Every year since COVID, private equity firms based out of California, Seattle, and New York have been investing hundreds of millions of dollars gobbling up independently owned HVAC, Plumbing, and other trades-focused contracting businesses.
Here’s why they will fail.
Reason 1: Taking the founder out of the business fundamentally changes the incentive structure for employees.
The founders (called owner operators) eat what they kill. They get paid exactly whatever the profits are from the business. This means that they are highly focused on profit margins, and operating efficiently.
At the same time, they’re also focused on the long-term success of the business. Meaning they aren’t going to take actions that will hurt their reputation and brand. It’s their name and number on the side of the vans! They see their customers at church, at the grocery store, and at local restaurants!
By taking the owner out of the equation, employees are no longer working side by side with the owner of the company in the battlefield.
Now, they’re working for “the man”. A big, faceless corporation, that’s in California, Seattle, or New York.
And once this happens, you’ve lost the loyalty of the employee. You’ve lost the ethos and ethics of the owner. And now, the company is entirely run by employees who don’t have that same emotional connection with the new owner.
This leads to employees who are less willing to work overtime, less willing to go the extra mile for the customer, and are more likely to get comfortable and complacent. And why shouldn’t they? Before, the employee’s purpose was to help the owner serve the local members of their community.
Now? They’ll be told constantly their job is to turn a profit for the new owner who they never even see.
This means that inefficiencies are bound to creep into the business that didn’t exist before. It doesn’t matter how many metrics are implemented, how much managerial accounting you put in place, or even how much you tweak the incentive and pay structure. You will never get the same passion, attention to detail, and energy that comes with the owner and founder leading the company from the battlefield.
Reason 2: These contractors make a name for themselves by being honest, by being a member of their community, and by putting their customer’s first.
In an attempt to solve the problem and “align incentives”, PE firms will change the pay structure for the employees.
Johnny the technician will be taken off of a salary/hourly wage system, and moved onto a commission and % of profit structure. Now, you’ve fundamentally changed the way Johnny interacts with customers.
Now, Johnny is incentivized to increase the invoice and ticket size as much as possible, and to maximize profit.
If an eight year old air conditioner breaks down, what would have previously been a simple $150 capacitor replacement turns into a $3,500 Air Conditioning Condenser change-out, along with a $3,000 furnace changeout (because if you’re changing the evaporator coil on top of the furnace, you might as well do the furnace at the same time!), for a total cost of $6,500.
Johnny will make an $800 commission for selling the air conditioner replacement, compared to his measly $20 base rate for a capacitor replacement.
With Johnny’s new born baby and wife relying on him to feed them, the $20 base rate just won’t cut it. So, he tells the homeowner they need to replace the 8 year old system (which realistically could last another 7-10 years if maintained properly).
But will homeowners simply just believe him? They might be suspicious.
But luckily, Johnny has been trained by his new Private Equity overlords exactly for this moment, and he knows how to put the pressure on the homeowner to “convert” the opportunity into a big sale.
Oh, Mr. Homeowner, you can’t afford it? Well, for only $23 per week, we can provide financing for you to get a brand new system!
Nevermind that you’ll be paying 10% interest for 25 years, and end up paying over $29,900 when it’s all said and done. Johnny is trained on how to frame the financing so that he can close the sale and overcome the objection.
“It’s only $23 per week! You spend more than that on coffee each week.”
And often, this works. Johnny will close the sale, make his $800 commission, feed his family, and a single mother (or elderly customer living on a fixed income) will be stuck paying this bill for the rest of their lives — long after the new furnace and air conditioner age past the recommended replacement age.
Which brings me to my next point:
Reason 3: These independent contractor’s are successful because they don’t use high pressure, sophisticated sales tactics. Not despite not using them.
Private equity firms seem to think that they can buy out a mom & pop business, bring in an outside sales consultant to teach technicians how to increase their average “ticket size”, train them how to sell more equipment replacements, and drastically overnight, they will increase the company’s margin! Almost like magic.
The problem? Smart homeowners catch on. They share their stories with other homeowners. They tell people: “Don’t trust that Whipple company! They will take you for every dollar they can.”
Smart homeowners intentionally seek out small, independent contractors who they know aren’t going to manipulate them into spending more on an issue/repair than they need to. They know that bigger companies make most of their money by increasing the average ticket size.
By buying out these existing independent contractors, the main thing private equity accomplishes is removing competition from other independent contractors who run a more noble, affordable business model.
These independent contractor’s often don’t need to advertise, because their services and prices are just better than the big companies, and their customers gladly pass along their contact information to friends and family when they need to hire a contractor.
As Warren Buffett Said: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
Private Equity will quickly ruin their reputation by deploying more manipulative sales tactics.
So, what is the future of residential services and contracting?
Private Equity believes the future is with dishonest sales tactics, burgeoning management systems, new employee incentives and commission structures, and spending lots of money on advertising and marketing.
I believe differently.I believe the future is with the little guy, with the independent contractor. I believe the future is with the owner-operator, who is in the field, earning an honest, reasonable wage, and who is doing right by the members of his local community.
The future is with small entrepreneurs. With independent contractors who aren’t obsessed with maximizing their average ticket size by taking directly out of the pockets of their neighbors.
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Kody is the founder of Field Rocket, an online platform connecting homeowners with honest, transparent contractors that are local and independently owned. Field Rocket is on a mission to empower the independent contractor to help their customers the way they do best — in an honest, transparent, and fair way.
