October 2004
  
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Controlling Costs

  Al De Wachter
ICS Inc

Controlling Material, Subcontract, Miscellaneous Costs
Better understanding and management of job costs.

This is part 3 of a series of commentaries that are intended to stir up ideas for the high-tech contractor. They consist of excerpts from “PLUG” or the “Plan Users Guide”, a practical catalyst intended to promote positive change in the automation contractor ‘s world. The complete series will be made available upon request after all modules have been published in AutomatedBuildings.com.

Material Cost Control

For optimum effectiveness, the job design format should be the same as, or similar to, the job estimate format: clear segments that are understandable. The estimate breakdown, typically by geographic areas or another installation-segment related building area factor will produce discrete blocks of material costs that enable a measure of control because the material content can be understood in relation to the system it is deployed in. Bulk “Laundry lists” of material should be avoided because they detract from the ability to understand the material cost commitment and analysis.

Design / Project Engineering personnel are in charge of the materials ordered, i.e.

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Material Standards are an important Key
To achieve consistency of operations and credibility with a customer base, it is crucial to do everything reasonable to standardize on the optimum material choices. ‘Optimum’ refers to a proper combination of quality, first cost, installation (manpower) cost, and warranty cost combined. However, it goes a lot deeper than that. Once a certain product is accepted as the ‘office standard’, all kinds of benefits result from this decision. Sales people know what to sell, designers know how to engineer it correctly and where to purchase it, field people know how to install, adjust and program it, spare parts are easy to obtain and cheaper to inventory, and customers know what to expect. Also important is that libraries of standard systems can be developed that save estimating and design time and increase bid confidence and profitability.

This also implies an effective Material Follow-Up process: who selects the devices, who buys them and when, what is the ordering and receipt process, what are the rules for storing the materials until they are needed, how is pilfering avoided? Can you order and get paid if the material is on site, what is on-site security like, who looks after delivery follow-up and how, etc.

After the 'design' process, the operations department is responsible to perform a material-and-labor cost review (engineered estimate) on the job, to ensure that the Design team interpreted the job similar to the Sales team. The engineered estimate process typically consists of a modification of the sales estimate, using the same guidelines, but allowing for the ACTUAL (as designed) equipment, installation material (scaled tube/ conduit/ wire runs) and associated labor costs and assumptions.

A detailed labor plan follows naturally from this process, since the estimating (as-sold) AND re-estimating (as-designed) system drive the labor hours, which is the basis upon which the field labor can be measured and controlled. This is discussed later.

NOTE:  We suggest that you adopt a rule that says that Design Engineering personnel are the ONLY people allowed to place orders for EQUIPMENT (devices) to be charged to a job. Violation of this rule introduces corruption in the project material cost control integrity, and deteriorates the concept of accountability.

Equipment purchases are subject to review/approval:

Equipment / material cost control comes down to the following guiding principles:

NOTE: 'Equipment' above refers to 'devices', typically having a manufacturers part number; 'Installation material' refers to tube, wire, conduit, and installation accessories typically bought 'in bulk'.

CatNet Systems Adherence to these principles will ensure that material costs are NOT going to be a 'surprise' issue in final job costing. The design team verifies the estimate. The designers determine what is to be placed on order. Administrative people process the approved orders only. After ordering of the equipment, installation materials, material costs are already committed.

In summary, the effective control of material costs depends on the simple principle that if we determine in advance what we will buy, and then stick to that plan, the material cost is known and under control.

It must be appreciated that the success of this simple system lies in the strict adherence to the premise that only certain people are allowed to purchase job equipment and materials.

If the Project Manager has in his possession a full list of the 'engineered' material and equipment for the contract, then he has at his fingertips a powerful tool to ensure that NO orders are placed except as per the contract drawings, which he has approved and accepted.

Control of Subcontract Costs

The concepts related to Subcontract Cost Control are highly similar to Material Cost control: the purchase decision is made at one point in time, which represents the control factor. Unless special situations arise, timing of the payment is not important for ‘subcontract cost control’.

However, where subcontracts are used to do significant parts of the work, it must be recognized that effective subcontracting is a whole separate 'skill' to be mastered. A basic premise in any subcontracting is that information transferred to a subcontractor must be sufficient in quantity and quality such that you may expect a professional quote and installation from the subcontractor without later being 'nickelled and dimed' because his crew is not productive due to your poor documentation.

This is of course is no different than the info your OWN people need to do a proper job. In fact, your documents should ALWAYS be good enough to subcontract from, whether or not you choose to do so. This implies a quality in the drawings etc. that stands up to the scrutiny of the 'field'. Sometimes, your “own people” feel they are in no position to complain about the quality of internally produced documents, and they are expected to be mind readers. Subcontractors will not only complain, they may demand more money due to inadequate documentation.

Subcontract cost control starts with clear, complete information to which the subcontractors (always two or more) can bid. Failure to have a complete set of 'Subcontract Bid documents’ will merely result in extras for which you will GET no extra money, but for which you will have to PAY out of your profit margins.

After you select one of the bidders based on price and ability to do the work to acceptable standards and in the necessary time frames, the subcontract document is drawn up, and at this point the COST IS COMMITTED. All remaining activity will result in WHEN we pay the bill, (as the work progresses) not HOW MUCH we will pay. The subcontract cost has just been ‘controlled’.

Control Solutions, Inc Installation Standards are an Important Key
Often we fail to remind subcontractors, or fail to enforce as needed, the use of specified or technically necessary installation materials such as type and grade of conduit, wire, hangers, connectors, panels etc. We do not always insist on the quality of installation as it relates to installation standards. Together with your direction on installation materials used, you MUST have clear instructions for, and expectations of, the workmanship and methodologies used to perform your work. A low price is not good enough. This may extend to color coding rules, wire terminations markers, conduit routing, pull wires included in conduit, in-panel work, and all adherence to terminologies and markings on your drawings. (which must obviously be clear and correct).

It is extremely unwise to ignore the quality of the subcontractor’s work, as he represents you in the eyes of your customer. Don’t be penny-wise and pound-foolish.

Similar to Materials cost control, true cost control for subcontracts takes place BEFORE the subcontract is issued, assuming that the P.M. ensures that the Subcontractor does the work as instructed. KEEPING TRACK of the cost via vouchers in the office accomplishes very little for the final cost outcome.

There is, of course, a need to stay aware of the subcontractor's progress, such that you will not pay him for more work than he has really accomplished. (In that case, you might lose money in the event of his bankruptcy.)

Control of Miscellaneous Costs

All miscellaneous costs should pass through the Project Manager’s hands in the form of decisions and approvals. Real "control" in the sense of influence exerted on the events taking place, happens at this time. The thought process that decides to make the expenditure or not, is a SITUATIONAL one, not one that is planned in detail in advance. This means that a decision to spend or not spend the money, is made at the time the event occurs. Later 'tracking' does not change the outcome of history; although of course, history will repeat itself unless we learn from it. (Which is one reason for MIS Tracking costs.)

In all cases, the initiative to SPEND must be weighed against the estimate (did we estimate 'it'), against the need (do we really need it), and against various other factors:

This decision process is similar to what the Design Engineer goes through when he selects the job equipment. What should be understood is that the DECISIONS that are being made by all project personnel will be BETTER decisions if all the players on the team share the same, clear understanding of what the PLAN and SCOPE for the contract execution are.

Excessive office 'tracking' efforts result in extra labor being spent with no real results in increased control. A month-end MIS report adequately serves the purpose of COST AWARENESS to your satisfaction, provided that the breakdowns in the accounts are sufficient, and can generally be related to (line up with) the Estimate and Project reports.

Labor Hours Control

Labor COST control is directly related to labor HOURS control, which is arguably the most difficult of the control tasks.

Reliable Controls Installation Standards are an important Key
As with material and subcontracting, STANDARDS have a great impact on labor hours control. To achieve a level of measurability and controllability, the labor task disciplines used in the operation should include appropriate and well thought out standard approaches such as: installation processes, commissioning, calibration, verification and testing, client and internal communication. There should be appropriate check-off forms that can be used to document the process with the client or consultant, which also helps from legal (obligations fulfilled) and financial (collections) aspects.

An ACCEPTANCE PROCEDURE should be employed for all labor tasks so that expectations are as clear internally (your people know what is required) as externally (the customer knows what he’s getting). This helps people distance themselves from vague processes and hollow wheel-spinning, and towards clear expectations and purposeful, goal-oriented activity.

Working towards acceptance should start EARLY in the project, one could say DAY 1, so that the project is self-documenting for technical, legal, financial and training purposes.

With some provisions made for labor pay rates applicable, overtime labor used, and the use of apprentice labor etc., the relationship between hours and dollars is direct, and LABOR COST is indirectly taken care of if LABOR TIME is controlled. The message should be that TIME is of the essence, that you are meeting a DEADLINE measured in TIME, not dollars.

Don’t ask your people to control labor cost – ask them to control labor hours. This difference may appear trivial, but it must be remembered that the people who determine the time spent on certain tasks, are the people doing the actual work. Invariably, there is not a strong level of acceptance by these people of COST accountability, whereas TIME is much more readily accepted as being under their control. Additionally, attention paid to DOLLARS reduces the focus on the labor HOURS measurement and control efforts. DOLLARS may be interpreted as being "not MY problem; MY job is to solve real, technical job problems, and to do a fair day's work”. Why fight human nature? You’ll lose every time! Measure hours - not dollars.

Difference between Tracking and Controlling Labor
It’s important to recognize the differentiation between TRACKING and CONTROLLING labor.

TRACKING labor involves collecting data, via time sheets etc., on the amount of time already spent on a job. TRACKING may show us how successful control IS or HAS BEEN, and how it compares against the estimated time. TRACKING deals with HISTORY.

CONTROLLING labor involves the SETTING of labor goals per measurable area and tasks with the people involved, COMMUNICATING these goals to these people, MEASURING progress against goals and time constraints, and COMMUNICATING the results to the team. It implies taking proactive steps to influence the amount of hours expended. It is deceiving to think that you can control labor by tracking it, although tracking may provide valuable historical information. ‘Control’ happens when careful steps are taken to implement a plan through measured actions that are proactively devised to achieve the desired result.

Performance and progress should be observed so as to follow the designs and specifications, which validates the plan (if everything goes OK) or raises flags early (in case of problems).

Successful Job Cost Control flows from these few basic elements:

Segments
One key to cost control is in your OVERALL ability to break the job into the 'right' pieces or geographic building areas. Ideally this starts from the SALES estimate, through to the DESIGN and into the planning and INSTALLATION phases. The suitably-sized segments are then more easily grasped by the Project Managers and trades-people in setting production expectations and standards, and measure the actual production against expectations in fairly small intervals of time and tasks performed.

This way, responsibility and accountability for performance remain as close to the trades level as possible, which is a necessity for successful labor control. People must be IN CHARGE - and accountable!

The Project Manager must ensure that the breakout job segments or areas lend themselves easily and naturally to be recognized as:

Feedback from the field will typically be in the form of weekly timesheets, showing the area and the tasks worked on during a certain period. Technology is moving in the direction of daily, even instant feedback of tasks. The key to success here is to keep the work areas easily understood, and the tasks very simple. Hopefully, the number of tasks a tradesperson performs should be limited to 3 or less, and ideally as little as only 1 per day. The design, programming, drafting and Project Manager work is not area or segment oriented, and will often be reported as 'tasks' only.

LABOR UTILIZATION

Anyone can get the job done within the budget if they don’t charge their time to the budget. When an employee charges time to accounts other than projects, that time is not absorbed in projects, and we say that our labor utilization is affected.

CatNet Systems When management prepares an annual budget of revenues and costs, certain assumptions are (should be) made regarding labor utilization. If it was assumed that a technician would charge 80% of his time to projects, (40 hrs/week x 80% = 32 hrs), that leaves 20% to be absorbed elsewhere, in overheads.

If in reality he charges only 60% (40 hrs x 60% = 24 hrs) to projects, there are 8 hours per week, or 400 hours per year, that will become a burden on the overhead recovery. The projects may look better, but the overhead is killing the company, and profitability is erroneously reported.

To defray the personnel costs onto projects, the hourly rate estimated and charged to a project could include an allowance that covers absorption. Alternately, an ‘overhead charge’ to each project can defray these costs. In either case, it is important to recognize that if the ACTUAL absorption differs from the PLANNED absorption, the difference will show up on the bottom line as a gain or loss. NEITHER one is desirable, because any erroneous absorption can either mean we’re losing money, or losing work.

If the absorption is made part of an hourly rate, and if an employee costs $50.00 per hour as calculated at 40 hrs per week, an absorption rate of 80% would drive an hourly charge rate of:

                $50.00 x 40 hrs
                 ------------------         = $62.50 / hr
                40 hrs x 80%

Generally, the principle is that PROJECTS are the only revenue producer and they pay for running the whole operation. Hence the goal of absorbing costs into projects is to defray all costs either through direct or indirect project charges. There is no other “pot of gold” from which to draw.

Trailing Labor Costs and Warranty
Trailing costs are costs that ‘trickle in’ after a project has been closed and final financial reporting has been done on the “completed” project. If costs trickle in that really belong to the project’s installation, these should NOT be treated as Warranty costs. In actuality these types of costs should NOT happen and the reason for their existence should be procedurally eradicated. An example is late invoices for material or time sheets, subcontract invoices, cost transfers from other projects, etc. If these costs are allowed to “fall to the bottom line”, then a project’s profit is artificially overstated (with possibly performance incentive or other cost repercussions). Trailing costs should be tracked and reported by projects, and the faulty processes should be corrected.

Warranty costs are costs incurred after the project is completed and accepted. These costs are legitimate costs that are incurred when defects, breakdowns, etc are corrected. These costs should be anticipated. When a warranty cost is estimated, (whether or not the warranty cost is marked up for profit), this cost is NOT really a part of the project’s cost, and should not be declared as PROFIT at the close of the project. In reality, the warranty should be placed in a 'pot', or a separate project could be set up that represents the “Warranty Job” so that it can be separately tracked as a project, with its own estimated and actual costs. At the end of the warranty period, it can be closed out with an associated profit or loss, which imparts validity to the amount of warranty estimated, and/or to the success of the warranty performance process.

If warranty performance is sloppy, significant margin dollars can be lost without clear knowledge of where the money is going. Often poor project performance is hidden by dumping trailing costs and actual project work into a global “Warranty account”. This is not a good business practice.

Part 4 will discuss Job planning and Specific planning steps


About the Author

Al De Wachter has been active in the Building Automation industry for over 35 years.  He has held senior positions with leading companies in the field and is currently the president of Independent Control Specialists Inc.  Al has directed the development of advanced productivity software for Building Automation Contractors since 1990.

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