Last month, I touched about estimating systems, but this month I want to get detailed on a couple. So far in 2013, I’ve been in 25 states and have benchmarked the operations of more than one hundred green industry contractors.
These contractors have me review their budgets. During this process, I am looking for areas where the systems (estimating, job costing and accounting) that these clients are using contain mathematical errors and false mathematical assumptions.
They realize that if their systems contain such errors today, it will cost them jobs and money in the future. Such errors need to be identified and fixed.
Your estimating is your future. Twenty years ago I worked with a $5 million commercial landscape company in the Northwest U.S. who lost $500,00 of work because he used a faulty estimating system (the multiple overhead recovery system – MORS) that caused him to overprice his work. Had he won this work, it would have significantly increased his net profit margin for the year.
As I have stated in this column many times, the primary objective of any cost estimating system is to calculate all of your costs accurately. In order for a contractor to wrap his or her head around their business, they have to accomplish three things regarding their work (projects and services): 1. Price it right. 2. Produce it right. 3. Produce enough of it. The first is about cost estimating. The second concerns job costing and the third concerns sales volume. You can price your services and projects correctly, produce them correctly (as you priced them), but it’s all for naught if you do not have enough volume.
Back to the future. Many contractors this year have told me that they created their own cost estimating systems, mostly in Excel. Many asked me to review their methods. Estimating material, labor wage and burden, and subcontractor costs are fairly simple.
Estimating systems usually break down when calculating the equipment and general and administrative (G&A) overhead costs to include in a bid for projects of services. This last January, a landscape contractor and I had a robust discussion regarding his MORS estimating system.
He argued that it was more accurate than my G&A overhead per labor hour (OPH) system. He had bid a $5 million project that would comprise about 25 percent of his work for the year.
Using his MORS system, he marked up his costs for materials, labor, equipment and subcontractors by predetermined percentages (normally 10 percent, 35–95 percent, 25 percent and 5 percent, respectively) in order to calculate the amount of G&A overhead to include in this rather large project. He then added net profit to these calculations.
I pointed out that whenever you use percentages to calculate and allocate your G&A overhead costs to your bids, you are automatically making a mathematical mistake. He disagreed. He then went on to admit that the MORS system calculated and added almost 50 percent of his overhead for the year on a job that make-up only 25 percent of his budget. Put another way, the MORS estimating method calculated and added six months of G&A overhead to a three month job.
He just made my case for me. His MORS method did to this job what it did to the contractor in the northwest 20 years ago. He then went on to tell me that he also calculated this job using my OPH system and it put far less G&A overhead on to the bid – three month’s less. Duh! End of discussion.
The MORS estimating method did to this contractor exactly what I said it would do. It adds too much G&A overhead to some jobs and adds too little to others. Occasionally, it gets it right. And guess which jobs you get – the ones you underprice.
Back to your future. Too many contractors that I see use percentages to measure, allocate, recover and control (MARC) their G&A overhead costs. Whether you use one markup percentage on all of your direct job costs, two markup percentages on just material and labor costs or four markup percentages in the MORS method, you are making a serious mathematical mistake that will cost you jobs and money.
In order to more fully understand the mathematical errors contained in the six most popular estimating systems used in the green industry today, send me an email and I will send you a free copy of my audio book, “A Critical Analysis of the MORS Estimating System.” Doing so today will help you prevent cost estimating mistakes tomorrow.
JIM HUSTON runs J.R. Huston Consulting, a green industry consulting firm. See www.jrhuston.biz; mail email@example.com.