Why do construction projects experience profit fade? The obvious answer is they incur more costs than planned and overrun the budget. The more difficult question to answer is what is the root cause of profit fade? Is it a systemic problem that is linked to project control weaknesses or deficiencies? Consider some of the root causes of profit fade and underlying controls designed to prevent these occurrences.
Pricing and Estimating
Pricing and estimating are often equated during the bidding phase—a common problem in organizations. Estimating should define the effort and resources required to complete the project. However, pricing is a market-driven number. How low do you bid the project in order to win the work? Even negotiated work is subject to an owner's downward pricing pressure. As a result, estimates get trimmed to meet a pricing expectation. Contractors cannot overcome market pressure pricing. However, they can separate estimating from pricing with planned write-offs. Planned write-offs are the difference between market price and the estimate for the job. Utilizing this benchmark enables project accounting to track a project's performance to the real construction budget and quantify the financial impact of discounting the project to meet market expectations. Trend analysis of over- and under-budget projects highlights the efficient project delivery teams, under-performers and ineffective estimators.
The next milestone in the project development life cycle is the contract. Regardless of the parties, the contract sets the terms for how much the contractor can bill for the project. Well-defined contract terms and conditions protect the contractor's rights and contribute to better construction relationships. The terms and conditions should define expectations for performance by all parties. For example, the change order clause should define the different types of authorized changes that may occur, how they will be communicated, expected response time and pricing mechanism to ensure the contractor recoups their real cost for the change order. If estimating and sourcing time is required for the change order, make sure the terms enable collecting for these services.
Thorough Project Documentation
In addition to the contract, good project documentation tells the project story. Failure to document costs, events and decisions leads to misunderstandings, rejected requests for reimbursement and claims. The easiest of all documentation requirements is the support for reimbursable costs. The goal is efficient capture and processing of the invoices. One successful approach is to establish that all requests for payment, supplier invoices or other accounts payable support are first coded and scanned by accounts payable. The voucher status stays unapproved and pending project manager review. The scanned documents are emailed to the project manager for review and approval. The benefits of this approach are project costs are posted timely to the project, are available for billing sooner (reducing days of revenue outstanding) and lost documentation is minimized. Additionally, aged, unapproved payable reports enable project accountants to quickly identify potentially problematic vendors. This correlates directly to billing controls as well. Work in process balances that are growing due to unbilled reimbursable costs may be an early indicator of budget constraints or potential quality issues.
Documenting decisions, events and progress as they occur are imperative to prevent memory loss or worse lost revenue opportunities. Enforcing a documentation policy can be difficult. Simplify the process for project managers and superintendents with a tablet-enabled electronic form. Include checkboxes for common jobsite events, such as delays, owner site visits, inspections, site condition changes and constructability issues on the form.
Many enterprise construction management systems have released customizable forms that are easy to complete and automatically archive to the project communication file. These tools not only capture the daily event, but failure to complete can be tracked and notify management that a follow-up activity is required.
Documenting the cost incurred is only part of the control environment. Physical material control is necessary to ensure materials received meet specifications and quantities match purchase orders. Material control is a challenge at many jobsites because common carriers deliver pallets of supplies and the first available employee will sign off on the delivery ticket with little verification of the materials received.
Jobsites need to follow basic two-way matching of the purchase order to the receiver and a physical count of materials received. Procurement can facilitate this process by providing a receiving schedule informing superintendents of the expected daily deliveries. The schedule should include information about the supplier, carrier, material description and quantities. The receiving process must be simple in order to minimize delays at the jobsite. Match the bill of lading descriptions with the receiving schedule, physically inspect the condition of the goods, verify the protective wrappers are still intact while still on the truck and count the product as they come off the truck. The truck has to be unloaded and bill of lading signed regardless of any quality control activities.
These nominal additional activities will notify the superintendent of quantity or quality issues at the earliest possible time. Additionally, sharing this documentation with procurement enables a rapid resolution to material problems.
Direct labor is the resource the contractor has the most control over. Experienced companies know how many labor hours are required to complete the assigned scope of work. This information can be used to measure worker productivity. A powerful measure is comparing physical progress with labor budget spent. Negative variances of more than a few percentage points may be an indicator of environmental or site conditions impairing worker productivity. This information can be used to change the conditions and recover lost productivity or support potential change order for out-of-scope site conditions.
Change Order Control
Change order control is the king of project controls. Contracts, policies and procedures all define what change orders are, who should approve them and the conditions that lead to change orders. Why do so many legitimate change orders go unapproved? The one attribute that systems and controls cannot affect is that people avoid conflict. They are uncomfortable discussing change that needs to happen with decision makers. As a result, some project managers minimize the conflict associated with change orders by procrastinating. Indicators of profit fade from lost change orders include monthly project meetings that end with the recurring statement,"I need to send the owner a change order." Additional indicators are old RFI items that never clear the RFI schedule and significant time passing from RFI date to change order submittal. As time goes by, risk of not getting the change order approved increases. Time erodes memories of the event, and as project closeout time arrives, that can leave the contractor with potentially unrecoverable costs. There is a connection between documentation and change order approval. Contractors that demand project managers and superintendents have the discipline to document the daily events and provide written communication to owners have fewer change order approval issues and, as a result, experience better project profitability. Leaving change orders to memory, procrastinating and trying to collect at a project's close leads to greater profit fade.
Project controls can be a powerful tool for the contractor to prevent profit fade. Using benchmarks and reports as performance indicators can help manage events that impact project profitability. Physical controls over materials and labor can prevent shortages and abuse. Lastly, documentation capturing the project history memorializes events and decisions supporting the contractor's actions from pre-construction through commissioning and occupancy.
Learn more at the Construction Financial Management Association (CFMA) Annual Conference & Exhibition in Chicago, June 27-July 1 and make a difference in your company's bottom line. Register at cfma.org/conference and follow CFMA on Twitter, Facebook and Instagram with #CFMACONF15.