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Overhead Costs are the Silent Killer of Project Profitability

Overhead Costs are the Silent Killer of Project Profitability

Most contractors today exist in a very competitive landscape where margins are tight, and customers are demanding.  This leaves them little room for error when executing on projects – otherwise their profits will quickly be eroded, their reputation damaged, and their ability to sustain a healthy, growing company will be severely compromised.

 

cost and profit sized-1

 

When bidding on projects, companies will naturally bid their price to ensure they make as much profit as they can without risking losing the deal.  Once the deal is awarded and the project starts however, most companies fail in the ongoing monitoring of that profit as the project plays out.  “The organization that depends upon project profitability for survival can be severely affected by how well the Project Manager maintains the profit originally planned.”  So says Janet Moore and Jay Gassaway in their excellent paper on Project Profitability.  This is a common challenge since most contractors focus the bulk of their attention on doing good work and making the customer happy.  Clearly, few would argue about these being the primary objectives.  They should not, however, be at the expense of losing money on the deal.  To address this common trade-off, Moore and Gassaway discuss the optimal balance between Quality, Profitability and Customer Satisfaction as the three critical success factors of any project. “Achieving quality and profitability goals without customer satisfaction are not worthy objectives. Clients demand that project managers deliver quality solutions on time and within budget. Dissatisfied clients often lead to overrun projects, little or no profit, and little opportunity for repeat business.”

 

Profit is at the Heart of Why We Do This

Most contractors will tell you that they are very good at what they do.  They have the experience, skills and talent to execute with precision and truly deliver results for their customers.  What they’re not always as good at, is maintaining focus on the business side of the project – meaning, keeping things profitable.  Yet, despite their high-quality work, profitability is unmistakably at the heart of why they’re in business.

There are several major factors that can get in the way of profitability if not managed carefully. Things such as: Change Orders, Schedule adherence, Material Delays, access to reliable labor pool and a reliance on subs & trades, to name a few.  These are examples of typical things that are known and expected, and most contractors have processes in place to deal with them, and manage their impact through contingency, change orders, etc. For a contractor to stay in business, they absolutely must have a solid grip on these common snags or they’re clearly going to fail.  “Proper financial management of a project,” assert Moore and Gassaway, “is critical to an organization’s stability.”

 

It’s Overhead that Kills Profit

With tight margins and aggressive deadlines, there’s really no room for inefficiencies, redundancies and waste – otherwise projects will barely scrape by with nominal profit.  Of course, all projects require a certain amount of overhead to function – indirect activities like project management, purchasing, project controls, finance and admin staff are the glue that hold everything together.  It’s in this overhead however, where most of the inefficiencies are hidden, and can impose insidious costs on the project that swallow up significant chunks of profit margin. 

It’s not uncommon, for example, to see contractors with a bulk of staff just to track, re-key and process daily costs and activities from the jobsite.  Daily information from jobsite is often tracked using spreadsheets and paper then tossed over the fence to the back-office people to deal with the errors and omissions. They then try to piece it all together and re-key it into another system to record project costs; and then organize it for billing backup.  On top of all that, they have to chase project managers around to get vendor invoices approved as part of accounts payable.  All this is very labor intensive and causes delays and mistakes – not to mention missed billings.

What’s even more sinister about these costs, is that many companies don’t track them directly to their projects, so they have little visibility into the true cost and profitability of their projects.  Mostly, overhead activities are treated as general expenses and are sunk into overall corporate costs.   As a result, these costs not only don’t show up as project cost, but organizations don’t typically factor these costs into their project’s price either.  They’re truly invisible, but significantly impact the bottom line.

 

Eliminate Unnecessary Overhead with Systems and Processes

With proper systems and processes in place, the vast majority of these inefficiencies can be eliminated; and companies can recoup 5% or more of their overhead project costs. That may not seem like much, but when companies are banking on single-digit margins, that can make a massive difference. 

I’ve lumped ‘systems’ and ‘processes’ together since they’re typically addressed, adopted and improved at the same time.  In other words, the labor-intensive and inefficient processes that have emerged for many companies over the years of being in business, are a direct result of not having a system in place to streamline those processes.  

 

It’s a Natural Evolution

It’s a very common challenge for contractors large and small to come across these typical issues that come with growth.  It starts with a smaller, dedicated team performing on modest-sized projects – and grows to a larger, distributed team, and bigger projects that have the potential for greater revenues and profits; but equally greater risk.  It’s at this point that organizations feel the weight of chaos that comes with growth, and need to look at technology and streamlined processes to match the complexity they’ve undertaken.

 

REFERENCES

https://www.pmi.org/learning/library/project-profitability-plan-keep-it-7190

Moore, J. C. & Gassaway, J. D. (2007). Project profitability—plan for it and keep it! Paper presented at PMI® Global Congress 2007—North America, Atlanta, GA. Newtown Square, PA: Project Management Institute.

 

By Christopher Ronak | April 16, 2019 | Categories: Construction Cost Tracking, business process improvement, project cost management software | 0 Comments

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