A high operating margin is usually good news. In a business that has committed to aggressive growth and is hitting its growth targets, it is sometimes a signal that money is not being put where it needs to go.
That is a conditional claim and the conditions carry all the weight, so let me state them before anything else.
This applies to a business that has decided to grow substantially, has set targets and is meeting them. If you are not trying to grow, or you are trying and missing, none of what follows applies to you and a strong margin is straightforwardly a strong margin.
The pattern
In residential and commercial service businesses, roughly 10% operating profit is a reasonable standard. Owners who consistently clear it are doing well.
What I have seen among growth-committed businesses is a divergence between two groups: the ones pulling around 10% and reinvesting the rest, and the ones pulling 13, 14, 15, 16% or taking distributions out of the business.
Both look fine in the year you compare them. The difference shows up roughly three years later. The second group tends to stagnate. Not collapse. Stagnate. They hire less, they train less, they postpone the benefits expansion, they do not build the management layer and eventually growth slows to whatever the existing structure can carry.
The margin was never the problem. The margin was the visible consequence of a series of postponed investments, each of which was individually reasonable.
A caveat I want to be explicit about: this is a pattern I have observed in the businesses I have worked with and studied, not a researched finding, and I cannot speak to every industry. The three-year timeframe is a rough characterization rather than a measurement. Treat it as a reason to examine your own numbers rather than as a law.
Why it happens
Nobody decides to under-invest. It happens through a series of individually sound decisions.
The marketing budget stays flat because the current level is working. The manager hire waits until it is unavoidable, because payroll is certain and the return is not. The training program does not get built because there is no time this quarter. The extra vehicle waits one more season.
Each decision is defensible in isolation. Together they mean the business is being run at the capacity it already has rather than the capacity it needs next year, and capacity has a lead time.
That is what is actually happening. Growth investments have a lag, and the lag is longer than the quarter in which you decide not to make them. A person hired today is productive in three months and genuinely good in six. A marketing channel takes a quarter before you can read it and another to get it working. A training program takes a season to build and a year to show up in quality and retention.
If you wait until you need the capacity, you are already a year late, and the year you lose is a year of compounding.
The diagnostic
Two questions, in order.
1. Are you actually committed to growth?
Not aspirationally. Have you set a target, put a date on it and made decisions that only make sense if you hit it?
Plenty of owners should answer no. A stable, highly profitable, owner-operated business is a legitimate and often excellent outcome, and for that business a 20% margin is a win with no asterisk. If that is what you are building, stop here.
2. If yes, what is the gap between your current structure and the structure your target requires?
Not today’s business with more revenue in it. The actual company at that size: the management layer, the vehicles, the space, the benefits load, the systems, the marketing spend that produces the lead volume.
If you have never built that budget, build it before you conclude anything about your margin. It is the single most clarifying exercise available to an owner planning growth, and it takes an afternoon.
You are not aiming for accuracy. Best case it is 93 to 95% right and worst case around 75%, but directionally it will show you which parts of the current structure have to be replaced rather than scaled. Then the margin question answers itself, because you can see what the money is for.
Where the money should go
When reinvestment is the right call, it goes to people, process and growth. In rough order of what I see produce the most.
Hiring slightly ahead of demand
The one that returns the most, and the one that feels worst.
Hiring three or four months before you strictly need someone means you eat the payroll during the ramp. It also means you can train them properly, evaluate them while the pressure is low and have them productive when the season turns instead of onboarding somebody during your busiest month.
The tradeoff is real and it is cash. You are carrying non-productive payroll on a bet. If you do not have the reserve to carry it, this is not the right first investment, and the right first investment is the reserve.
The exception: do not hire ahead into a role you have not defined. Hiring early into a clear seat is an investment. Hiring early into a vague one is just payroll.
Marketing, once attribution exists
Increasing spend into a channel you can measure is one of the more reliable ways to convert profit into growth.
The condition is attribution. If you do not know where leads come from, which sources close and what a customer is worth, additional spend is a guess with a bigger number attached. Building the attribution is itself the investment, and it usually needs about four months of lead time before it produces decisions you can trust.
Compensation, benefits and the ability to hire well
This is the one owners defer longest and it has the longest lag.
At small size you compete for labor against businesses like yours. Past a certain point you are competing with employers generally, including ones with benefits, predictable schedules and easier work. The wage that made you the best option in your category stops being the relevant comparison, and the quality of applicant you can attract determines the quality of what you sell.
This gets expensive quickly, which is exactly why it needs to be a planned investment rather than a reaction to a hiring crisis.
Process, training and documentation
The least visible and the one that determines whether the others work. A training program means new hires ramp faster and more predictably, which is what makes hiring ahead of demand affordable rather than reckless.
It produces nothing in the quarter you build it. It is also the difference between a business that can absorb ten new people and one that breaks at three.
Systems and equipment
Real but usually not first. Software and equipment tend to be the investments owners find easiest to justify, because they are concrete and they arrive in a box. They are rarely the thing actually holding you back. Be honest about whether you are buying capacity or buying the feeling of progress.
The case against reinvesting
I do not want to write a one-sided article, because there are good reasons to take the money out.
Concentration risk in the business. If most of your net worth is in one small company, moving profit out is diversification. That is a legitimate financial decision even when it costs growth, and an advisor who tells you otherwise is not accounting for your whole position.
Personal circumstances. If the owner’s household is under strain, taking money out is correct. A business is supposed to produce a life, and an owner in financial stress makes worse decisions inside the company anyway.
No confidence in the deployment. If you cannot say what the next dollar of reinvestment would do, holding it is better than spending it badly. Reinvestment without a thesis is just higher expenses.
The growth is not there. Reinvesting into a business that is not growing does not produce growth. It produces a higher cost base and a worse margin.
The honest version of this article is that a high margin raises a question. It does not answer one.
What to do with this
- Decide whether you are actually committed to growth, with a target and a date. Be honest, because the rest of this is conditional on it.
- Build the budget for the business at that target size. Down to margin by service type if you can.
- Compare it to what you have. The gaps are your investment list.
- Sequence the list by lead time, longest first. Anything that takes a year to work has to start a year early. This is usually people and training, which is exactly what gets postponed.
- Fund it deliberately, as a line rather than as leftovers. Investments that come out of whatever is left over do not happen, because there is never anything left over.
One thing to do first, before any of it. If you do not have a cash reserve, build the reserve before you fund growth. Every investment on this list carries a period where you have paid and not yet been repaid, and a business without a cushion cannot survive that period without abandoning the investment halfway, which is the most expensive outcome available. Reserve, then invest.
Frequently asked
What is a good operating margin for a service business? Around 10% is a reasonable standard for residential service. Higher is generally better, and the exception is the one this article is about: if you are growth-committed and hitting your targets while running well above it, look at what you are not funding.
Does this apply if I am not trying to grow? No. A stable owner-operated business running a strong margin is a good business. This entire argument is conditional on a growth commitment.
How do I know if I am under-investing or just efficient? Build the target-size budget. If your current structure can plausibly get you there, you are efficient. If it obviously cannot, and you are not funding the gap, you are under-investing. The budget separates the two.
Should I reinvest or pay down debt? Depends on the debt. If it is expensive or short-term, retire it. If it is cheap and long-dated, and you have a growth investment with a clear return and a reasonable lead time, the investment usually wins. Neither should come before a basic cash reserve.
How much should I reinvest? I would not give a percentage without knowing your business. The better approach is bottom-up: build the target-size budget, identify the gaps, cost them and sequence them by lead time. That produces a number with a reason attached, which is worth more than a rule of thumb.
If you want help building the target-size budget and working out what the gaps actually cost, here is how I work.