Business strategy: Diversify or specialize services?

I learned about a company recently that has proactively developed a niche to physically lift homes to meet current hurricane-proof standards. Based on a federal grant for homeowners, the construction company is tapping a need that has meant growth for its business as well as a benefit to residential customers. 
This got me thinking about the potential for construction and remodeling companies to create new service niches—or whether it’s better to stick to a specialty. There are pros and cons to each option. The decision for each commercial construction or remodeling enterprise really depends on the following factors.
Market demand
Is there enough demand for the specialty you want to explore? Companies that focus on the craft of millwork, for example, may consider specializing in ceiling treatments because they desire to be the best at one thing. Their target clients must also desire the high quality—and longer timeline—that goes with expensive materials and custom designs. If the market doesn’t demonstrate enough demand for this level of quality, it will be hard to grow the specialty.
In addition, a company that focuses on a specialty will need to forecast changes to that market and be ready to adapt to trends or customer preferences in order to remain relevant and in demand. Is the specialty recession resistant? Not much in construction is, but some areas such as insurance damage repair can be less susceptible.
On the flip side, a construction company owner may want to balance out seasonal work in roofing with a variety of off-season remodeling projects such as finishing off basements. The demand may be high, but it may also involve intense competition and lots of marketing. The challenges here are less about market demand. They involve business strategy, skills and a pricing structure that are potentially different than in the roofing business.
Skill sets
After determining a good market demand, business owners will need the right skill sets or certifications required to perform the work. They may already have the skills in-house, which is valuable for promoting a specialty. Otherwise, they may need to hire internally or subcontract the work.
If companies choose to pursue a new service that requires training of new staff, this will take time and money to get the workforce up to speed for efficient production and better profit margins. Companies could operate for months or longer without turning a profit as they develop the niche team and processes.
At the same time, if the company subcontracts the work, it is harder to control the processes or final product. Owners are trading quality control for potentially faster profit margins. There is a reputation risk to the results, but it is a lower cost for entry into a new service. To manage risk, select trusted subcontractors known for the specialty and with strong references.
Cost to entry
Sometimes a new service has a high cost to entry because it involves new regulations or certifications as well as more complex accounting or business structuring. To mitigate liability risks, it may be beneficial to set up separate entities for different operations such as property management and construction.
Government-funded services (such as that hurricane-proofing program I mentioned) require research to determine contractor eligibility. There may be specific training and inspections required. It may require investment in additional equipment and insurance. Then there are costs for marketing and communicating the service accurately to customers. The program may also require special record keeping and reporting of results by the contractor as part of program compliance.
If a company is exploring a specialty, keep in mind that the existing business will need to shoulder these costs of entry until the new service is functioning at full capacity. Otherwise, it may be best to set up a new entity to focus on a specialty.
Industry relationships
How well do you understand the industry you want to serve? For example, some companies focus on hospitality while others are known for mixed-use retail. When diversifying through a new industry niche, what are the preferences, expectations, terminology and trends of this industry compared to other industries? Is the company involved in related trade associations to familiarize the team with business opportunities and the decision makers?
To be known for a specialty, however, companies should pursue good relationships with other contractors and get customer referrals. As stated before, subcontractors in a specialty must provide positive references about their work to industry influencers and also understand the contractual and financial standards for the target industry. Work with a CPA who is experienced in construction—advising on competitive pricing structures, accounting methods that fit the value of these contracts and well-organized bookkeeping. Being organized and maintaining cash flow will be critical for growth.
Ability to scale up
This brings us to the growth factor. If the chosen industry niche or specialty forecasts growing demand, can processes be automated and labor efficiencies scaled up to improve margins over time?
To improve margins, owners and leaders either reduce the bottom line costs or increase capacity for the top line opportunities. Most companies focus on both—continuously refining their processes and skills in order to reduce expenses and therefore be competitive to attract new customers.
Because construction and remodeling is an expense-intensive business, the potential to improve or automate processes, use teachable and repeatable skills and delegate management are important to scale up a specialty or to diversify services. There are methods to review and improve processes in financial systems as well as operations as the company grows.
These are just some of the business elements when considering whether your company is better off specializing in one type of construction/remodeling service or diversifying your services or customer base. Use them as a guide to discuss your goals with trusted financial and legal advisors.
Sean Kelly, CPA, is with Markowitz, Fenelon & Bank LLP, a certified public accounting and advisory services firm on the East End of Long Island, New York. He has more than 12 years of experience in tax consulting for a variety of industries, including construction, and is a member of the Long Island Builders Institute.

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