As the construction industry moves toward industrialization, the role of a construction financial professional (CFP) continues to change. Understanding more about a project and getting feedback from the field is critical to profitability predictability.
Encouraging operations to measure jobs independent of accounting measures and help develop a catalogue to account for what labor does is becoming a requirement. And, linking the field, accounting, and estimating information databases is key to a company’s success.
Regarding the five steps of Industrialization of Construction®, this article focuses on the need for management of labor to predict project and company performance.1
Project Predictions
When looking back at a project’s profitability, did it equal what the team was expecting? And do you know why? Can you use that information to predict the profitability on the next project?
Your company likely has a method for estimating projects that considers company overhead as well as labor, materials, equipment, subcontractors, and more. The estimating team likely reviews drawings, walks the site, analyzes risks and unusual conditions, and accounts for those factors in the estimate. The company then agrees to submit the estimate with an expected profitability, and if the job is awarded, the team runs the project. However, the results are not always what was predicted.
From MCA, Inc.’s data analysis of many companies,2 Exhibit 1 shows that job-to-job profit percentage has considerable variability from what was initially predicted. This likely boils down to several reasons:
- Cost-based pricing vs. price-based costing
- Managing projects as individual zero-sum games
- The point at which you got an indication of what was about to happen
- Having tools to predict the outcome
The construction job process must be controlled during the project so that the project’s financial performance and the overall company performance can be predicted. Lack of project performance predictability will impact the company by potentially leading to higher costs and increased uncertainties based on bonding, insurance, and financial organizations’ negative perceptions of company performance.
MCA, Inc.’s industry research over a period of three years and over 500 closed jobs found that actual project performance exposure for a construction subcontractor (not specifically unique to the contractor) had a profitability range from -18% to 90% (the planned was 0-56%). Exhibit 2 shows how that variation can impact the company — there can be an $11,000 swing on a $10,000 job or a $11 million swing on a $10 million job.
Cost-Based Pricing vs. Price-Based Costing
Do you know how you are controlling your profits? Are you managing to a fixed profit or just getting what you get?
In many cases, you’re in a market or area of the industry where you get jobs based on relationships or limited competition, which may allow you to pad your estimate with either labor hours, profit, or other believed hidden areas and predict how the customer will behave. But this only works until competition or margins get tight and the performance of your company/system needs to be predicted.
Cost-Based Pricing
Exhibit 3 shows a traditional cost-based pricing model where material, labor, and overhead costs are gathered for each sale or estimate (assuming it’s fixed) and the profit is added, resulting in your estimate. But what happens when material prices go up or overhead isn’t managed?
This can be looked at through dynamic budgeting3 or by recognizing that labor spend to avoid overruns. The team needs to agree that your company is in business for predictable profits and work toward changing their philosophy of its operations.