn't just a slight deviation from the norm; it's a fundamental reshaping of the opportunity landscape.

This massive disparity stems from the unique structure of the construction industry. To really understand it, we need to take a deep dive into the financials of a typical construction project.

The P&L of the industry

Let's break down the profit and loss statement of a typical general contractor:

Exemplary P&L breakdown of a construction general contractor

Revenue: 100%

Net Profit Margin: 2%

Costs: 98%, thereof 2-3% IT and the rest is material, labor, and just a little bit of other overhead

(this is a generalization, which hits the truth on the ground remarkably well)

That razor-thin 2% profit margin is the first thing that jumps out. It's a stark reminder of just how competitive and cost-sensitive this industry is. But the real story is in that 98% cost base.

Of that 98% in costs, the vast majority is split between materials and labor. This includes both direct costs (think actual construction materials and on-site workers) and indirect costs (like project management and overhead).

Interestingly, distribution costs are relatively small in construction. This is because project acquisition is often a transparent, well-defined process. Everyone in the industry understands how bidding and procurement work, so there's less need for huge sales and marketing budgets compared to other industries.

IT Budgets

Now, let's zoom in on the IT spend, because this is where things get really interesting for tech startups targeting this space.

In 2015, a study by JB Knowledge revealed some eye-opening statistics:

Source: JB Knowledge

76% of general contractors spent less than 1% of revenue on IT

Only 12% spent 3% or more on IT

Fast forward to 2021, and we see some improvement:

58% spend less than 1% on IT

25% spend 3% or more on IT

This is progress, no doubt about it. We're seeing a clear trend towards increased technology adoption in the industry. But let's put this in perspective: even with this growth, IT spending typically accounts for only 2-3% of that massive 98% cost base.

What it means for founders

If you're a founder in the construction tech space, these numbers should fundamentally shape your approach to the market. Here's my advice:

  1. Don't blindly follow the SaaS playbook. Yes, SaaS can be part of your solution, and it can especially be your end game, but it doesn't automatically have to be your beginning.
  2. Focus on delivering outcomes, either through services or through your software tooling. Remember, this industry buys results, not wall paintings.
  3. Build trust and track record. In a project-based business with thin margins, no one wants to take a chance on unproven technology.
  4. Start with services, then evolve. Use your service offerings to get your foot in the door and prove your value. As you build relationships and demonstrate results, you can explore more SaaS-like models as part of a broader solution.
  5. Understand the whole value chain. Your software might only address a small part of the P&L directly, but if it can impact those big material and labor costs, that's where you'll find your real value proposition.
  6. Outcome as a Service (OaaS) is a super legit mode to replace SaaS for our sectors.

Remember, in construction, guaranteed results trump fancy tooling almost every time. Your technology needs to directly contribute to project success – whether that's through cost savings, improved quality, faster timelines, or reduced risk.

Yes, the construction industry is ripe for innovation, but it requires a nuanced approach that respects the realities of how this business operates. If you can crack that code – finding ways to address that massive 98% cost base rather than just the slim IT budget – you're always looking at an enormous opportunity.

If you want to dive deeper into these concepts, I'm always open for business. Let's figure out how to capture that 50x larger market opportunity and build the next generation of construction technology. I LOVE service

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