Tag Archives: Profit

Perspective on percentages

Estimating involves a lot of details and mathematics which must often be communicated with great speed and precision.  Unfortunately, there are terms that are so frequently misused that the information being shared is of little value.  A percentage is a simple concept with great utility and flexibility depending on your perspective.

Sometimes 10% to one party isn’t 10% to the other

Subcontractors regularly call to request bid results of the General Contractor (GC) estimator to define how closely their bids are following market prices.  Estimating often requires discretion during the bid (before the deadline) in order to maintain a fair competition for the subs, and to protect the firms interests.  All too often, the focus on discretion leads GC estimators to be incredibly reluctant to provide their bidding subs transparency in bid results.  The best bid results many GC estimators will offer is a percentage presented in vague terms.  “You were 10% higher than the low bid” is a typical example.

For simplicity’s sake, let’s assume that the inquiring subcontractors bid was $100,000.  Ten percent of $100,000 is $10,000.  So we might think the low bid amount was $90,000 so far, so good. But it’s wrong!

Perspective on percentages

“Yep, that’s the look of someone who’s made a rookie mistake.”

If the low bid actually was $90,000, adding 10% would make the 2nd low bidder $99,000 not $100,000 because 10% of $90,000 is $9,000.

In order to figure out the low bid amount, using only the information provided we can lay out what we know in an equation.

The percentage given represents the difference between the low bid, and the calling subs number in proportion to the low bid amount.

Putting this into an equation gives us:

($100,000-$Low bid)/($Low bid) = 10%

Solving for low bid we have:

($100,000)/( 10%+1) = $Low Bid

$100,000/1.1 = $90,909.09

Deducting the calling subs bid from the low bid give us the dollar amount they lost by.

$100,000 – $90,909.09 = $9,090.91

This means the calling subs was $9,090.91 higher than the low bid.

Rounding to an even $9,000, it’s plain to see that the calling sub would have needed to cut 9% from their $100,000 proposal to match the low bid amount.  Since the entire point of bid results is to define what you’d need to improve, it’s imperative to correctly interpret what you’re being told.  The GC’s is telling the sub they are 10% higher than the low bidder, when the Sub actually needed to cut 9% to match the low bid amount.

That simplified example might lead you to think 1% is no big deal, and on smaller projects, that might be true.  Have a look at what happens when we run through that example again with a 30% difference.

($100,000)/(30%+1) = $Low bid

($100,000)/(1.3) = $76,923.08

$100,000 – $76,923.08 = $23,076

Round that to $23,000 and the sub only needs to cut 23% from their bid to make up a 30% difference at the GC’s desk.  A 7% difference in perspective can lead to completely wrong conclusions.

Just to sum up, the GC is calculating the bid-result difference as follows:

($Sub bid – $Low bid) / ($Low bid)= % Higher than low bid

The sub is calculating the percent they must cut their amount to meet the low bid as follows:

($Sub bid) / (1+ % Higher than low bid) = % to match low bid

Many GC estimators prefer to give bid results in percentages because this minor obfuscation  spares them from actually speaking dollar amounts aloud where they might be overheard and misconstrued as bid shopping.  Bid shopping is when a GC informs a colluding subcontractor of their competitors price for the purpose of soliciting a lower bid.  In some cases bid shopping is illegal, and in all cases it’s unethical.

Subs calling for bid results should be prepared to think on their feet to rapidly calculate the hard numbers behind the percentages.  Responding to the percentage provided with “So the low bidder was $XYZ amount?” gives subs a chance to confirm what they’re being told, without obliging the GC estimator to speak the number aloud.

514007541_1bd174d191_z

Photo by Andrew Dobrow

Contractor cloaking technology isn’t very sophisticated

Subs should be especially conscientious about clarifying the bid results they receive from  Project Managers (PMs).  PM’s traditionally “buy out” the estimate which means they’re checking their estimators work, and addressing the problems they find.  They might have discovered that the  bid-day low sub was missing some costly scope inclusion, which made a different bidder the legitimate low-bid.  This vital error-checking process naturally requires  discretion to avoid the appearance of impropriety.  PM’s providing bid results after all that review may be looking at a considerably different situation than their estimator presented.  Honest PM’s will do their best to work out the errors in the order of bid-day performance.  If the corrective addition to the low bid makes the new total higher than the 2nd low bidder, the PM will hire the 2nd low bidder (provided their scope is complete).

I should mention that it’s a curious coincidence that many of the most dishonest PM’s I’ve encountered have a habit of saying every bid was “close” or “within 2%”.  Estimators should be particularly wary of clients showing any signs of dishonesty.  The false pretense of a  hotly contested bid is a potential warning sign of bid-shopping, especially when similar projects deliver a larger spread between bidders.

Where percentages work, and where they really don’t!

There are several components of an estimate that operate on percentages.  Profits, taxes, fees, and bonds are frequently calculated as percentages of the total costs.  There are some estimators who believe that overhead should be calculated as a percentage of project cost despite the many ways this goes wrong.  Unfortunately, this archaic thinking is sometimes bound into contractual terms where change orders are limited to predefined percentages for overhead and profit.

Overhead is the cost of doing business over time, which is not directly driven by the project cost.  Imagine a one month duration project that has a slightly cheaper level of finishes, resulting in a lower total project cost.  Did that decline in finish alter the rent at your office? No, your rent is the same regardless of what your client’s project costs, so why jeopardize the means to cover your overhead by pricing it as a percentage?   This practice virtually guarantees that projects above a certain value will be overpriced, while projects under that value will be under-priced.  In extreme cases, you’ll never win big jobs, and you’ll go broke doing little ones.

The difference between markup and margin

All business is a balance of risk versus reward; estimators calculate that potential reward in terms of profit.  It’s here that we encounter some terms that are often misunderstood, and misapplied.  Let’s say we’ve got a project worth $100,000 after all the costs are included.  Now for that $100,000 worth of work (risk), we’d like to see 25% profit (reward).  This percentage is known as markup.

$Subtotal X Markup % = $Profit

$100,000 X 25% =  $25,000

We add that profit to our subtotal and our bid amount is $125,000.

Now let’s say we won ten such jobs in one year.

10 x $125,000 = $1,250,000

That means the company had a total revenue of $1.25 Million.  So the boss is reviewing the books at the end of the year which will show all the costs, and all the earnings.  The difference between all the costs and all the earnings is your total profit.

We know that every estimate had $25,000 for profit, there were ten jobs, and to keep things simple, we say everything went perfectly according to plan on all of them.  This means the total profit should be $25,000 X 10 = $250,000.

Let’s take that $250,000 total profit and divide it by the $1,250,000 total revenue to determine the percentage of profit we’re actually earning.

($250,000) / ($1,250,000) = 20%

The percentage of profit we’re actually earning on our revenue is known as the Margin. As we can see, a 25% markup yielded a 20% margin.  This is where estimators need to consider what’s going on from an owner’s perspective.  The overall risk versus reward to the firm is the total revenue versus the total profit.  They’re not working off the subtotals of every estimate, they’re working off the contracted total amounts.  Margin makes sense when you’re working off of revenue amounts, because it directly speaks to the profitability of your entire operation.

Imagine how serious it would be for someone who misunderstood markup to be margin.  The 5% difference between 25% and 20% may not seem like much until you consider that profit to be their annual income.  That would be like working five days a week and only getting paid for four!  Many entrepreneurs  have failed because they didn’t understand this concept until it was too late.

Photo by strange_r

Photo by strange_r

Jim knew things weren’t adding up, but he couldn’t figure out why.

Just like the bid-results example above, the differences grow with the percentages in question.  A 25% Markup results in a 20% margin, whereas a 33% markup results in a 25% margin.  The percentage of markup is always higher than the margin percentage.

Putting this into formulas we get:

% Margin = (% Markup)/(1 + %Markup)

% Markup = (%Margin) / (1- %Margin)

We can calculate the total with a specific margin by using this formula:

$Total = ($Subtotal) / (1- %Margin)

So why do people get this wrong all the time?

The construction industry is very competitive which means that contractors must bid with lower profit percentages in order to win work.  It’s quite common for hard-bidding GC’s in tight markets to bid with less than 5% markup.  The difference between markup and margin is quite small when the percentages in question are in the single digits.  If the project isn’t worth very much to begin with, these differences become even less significant.  Sadly, many firms have leadership that developed bad habits when they were small and just starting out, that are ruinous to the larger operation they oversee in the present.

Fiddling with your fee

Sometimes markup is known as a fee which can get confusing when we are dealing with cost-plus contracts.  Cost plus contracts are invoiced on a “time and material” basis with either a fixed fee (set dollar amount), or a fixed percentage.

In the case of a percentage based fee, it’s absolutely critical to understand whether the fee is actually a markup, or a margin.  Contracts stipulating that the contractors fee may be no more than XYZ% of the total invoiced amount, are allowing the fee to be calculated as a margin.

Conversely, contracts stipulating that the contractors fee may be no more than XYZ% of the total time and material costs, are requiring the fee to be calculated as a markup.

This same logic applies to contractually stipulated overhead and profit percentages on change orders.  It’s been my experience that if the client took the trouble to stipulate overhead and profit percentages, they’ll likely limit those percentages to markup only.

I hope this article has helped to shed a little light on how percentages change with perspective.

 

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© Anton Takken 2016 all rights reserved

 

 


Clarity of Purpose

Whenever I think about the truly exceptional people I’ve worked with, there’s only one quality they all shared; clarity of purpose. Now it seems like fulfilling the job description that Human Resources typed onto your offer letter would succinctly define your purpose, sadly that’s not always the case.

Timely and tidy

I’ve worked for people who had well-defined expectations for their estimator, however they didn’t consider the estimators purpose in their organization. Delivering tidy proposals before the deadline is an absolute job requirement but that’s documentation (process), not procuring work (product). I’ve never seen an estimating job offer that stipulated how much work you’ve got to win, but I know plenty of people who “used to work in estimating”. The pervasive mindset of most firms is that executing a proscribed process known as best practices will lead to an acceptable number of awarded contracts. Anyone who isn’t successful must not be working hard enough. Estimating is viewed as a machine, and they’re hiring you to crank out wins. The problem with this perspective is that it only works when winning profitable work is easy.

Clarity of Purpose

Competition is different in a booming market

Too much and too little

Meanwhile, there are lots of estimators struggling with the estimators paradox: You lose because you included something extra, and you win because of something you left out. Knowing what to include in your bid can be a strenuous exercise in judgment. Balancing the gaps in information against the surpluses of available minutia can easily consume all the estimators time. Time is lost right at the start as some estimators struggle to get the invitations to bid (ITB) out to their subcontractors (subs). The struggle is compounded when questions arise and the estimator has to write Requests For Information (RFI’s). All this information management work is in addition to actually estimating anything. The problem is compounded by the standard practice of having several estimates in process.

What do you think you do here?

It’s a simple question, what’s your purpose in this business? The answer is emphatically not “estimate the cost of projects” because that’s the process not the product. Your purpose is to win profitable work. Working from that position, it’s obvious that there are immediate hazards surrounding the winning number. If you’re a little too low, the work won’t be profitable. If you’re a little too high, you won’t win. These hazards get more severe the further your number is from the correct answer. Way too low may irreparably harm your company, and jeopardize the project. Way too high, and you may harm your firms reputation, leading to exclusion from future opportunities.

How to get where you’re going

Effectively dealing with these hazards can be summarily described as controlling risk. Let’s take a moment to visualize uncertainty in the example below.

Guessing——————————————————————————————Actual built price

Greatest uncertainty                                                                                                     Least uncertainty

 

The left side represents the least amount of work, and the greatest amount of risk. There’s a chance that you could guess perfectly, but it’s very small. This approach is better known as gambling. The right side represents the most amount of work and the least amount of risk. Companies obviously can’t afford to build models of every project to negate risk. They can, however compile past project information to help price similar work.

Clarity of Purpose

Above: Design driven risk

Estimators conduct Quantity Take Off’s (QTO’s) of the Construction Documents (CD’s) to quantify and value the project scope. The relative merit of their efforts will place their bid proportionately on the scale above. This is the reason estimators control rather than remove risk. If there was no risk, the bid would be done by a cashier.

Multi-level thinking

So if estimators are supposed to win profitable work by controlling risk, and risk is controlled by QTO’s, how are contractors wrong for overemphasizing timely and tidy bids? The problem here is that not all risks are driven by project scope uncertainty.

If we recognize that not all clients are fully funded, we’re forced to admit that not all opportunities are equal. “Winning” a bid with a client who can’t/won’t award a contract is a risk that has nothing to do with how accurate your QTO’s are. Picking only opportunities that you’re likely to profitably win is a fruitless exercise if there’s no contract award.

Very successful estimators pick opportunities that they’ve got an excellent chance of landing a profitable contract award. Remember the estimators purpose is to win profitable work. No contract means no work. From this perspective, estimating could just as accurately be called “Contract targeting”.

Clarity of Purpose

Sheep’s dog, isn’t the same as sheep dog.

What defines an estimators chances of landing a profitable contract? Competition for one, efficiencies of scale for another. General Contractors (GC’s) by definition, contract portions of the project scope to subcontractors. The VAST majority of the actual work is completed by subs. GC estimators are competing on the basis of their relationships with subs. The GC with the most market leading subs has the best chance of winning. Success here, is all about building market leading subcontractor loyalty.

What defines if the work will be as profitable as it should be? In-house, the leadership and administrative abilities of the Project Manager and the on-site staff. Chasing work that’s aligned with their skills, abilities, and past successes is the best way to ensure profitability. On the other side of the contract sits the client and their representatives. Ethical clients with solid design teams are rare gems that attract fierce GC competition for their projects. Incomplete plans and short deadlines is the signature play of the troublesome client.

Clarity of Purpose

“Well our design isn’t complete but we’ve got cloud based computing to share the misery equally”

There’s never time to do it right the first time, but there will be time to do the work again. Unresolved issues handed from estimating to project management tend to harden in the arteries of a project, choking off progress until you’re lucky to simply escape. The estimators purpose is to win profitable work. If it’s not going to be possible to profitably complete the work, there’s no reason to pursue it. Estimators need to keep track of clients and design teams who’ve run contracts into the ground. Very often the client or their design team is the contractors greatest risk on a project.

Deductive reasoning and streamlining your process

Deductive reasoning is a process where you begin with premises that you must assume to be true. Then you try to determine what else would have to be true if the premises were true. Applying this to our situation, we have two premises; Estimators must win profitable work, and estimators work by controlling risk. Earlier I applied deductive reasoning to explain why we do QTO’s, or why it’s important to pick the best opportunities. My intention was to reveal the wider scope of what it really takes to be a successful estimator. If you’re already struggling with the stress and boredom of grinding out bids, this probably looks like I’ve dropped a whole lot more on you. Take heart, that’s not really the case. First off, MOST estimators are losing more than they’re winning. If you’re winning profitable work all the time, I implore you to start a blog! For the rest of us, this means that the majority of your daily work isn’t achieving your purpose.

A critical concept of successful estimating is that in order to win more, you’ll have to bid less. Winning comes from bidding only good opportunities that strategically align with both the GC AND their subs. It takes a lot more focused effort to bring all of that together on an individual bid. Losing bids diminishes the GC’s reputation with the market leading subs. Not only are you wasting your company’s time, you’re damaging your “pull” with subs. More bids means less focus which means higher risk which inevitably translates to lower profitability. Simple things offer no shortcuts.

Most estimating managers won’t consider reducing your workload until you’ve won more work than the company can handle. This circular pattern is why very few people want to become estimators. It’s a ton of work that’s rarely successful because the focus is on single-minded process rather than multi-faceted product.

Elevating the situation requires multi-level thinking. Being able to accurately identify your odds of success is a basic necessity. For more, read up on estimate tracking here. Once you’re clear on the odds, you should be tailoring your efforts to get things rolling quickly. Keeping momentum is how we keep the stress and boredom at bay but that’s not enough to really solve your problem. It stands to reason that you’re tasked with bidding something that’s an obviously poor fit.

Clarity of Purpose

“I can see this client has made some risky decisions…”

Treating every opportunity like it’s equally valid may sound like a best practice but it’s profoundly counter to your purpose. If you’re certain to lose the job, you’re not helping yourself by compromising better opportunities.

Many managers are amenable to courtesy bidding the turkey job to free up resources to land the great opportunity. Gaining a little leg room, then delivering the victory builds faith in your judgment. Backing your judgment with facts and figures, is how you prove your expertise. Trust is built through honesty, transparency, and accountability.

Overworked estimators often hear: “You can’t win if you don’t bid”. The unsaid counterpoint is:”It’s not the job you lost that puts you under, it’s the job you won”.

Clarity of purpose is a simple concept with powerful implications. Give yourself time to consider what you’re doing and ask how it achieves your purpose. We get a lot of encouragement to maintain disciplined process like a regiment on the march, but very little for picking the right direction. It’s only after you’ve arrived at the destination that people realize you knew what you were doing.

 

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© Anton Takken 2016 all rights reserved


Stuff nobody will tell you about estimating

I suspect every profession has a few hidden qualities you wouldn’t discover until you’d been at the job a while. Estimating has some interesting features that can really make or break your chances of success, provided there’s somebody to point them out to you.

Speed is your friend

On the surface, estimating seems to be about careful measurements, considered accounting, and an overwhelming obsession with minute detail. In practice, successful estimating is about time management. General Contractor (GC) estimators are responsible for getting the information out to their subcontractors (subs) as well as getting the subs questions answered by the design team. Every problem needs time to resolve so it’s really important to maintain rapid communications during the bid.

Stuff nobody will tell you about estimating

Mobile office solutions, speeding you on your way to the next crash…

It’s really tempting to silence your phone and ignore your email for a few hours to get something done. Which leads to the next item…

Leadership is more important than takeoffs

If your estimate relies on sub or vendor quotes, your first priority should always be to providing direction, insight, and encouragement to those bidders. Specifically, your efforts should be directed towards finding a unique and advantageous approach to the project. Ineffective estimators tend to assume that there’s something special about their company that will ensure that bidders will give them their best efforts. In a vacuum of leadership, subs will hedge towards protecting their own interests which never means low prices.

Perspective, then persistence

Hard work and persistence are admirable qualities that absolutely will not lead to success on their own. Lots of estimators assume that bidding and winning have a cause and effect relationship. It’s true that you can’t win if you don’t bid. However the reverse is not always true because there are insincere/unfunded clients with projects bidding that have no chance of being awarded. Sadly these clients consume the lion’s share of the slow market. While they can occur at any level of the market, these clients tend towards the bottom strata wherever they appear. They can be identified by their incomplete plans, short deadlines, multiple alternates, and resistance to answering questions. Everything is supposed to start right away despite the lack of permits, or even plans that would pass building department review. These clients range from uninformed neophytes, to jaded negotiators. What they have in common is the general belief that they don’t owe the low bidders a contract award in exchange for the free bids.

In the worst cases, the client will use the proposals to inform their negotiations for bid shopping. “Helping” an unethical client to award your competitor is a destructive use of your time. Morally flexible estimators might think it’s great to be the person such a client calls to “negotiate” with. Clients who bid shop are cheating all the companies who bid in good faith.   These negotiations open with two assumptions; the client is never fair to their contractor, and they think you aren’t smart enough to see that.

Any estimate that will not lead to contract is a waste of time. Better estimators don’t make better clients. Until such time as estimators can seek recompense for time wasted on feckless clients, we must protect our companies interests by declining to bid. In hard times, the estimator must be prepared to accept that this means precious few real opportunities will exist. This reality escapes those consumed with hope that behind every half-baked set of plans lies a great opportunity. The fact remains, when the good clients exit, the market declines. Down markets always have lots of terrible clients wasting everyone’s time with profitless jobs that rarely happen. It’s the only time they can attract bidders.

Stuff nobody will tell you about estimating

“Attention everyone, ship Desperation is now boarding..”

There is no market for bad news

Estimators looking to trade publications, and mass-media for relevant information on their market are bound to discover that there are precious few articles that will admit when things are bad in the present. Unless the article is written to influence an election, you can count on the article to refer to bad markets in the past tense framed in the perspective of steady improvement since then.

Periods of intense bidding with low backlog should indicate that contractors are starving for work and are chasing whatever is out to bid. Often, these times are couched in phrases like “Bidding picked up in the 4th quarter signaling potential growth this spring”.

Once spring rolls around and the summer rush work comes out to bid, these articles will say “Despite holiday season slow-downs, construction steadily climbs”.

This optimistic world-view is on display whenever you talk to other estimators. Go to a job walk and eventually you’ll hear someone ask; “You guy’s staying busy?”. With rare exception, the response is merely a list of the most impressive sounding projects that estimator won within the last nine months or so. Nobody likes a downer but it’s important to understand that what you’re hearing is not the entire truth. Estimators must learn to look beyond what’s said, and listen for what is missing.

If you’re struggling to land work, consider what you’re hearing from others. If the projects listed at a job walk are all finishing up, that’s a strong indicator that new victories aren’t newsworthy which may suggest that your problems are shared. Subs bidding to GCs should pursue bid results aggressively. GC’s are often more candid about the client, and the market after they’ve lost a bid. Estimators who speak truthfully and share what they see often benefit from information shared in kind. GC estimators are often listening intently to the nuance of what their subs are telling them. Don’t get too involved in trying to appear strong when you’re trying to find work.  Posturing sends the wrong message.

Decisions define us

Estimators exist because it’s not possible to simply “add everything up” like a cashier. Simply put, estimators must make decisions about what to do when things aren’t perfectly clear. The lack of information is a risk, making a decision on how to handle that risk means you’re accepting responsibility for the outcome of that decision. It’s easy to see that decisions based on the worst case scenario is the most likely to add money and time to your estimate. GCs who habitually sandbag their estimates are communicating their priorities. Competitive sub bids will go where they won’t be squandered.

While on the topic of unclear plans, it’s worth commenting on motivations. Missing, incomplete, or contradictory requirements may be a symptom of design team motivations. Estimators who’ve reviewed plans from a design-build project may notice that the plans have far fewer notes, and shorter specifications than projects developed for hard-bidding. Design professionals working on hard-bid projects are primarily concerned with their liability.

Design teams know that budget blowouts are a frequent outcome of bidding. Costly items are often sparsely mentioned on plans in the hopes they’ll be overlooked by the contractors. These buried notes are an owner-placating feature that the designer is trying to buy with the contractors money.

Stuff nobody will tell you about estimating

It’s rare to see such a perfect application for existing technology

Their decision to be predatory speaks volumes on their character. Exposing these traps through Request For Information (RFI’s) is how you can control risk without losing the job.

The advantage of ethics

Dishonesty is rampant in the construction industry. Incomplete plans labeled “100%”, or unrealistic schedules, are simple examples but this issue runs deeper. Information is withheld simply because it’s less risky to remain silent.

Bid results are traditionally provided upon request.  In practice, this typically means the GC estimator plays “keep away” with the information until it’s all but assured that the sub will never profit from it. Some GC’s are so focused on their own interests that it borders on cruelty. Providing bid results is seen as additional work that only benefits subs.

The deal offered to subs is to either award them a contract or furnish them with bid results in exchange for a free bid. GCs should promptly and publicly furnish this information to recompense subs for their bids. Better informed subs deliver better bids.

Acting ethically can present huge advantages beyond good-will. Trustworthy estimators benefit from stronger relationships with their vendors and subs. There’s less risk in working with honest people, lower risk means lower prices, which means you’re harder to beat and more profitable than your competitors.

It won’t do much good to pursue the bottom of the market with high-minded principles. However an established reputation for fair-dealing has a way of opening doors to quieter opportunities. The very best clients choose to work with honest contractors. There may be fewer opportunities compared to the hardscrabble market. However the work you’ll land is more successful, and reliably profitable than the high volume of profitless work out for public bidding.

Good estimators have pull

With all the information going back and forth, it’s easy to overlook a vital aspect of an estimators craft. GC estimators rely on subcontractor proposals to help define, describe, and value the scope of work. Attracting market attention is a function of a good opportunity, minimized risk, and profitability. Market leaders will avoid unprofitable, risky, or difficult projects. As an estimator it’s easy to think that the project’s intrinsic qualities aren’t under your control. To be sure, there are definite challenges in bidding ugly work.

The estimator must understand why they’re pursuing a project. Simply grinding out bids because a Request For Proposal (RFP) landed on your desk is what I call bid-milling. Bid-milling is the practice of chasing everything in the hopes that higher volume of bidding will create profitable wins.

Stuff nobody will tell you about estimating

It’s not a good look

This never works because each firm will be a market leader for specific opportunities. A contractor with a high volume of losses communicates that they’re not a real contender. The market-leading subs won’t waste a bid on GC’s who aren’t sincere about winning.

A GC estimator needs to understand that a mediocre project with a good client can be made into a profitable and low-risk opportunity through their leadership. GC’s who habitually work for good clients naturally attract market leaders. Contractors with a history of well-managed and reliably profitable projects are able to reduce the risk of less professional clients and their design teams. All of this starts with the estimators commitment to controlling risk.

Estimators who pursue good opportunities with accountable leadership, ethical dealing, and meaningful feedback are more successful than their competitors because they are the professionals, that everyone wants to work with.

I encourage you to consider those actions carefully. These simple actions are profoundly rare in professional estimating because most folks think their situation is different, therefore some aspect doesn’t apply to them.

Success in this craft requires clarity and intent above all else. There are no shortcuts with something this simple.

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© Anton Takken 2015 all rights reserved

 

 

 

 

 

 


To fee or not to fee…

Fee or profit, is the amount you stand to gain for taking on the risk of the contracted value of the work.  Most contractors competitively bid using a percentage for fee.  In the cases of a negotiated agreement, the contractor may elect to bid a fixed fee for a set duration.  Any extension beyond that duration has a weekly rate.  This can alleviate client concerns regarding changes because the General Contractor has no monetary stake in change orders that won’t extend the job.

Profit is not optional for a business to succeed.  Winning an unprofitable job may well consume resources that prevent taking on a more profitable prospect.  This is called “opportunity cost” and it’s terrifically important to consider when a client is looking for  help on a low-budget project.  “Helping” that client costs much more than just the profit.

To fee or not to fee...

Experience shows these clients are more likely to require extra revisions, extensive pricing breakouts, and as a rule, they pay very slowly.  Charity organizations that must “pass the hat” in order to pay an invoice are great examples of this.

Unpopular can be profitable

As counter-intuitive as it may sound, very few people are analytical about what makes work profitable.  Often in construction, the focus is on the difficulty of a project.  As a result ground up or new construction project is viewed as more profitable than a remodel.  While it’s true that there is a greater degree of uncertainty in remodeling, it’s not the only factor to consider.  Basic rules of supply and demand play a role.  When there is more supply than demand, prices must fall.  More contractors pursuing ground ups leads to greater competition and lower profit margins.

Balancing act

From the earlier article on overhead we’ve shown that overhead is driven by project duration, pay delay, inflation, and office commitment to that job.  Put another way, if a job is too small the overhead costs are too high to make that firm competitive on those bids.  If the job is too large, the company risks all other contracted work becoming “non-profit” while they scramble to keep up.  Companies obsessed with landing the big job are especially vulnerable to biting off more than they can chew.

To fee or not to fee...

Efficiency of scale is how economists describe institutions that must reach a certain size in order to make their product marketable.  This is especially true of General Contracting.

Many entrepreneurs fail to recognize that contracting is about assuming risk.  An estimator’s job is to reduce risk.  The test of an estimators nerves is to balance the risk and the profit while keeping a keen eye on what the market will bear. Some estimators are very intolerant of risk to the detriment of their vocation.  It’s a fine line to be sure but every good estimator must reach a point where they are comfortable with uncertainty.

Most contracts require retainage which is  traditionally 10% of contract value held as surety until the job is done.  Most competitive markets keep profit percentages below 10%.  When the retainage is greater than the profit, the contractor must complete the job to cover bare costs which is why it’s done.   This relates to a surprising difference of opinion on what should and should not have the fee applied.  Simply stated, any direct project cost to include overhead should have the fee applied.  Permits and taxes are typically calculated on the sum-total  including overhead and profit.  Bonding agencies typically provide a formula for calculating their fees.  Be advised that they calculate their fees based on the sum total of everything included in your contract total.  Since bonding fees are job costs, you’ll need them included in that total.  Look for future posts with some excel formulas to help solve this problem.

Beware of moving parts that eat your profit

When bidding it’s very common to encounter requirements to provide allowances, alternates, and unit costs to the client.  This information can and likely will be used to influence owner decisions on anything from scope of work, to change order pricing.  In the case of publicly funded work, it’s very common for there to be several alternates which the decision makers use to maximize their allotted funding.  Speaking very generally, you should add overhead and profit to all additive alternates, and unit costs.  With deductive alternates you should keep the overhead and profit from the base bid.  The rationale for this is simple.  Deductive alternates typically don’t always affect the schedule duration. That means that your overhead costs aren’t likely to go down.

Since additive alternates can be viewed as a separate and smaller bid, it makes more sense to bid them accordingly. The overall project duration isn’t typically extended with additive alternates which means there’s greater workload on every scheduled day if they’re accepted.  Making every portion of work “pay its own way”, ensures that you won’t come up short.

Unit costs and allowances should be treated like cost accounts rather than jobs.  Keep in mind that you need to be OK with the client adding or subtracting using this price.  With an allowance, it’s important to know that the client will expect unused allowance money returned.  It is not uncommon for costly undefined items to be carried as an allowance.  Be aware that clients and design teams view allowances differently.  It’s embarrassing for an allowance to come up short once the design team weighs in.

To fee or not to fee...

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Alternates can drive permit costs as well

One commonly overlooked issue with alternates is how they influence the permit fees, taxes, and bonding rates.  In some cases it’s going to be negligible, in others it could be massive.  From the permit counter’s perspective the project costs whatever your contract’s written for.  They’re not concerned with how the client asked for the pricing.  Be advised that some cities conduct audits on contractors and any penalties they assess will come out of your profits.  Some cities have a policy to conduct an audit within six months of final inspection for every project they permit.

Alternates can define awards

Let’s suppose that a bid had five alternates.  When all the bids were read and tallied, your bid was low for all possible combinations but one which sadly, is the combination the client selected.  It’s terribly frustrating to be low on five out of six prices, and still lose the job!

Reading the tea leaves of bid results will be a future post but let’s take a moment on a few details about the last example.  If a competitor was higher than you were on the base bid and four out of the five alternates.  It stands to reason that there’s something significantly different with that last alternate.

Strategy may look like error to the opposition

Lots of estimators would assume there must have been a mistake. There may be another explanation.  If that bidder knew which alternates would be accepted, they could determine the overall profitability of the job and make the strategic move to bid that alternate “for free”.

Knowledge is power

It’s easy to get into the mindset that everything in an estimate must be about uniform and consistent accounting.  Remember that estimating get’s you the working knowledge to reduce risk, but bidding is about winning a job.  Many fastidious estimators lose bids because they don’t have a strategy to win.  It’s critical to get your head up to see the big picture.

 

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© Anton Takken 2014 all rights reserved


Why overhead should not be figured as a percentage

Don’t get trapped

There are quite a few traps that people fall into when it comes to overhead and profit.  Perhaps it comes from a desire to simplify operations or a lack of follow through but one thing is certain: percentage based overhead calculations aren’t accurate most of the time.  It’s possible that a given percentage on a given project will end up covering the overhead costs for that project’s duration.  It’s just unlikely.

Overhead is not optional, imaginary, or driven by profit

Lets start with the nuts and bolts of overhead.  These are the costs of doing business.  Everything from office rent to printer paper get’s paid out of overhead.  Depending on how a company is structured, overhead may also pay the wages of staff members.  With rare exceptions, overhead costs are predictable and occur at regular intervals.

Why overhead should not be figured as a percentage

Like ammunition for example…

 

The key element I’d like to call attention to is that overhead must be paid as a function of time.  Rent will come due every month – it has nothing to do with how well the jobs are going.  As a bare-bones issue, overhead is a non-negotiable sum you must be earning at all times or you’re losing money.  Even non-profit companies MUST make overhead or they’ll go under.

Getting a handle on it

Figuring out overhead isn’t complicated, nor does it need to be.  I recommend taking the entire years worth of overhead costs (or projections) because some items are only payable annually.  For example a subscription to a trade publication, or the renewal fee for a license.  For companies with several years of records, I would encourage you to calculate the years separately to see year to year differences.  We’re looking to establish a baseline, not split hairs.

So annual costs (or projections) in hand it’s time to add for inflation and growth.  For the sake of simplicity let’s say that in an improving and expanding market, a 5% add is in order.  For a depressed market, it could be lower.  Unless you’ve got great reason to do so, don’t go negative.  Take this annual figure and divide by twelve for monthly overhead. Divide the total overhead by 52 for weekly.  Take your weekly and divide by five for working days.

Notice how I didn’t take the annual and divide by 365 to get days?  Working weekends isn’t typical for most businesses.  There are 260 working days (no holidays) in a year.  One way to handle the holidays is to assume 50 working weeks per year which give 252 working days per year.  The goal is to shift the overhead costs onto the working days.

Each job pays its own way

Now that we’ve got the daily overhead rate we need to answer some job specific questions.  First off, how many jobs will be going at the same time?  Each job needs to carry its fair share of the load.  Looking at company history to see what the average concurrent job count is will prove helpful here.  If there’s reason to believe you’ll have four projects going at all times, the overhead rate applied to each job should be a quarter of the total.  I call this office commitment. Be warned that each job is different.  If you’re looking at a very large job, it could consume all the companies resources for its duration.  Similarly, a “hurry up” job that requires you to drop everything would affect its bearing on your overhead.  You will quickly see that faster is cheaper.  A notoriously disorganized client, architect, or owner should indicate that a higher portion of your overhead costs will be attributed here.

Why overhead should not be figured as a percentage

Pictured above: A typical Owner, Architect, Contractor meeting.

Delayed gratification (and payment)

So are we done?  In a word, no.  The sad fact of the matter is that work is nearly never paid for as quickly as it’s done.  A standard practice in the construction industry is to withhold payment equaling 10% of contract value until the project is complete. A heavy equipment contractor would obviously complete their work well before a building is completed.  That contractor may not see full payment for several months!  Any financing costs arising out of their need to cover bills while awaiting final payment must be paid out of overhead which can be factored by the actual delay in getting paid.  Running a quick scenario, imagine it takes two weeks for that heavy equipment contractor to do a job and there’s about $1,000 a week in overhead for the operation.  If it takes sixteen weeks to get the last 10%  then $200 worth of the overhead is accruing interest for four months.  Let’s say it’s a credit card interest level of 15% which makes the additional cost $30 for the first month, $34.50 for the second month, $39.75 for the third month, and $45.64 for the last month.  Because it’s compounding, that delay ended up costing $149.89 to the contractor even if they got on to other projects while awaiting payment.

Taking stock of all these factors, you will arrive at a total overhead cost.  The overhead is not driven by how many people are working on site because those folks are job-billable.  The overhead is not driven by project cost because again, all of that is job billable.  Project duration, inflation, payout delay and office commitment are the only factors driving overhead.

Unintended consequences

Getting back to the headline of this article, I’d like to illustrate why percentile overhead calculations are so ruinous.  First off they work on the assumption that all jobs will consume overhead proportional to project cost.  This has the effect of charging too much overhead for jobs you’re really efficient at, and charging too little overhead for jobs you’re not as efficient at.  By extension this causes bids to run higher on jobs that more perfectly align with the companies abilities.  Conversely this causes bids to run lower on jobs that don’t align as well.

Let’s say we’re a company that furnishes and installs millwork.  There are two jobs to install millwork in commercial spaces.  One job specifies more expensive laminate material than the other but every other factor is the same.  Does it make sense therefore to bid a higher overhead amount for the nicer laminate?  Jobs are often won and lost by such amounts.  A set overhead percentage will only fit one dollar value perfectly.  Everything else is a bet against the future that you’ll pay for in lost overhead, or lost jobs.

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© Anton Takken 2014 all rights reserved