Category: Budget

Large or Small Contractors

smb-quality-managementI have had the good fortune to work for many varied construction companies. Ranging from very large international conglomerates to small “mum and dad” businesses. Both types have advantages and disadvantages but which offers the best environment for employees. I started considering this after spending two days interviewing for staff. Not senior people but a mixture of junior quantity surveyors, graduates and others embarking on their careers in our industry. They all had a similar goal to be project managers on large projects within a large construction organisation. They all believed best practice, the most experienced staff and the best career could be achieved within those types of company. The idea of working for a small or medium sized business wan an anathema to them.

When I interview potential staff I look for potential, energy and commitment. I may not necessarily like the candidate, in fact I prefer the candidates who I do not take an instant like to rather the opposite. I look for people who can, in time, do my job better than I can do it. I also have issues with strict selection criteria and believe in sometimes adjusting the role to suit the person.

So, which is better, a small/medium business or the big corporate behemoth. The main attraction to the small/ medium company is employees know what is going on within the business whereas in the large company with it multitudinous layers of management, employees get isolated on projects or restricted within the silos of estimating, finance, HR, IT, or other head office cells. In a smaller company, there are no hiding places and talent and commitment is more easily recognised.

Having worked in both camps it is interesting to look at gross profit, overheads and EBIT. The big end of town with their $100 million plus projects tend to be union dominated, with a small pool of approved” subcontractors which means tendering is extremely tight, with the same major contractor trying to cut their own throats to win jobs with a two to three percent margin. These projects are usually design and construct which means they need to understand that process and have the people on board to manage it. They often do not understand the process and do not have enough experienced people to manage value engineering, control novated consultants, and manage the projects commercially. Added to this is the millstone of head office overheads which the projects must support, including hanging on to staff between projects completing and commencing.  This is compounded by the simple fact large contractors pay their staff too much. At the end of the financial year many large contractors are struggling to make a positive EBIT.

The smaller contractor is not weighed down with union pressure, high salaries and overheads are kept to an absolute minimum. Which means their tender margins are higher and their net profit (we don’t here the acronym EBIT in this environment) is higher. Because their projects are of a lesser value, they turn them around quicker so one bad job is not the end of the world.

My personal preference is the small/medium size business which has several income streams: new construction; small developments, refurbishments and fit outs. These businesses can change direction quickly and the owners are usually heavily involved not just in the business management, but they know their employees, subcontractors and clients inside out.

The Bottom Line

TC 1 and 2I was asked recently by a subcontractor how they could increase their bottom line. They had fallen into the trap of believing increasing revenue would increase profit. In fact by increasing revenue they were going broke quicker.

Whether it is the overall business or an individual project the principle is the same. Revenue is usually determined on a fixed price contract and costs are controlled by the business and on projects, the on-site team.

The table below set out the difference in increasing revenue or reducing cost:

Current Required Difference %
Increase Revenue
Revenue 10,000,000 13,636,364 3,636,364 36.4%
Costs 9,500,000 12,886,364 3,386,364 35.6%
Gross profit 500,000 750,000 250,000 50.0%
Margin % 5.0% 5.5% 0.5%
Reduce Costs
Revenue 10,000,000 10,000,000 0 0.0%
Costs 9,500,000 9,250,000 (250,000) (2.6%)
Gross profit 500,000 750,000 250,000 50.0%
Margin % 5.0% 5.5% 0.5%

My subcontractor friend is not an accountant. COGS, EBIT, work in progress, accruals etc are a foreign language to him. He simply wants to make more money.

In this example I demonstrated how to increase his annual gross profit by $250K. So I explained based on the above if he reduces his costs by 2.6% he will increase his gross profit by $250K. To achieve the same by increasing his revenue he needs a 36.4% increase ie another $3.636M, along with more risks on variations not being approved, more clients who may pay slowly and this does not allow for maybe more overheads to handle the increased turnover.

This sounds simplistic because it is. Costs are variable and under our control, but we have to fight for every cent of revenue not included in the contract.

Cost Reporting

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As each month ends the project prepare the dreaded cost report. This report is reviewed by management and information extracted to be consolidated into the overall business reporting regime. But what value are these reports and what benefit do they provide?

The responsibility for the report lies with the project manager but it is usually prepared by the contracts manager/administrator and due to time constraints often the project manager has little input into the report even though he is responsible for it. The report can be quite long and detailed and all too often the only number the project manager looks at is any movement to the project margin.

The following points are all to often encountered in the preparation of the cost report:

The reports may include forecast revenue for head contract variations which have been submitted but not approved. The forecast cost of these must be include but not any margin uptake. However, in the world of design and construct how accurate are the forecast cost when design has not been finalized and the revenue/cost is not based on subcontract pricing but on elements of the cost plan.

The reports may not include all of the true project costs. Such as head office charges, late submission of subcontractor’s variations, late suppliers invoices, costs incorrectly costed to another project and incorrect cost coding.

Revenue may also be overstated by including the most recent client progress claim which is yet to be certified and is over claimed..

The cash flow report may show a large cash positive position. This may be due to subcontractors not submitting accurate claims

If there is over claiming it simply means the costs have not been incurred and the cost to complete are disproportionate to the physical progress on site. If this is not considered the margin position of the project is spurious.

They take too much time to prepare because:

  • The information is outdated often by a minimum of one month.
  • The report has simply too much information and detail.
  • Several people have input including Health and safety, programming, procurement, pictures and the person preparing it ends up chasing individuals who submit their “section” at the last minute not giving enough time for analysis prior to the report being tabled.

How to tighten up cost reporting (and control costs before they are incurred)

  • On a design and construct project It is essential that all decisions taken regarding design changes or trade lettings are based on a forecast of the cost implications of the alternatives being considered, and that no decisions are taken whose cost implications would cause the total budget to be exceeded.
  • The project leader must be involved in the preparation of the cost report, not simply reviewing what a junior contract administrator has prepared.
  • Accurate cash flow reporting is a function of accurate programming and an analysis of the programme status at the month end of the cost report period. Cash flow is not independent of the programme.
  • Only project members who have the authority to spend, commit expenditure or approve variations should do so. And should be carried out in accordance withe the head contract and the subcontract..
  • Most projects include a contingency for risk for items not included in the cost plan. However, before the contingency is accessed involvement by the cost planner is essential

Bleeding Dollars

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So how does a project start hemorrhaging dollars? I aspire to the old fashioned school of thought which states very simply “you make your money before you start on site, once you start construction you have to prevent losing money”.

Managing the risk with the client should be resolved in the tender process, what are we prepared to sign up to? Can we accept the draconian terms and condition the client wants? Have we allowed the gung ho business development manager too many long lunches, convincing himself in a haze of narcissism and red wine, that we can deliver a project on time, on budget but beat the rest of the tender pack by a country mile. Hopefully a company’s internal checks and balances and counteract this over-enthusiasm, stand up to the client and if need be, simply walk away. Often the client manages to wrap the contractor tightly within the contract, but the contractor is too loose with their subcontractors.

OK, we have won the job. The business development manager accepts the accolades and moves on to their next conquest. The cost planners have covered themselves with a multitude of caveats. The accountants are expecting the profit at tender to increase. All we as a construction team have to do is deliver. The first task is to sign up the subcontractors. So often we get a relatively inexperienced administrator to put “packages” together, to add to those issued at tender. These packages contain a scope of works, drawings, specifications, etc. The administrator fields the queries from the subcontractors. Eventually a short list of subcontractors per trade is prepared. How many times have we heard the cries of joy as a substantially lower price from a subcontractor is paraded around the office, until someone with the word ”commercial” on their business card slows it all down by actually reading what the subcontractor has offered. Often, the enthusiasm of the team is tempered by the Grinch aka: “The Commercial Manager”.

Next step – the deal with the subcontractor. There is no point in screwing someone in to the ground only for them to go broke mid-way through the project. Their price has to be based on a fully detailed scope of works with no “gaps” between their trade package and others. But all too often this is where many increased costs originate. The reason is that all too often, the wrong person has issued the package. Issuing tender packages requires construction knowledge, commercial acumen and rigorous internal review. Inexperienced administrators do not have the requisite experience or negotiating skills.

We are now underway on site. Every subcontractor has a signed subcontract so why do we not implement it. We have time requirements for claims, procedures for variations and extensions of time, so why do we not apply them. The reason we do not is often this task is left to an inexperienced administrator. We have a subcontract document, no doubt prepared by internal or external legal eagles, and often the people managing it do not understand it.

The hemorrhaging has commenced. Poorly written scopes of works, lack of contractual and commercial knowledge, now compounded by a third factor. That being the team’s self-denying something is going wrong. Somehow they believe by not reporting bad news, it will make it all go away. It does not.

The way to manage risk is through focusing and identifying, analysing, prioritizing, and managing risks to eliminate or minimize their impact on a projects objectives, profit target and success. We need the same rigor applied throughout procurement and construction that should is be applied at tender stage. This requires experienced construction professionals, and this usually means they have been burnt previously.

 

Picture courtesy of betanew.com

http://www.gkeating.com

 

 

 

 

Risk

riskBack in the sixties I received Waddington’s game of Risk as a Christmas present from my beloved, long departed parents. My favorite place on the board was Kamchatka. That was certainly a long way from home in Liverpool. I had never heard of Kamchatka and even today it is a place name not often mentioned in the media. The tactics were not complicated: build up your armies; protect your borders; and own as much as the board you can. Of course to own the board you had to roll the dice.

Okay enough of reminiscences from days long ago. We work in an industry full of risk. We take on projects that have been won my optimists, reported upon by pessimists and delivered by pragmatists. We do it because we have a passion for construction, but all too often that passion is tested in the extreme by the sudden realization that the risk we discussed at the start of the project, has increased exponentially.

As the economy gets tight, with a shortage of development cash, clients/developers want hard dollar, fixed price contracts with us builders. Then they want to push the responsibility of design onto the builder. Simply the project is a design and construct, fixed price contract. We then screw down the design consultants and the subcontractors in an effort to shift our risk on to them. But it does not work. Subcontractors are signed up on incomplete scopes of works, based on minimalist consultant documentation, and at the end of the project we are fighting with the client, consultants and subcontractors. The project team becomes tired of the battles and we limp towards practical completion watching the dollars hemorrhage from the budget. Add to this we have reduced the programme and contract sum in give backs to the client simply to win the job. So we are fighting time and money from day one on site.

But we as an industry keep doing it. Is it some masochistic trait within builders, are we deluded in believing we can achieve the impossible, that is making money on a hard dollar design and construct job.

We have to learn the lessons from previous forays into this model and simply not accept risk that we know will hurt us. We try to minimize the risk in draconian subcontract documents, but then we run a further risk in ending up in court with security of payment issues to subcontractors.

We all prefer the alternatives such as construction management contracts etc. and we can also reduce the risk by simply saying to clients, who want to screw us – thanks but no thanks.

http://gkeating.com

Damn Site Instructions

money-down-drain-6954787

Why on earth do site foreman/managers issue site instructions to subcontractors to carry out works which are contained within the original subcontract scope. It happens all the time and the larger the project the more it occurs. If they understood what is contained within the subcontract the amount of site instructions would decrease and of course the resultant trade cost over runs would be less.

There may be mechanisms for approval of site instructions by the project and commercial manager, but often the site foreman has issued a verbal instruction to the subcontractor and the argument about the validity of the instruction takes place after the works are complete. A case of trying to close the stable door after the horse has bolted.

Sometimes it falls to an inexperienced site based contract administrator to approve site instruction based variations in the subcontractor’s monthly progress claim. If all the boxes are ticked ie the site instruction is signed and issued, the subcontractor has submitted a full cost break up, then the dollars are approved and the subcontractor paid.

If after the payment some hawk eye spots that the paid for works were in fact part of the subcontractor’s original scope, then we begin the process of clawing the money back. We tell the subcontractors that variations are paid “on account” and that payment for a variation does not mean it has been approved. We then go into battle with a subcontractor who we need to finish his trade package. The smart ones may go legal and we get into arguments about Estoppel, deceptive and misleading conduct etc etc.

The worst case is when site instructions are issued after the work has been carried out. There is simply no excuse for this and in my view this is the time for badges and guns to be handed in and the first available window seat is to be organised.

The way to stop money going down the drain is to have a strangle hold in the issuing of site instructions and the only person who can issue them is that rare site based individual – someone who really does know what they are building.

http://gkeating.com

image courtesy of dreamtime.com

Lost Profit

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It is often said “we learn from our mistakes”. But why, in the construction industry, do we keep making the same mistakes? When will we have truly learnt our lessons? How many times does a project not deliver the profit that was envisaged when we signed the contract?

There are many reasons for not achieving the target profit but there is a common thread. That is poor commercial management. For some reason builders focus so much on delivery of product without putting as much emphasis on the delivery of profit.

It sounds simple but there are three key issues

  1.  If the project team did what it set out to do
  2.  Got paid for everything it was entitled to
  3.  Only paid out what it was obliged to pay

1         If the project team did what it set out to do

We build to the drawings, specification and scope of works. Therefore, we purchase subcontracts, consultant services, and materials in the same manner. But we do not. We allow consultants to over design and under deliver. Subcontracts have gaps between trades. Materials such as concrete and reinforcing always exceed what was in the cost plan. The reasons for this is inexperienced staff, who simply do not fully know how to build and manage subcontractors and/or consultants.

2         Got paid for everything it was entitled to

We sign a contract so why don’t we understand it, use it, and extract every cent out of it. Often the member of the project team responsible for the day-to-day management of the finances is a relatively junior, young and less experienced individual. The big guns from head office only get involved when the project is starting to haemorrhage substantial dollars. The inexperienced site based contract administrator often does not want to “take on” the client or has not been given the authority to do so. They are reluctant to highlight potential/actual losses and can be overruled or intimidated by an over bearing wily project manager.

3         Only paid out what it was obliged to pay

If we start with the premise that the project team does not grasp these three key issues we need to have in place some method of monitoring them and being able to take corrective action before it is too late. That means setting projects up with robust reporting protocols. That does not mean head office go through the monthly report and try to act like the Spanish Inquisition with the project team. It means identifying before we start on site the areas where we know there will be issues. We need to ask the simple question: is this project team really up for this job to maximise our profit or is it a simple case of this team will deliver a good project but yes they are commercially weak.

I have lost count of the amount of times I have had to explain to people responsible for project profit what the terms committed cost, certified cost, margin on revenue, margin on cost, work in progress, accruals, discounted cash flow, aged trial balance. I have even had to explain the difference between a certificate and an invoice; revenue and profit; forecast cost to complete and forecast final cost.

So we need to train these young “Harry Potters” who peer at their computer screens all day, send off curt circulatory emails to all and sundry, but they hardly walk the job, engage with subcontractors and generally live their lives in a bubble. If you want to manage costs you have to be able to manage people.

by Gerry Keating

http://gkeating.com

How to Burn the Budget

Let’s assume at the start of the project we know the budget is going to be exceeded. We know the design is incomplete, the cost planner was not in touch with reality, the program was prepared by a Primavera zealot and the project team are as motivated as a retiring politician. So the premise is that the budget will be blown, heads will roll and the project manager will develop a persecution complex.

How do we prevent it? By going back to basics and following a few simple rules:

  1. Don’t manage the design team – control them, make them earn every cent and get them to deliver what they are paid to deliver and by the date it is due
  2. Let 80% of the trade packages within 20% of the contract period.
  3. Assign the best people to the project team and pay them what they are worth.
  4. Have minimal internal reviews. Every time there is a new review or set of eyes someone feels they have to add to the debate.
  5. Make sure the program is prepared by someone who actually knows what to build, pin it up on the site office wall and status it daily.
  6. Ban spreadsheets for cost reporting
  7. Treat subcontractors as equals not servants
  8. Listen to experienced, practical site managers/foremen
  9. Keep hard copies of every email, site instruction, time sheet, order, site instruction and delivery docket if they back up a variation or EOT
  10. Open every meeting with a “safety share” and encourage all to contribute

Ok it is not rocket science, but we are not building space stations. Before we get carried away with BIM, CPA, benchmarking, discounted cash flows, IRRs, pivot tables, delivery strategies etc etc, consider delivering what we set out to, by the time allowed, to the required quality and with no harm to anyone.

 

by http://gkeating.com

No Subcontractors Thank You

CranesI recently struck up a conversation with a stalwart of the construction industry here in Brisbane. He had worked for the same company for over forty years. He started out as an apprentice, became a leading hand, foreman, site manager, and now a senior member of the construction management team. So we did what most of us construction survivors do, we exchanged war stories.

A common theme soon developed – most construction companies have forgotten how to be builders. Forty years ago we had a stream of apprentices who were the company’s future. Senior managers rose from the ranks based on ability and experience.

But the key point was that builders used to employ their own tradespeople to carry out the work with a very few specialist subcontractors. Nowadays a project manager is measure on how he can organise a rabble of subcontractors. If he is inefficient and disorganised, it costs the subcontractor. Using your own labour means if you are not organised it costs a fortune. To be organised you need to know how to build.

It could be argued that most construction companies set up a project with the minimum of their own staff, subcontracts out every trade, hire the cranes, hoists, scaffold, and they don’t even own a wheel barrow.

Of course the reason is simple. The client pushes the risk on the construction company, and in turn they push it on to the subcontractor. You cannot back charge your own labour force but it is easy to do it to the subcontractor. This style of project management is run on the same format as a shepherd herding sheep. As long as they are all moving in the right direction, just leave them to it. So the project manager herds the subcontractors and they build it.

This may be the norm in commercial and residential construction but is not the same story in the resources sector. Companies on mine sites tend to employ more of their own labour to carry out what would be subcontract trades. This is mainly due to the control exercised on the construction companies by the mine owners. However, due to the magnitude of these resources projects, there may be several joint venture construction companies who find themselves being treated by the mine companies in the same way a construction company would treat their subcontractors. They don’t like it, because being a subcontractor these days is the end of the food chain, having the biggest risk of not being paid but with all the responsibility that goes into a two hundred page subcontract.

So back to the construction stalwart. He is disillusioned with the industry he has given forty years to, he despises the short slightness of people who won’t employ apprentices, he shakes his head at Google Glass wearing, iPad toting project managers, wants to punch the light out of the Harry Potter lookalike who pays the subcontractors. But he still is cheerful as he can always look at his mark on the landscape that is he can take his grandchildren to see and touch not the jobs he managed but the buildings that he built.

by Gerry Keating

https://gkeating.com/

Don’t Sack the Gardener

leggoI have not looked at a household bill in years. Electricity, water, telephone, groceries etc are things which do not interest me. i spent my working day staring at damn Excel, arguing with subcontractors about variations, and with bean counters quizzing my costs. So all expenditure on the home front is managed by my darling wife. Ask me how much is a 200mm post tensioned slab per square metre and I will rattle it off. But ask me what we pay for cable tv and I don’t have a clue.

Yesterday evening my whist relaxing on the back deck after work, my wife suggested we sack the elderly gent who has been tending to the garden for the last ten years. She had been listening to the doom and gloom on the tv regarding ever increasing insurances, utility bills and the like. Even with my deft application of minimal encouragements I became drawn into the conversation. Based on the facts that I don’t own a garden shed, let alone a lawn mower, and the only items in the garage are cars, hell will freeze over before I start maintaining gardens, the pool and hedges. So the gardner has a reprieve.

But this made me think about what we decide to cut first in construction budgets. Of course it is the landscaping on the project. The majority of new apartment buildings are pretty boring. Leggo architecture, withe a few embellishments, an entry statement, and give an oxymoronic italian name. The Palazzo, the Paloma, they could be called Lambretta or Vespa, anything to make them sound better than they look. Then at the end of construction the landscape team move in. The budget has been slashed along with the height of the trees and number of plants. The landscape architects vision at the concept stage is now a nightmarish reality.

So it appears the household budget cuts are mirrored in commercial construction. I say leave the landscape design alone and keep lawnmowers away from my garage.