Tuesday, October 21, 2014

Home Magazine Stop losing money

Stop losing money

Columns - Industry Voices

Jim Huston | August 12, 2013

Jim Huston

Two contractors in the Midwest were using an estimating system that included all of their equipment and vehicle costs in general and administrative (G&A) overhead. As a result, they were not being competitive with their commercial bidding – especially labor-intense jobs. Another contractor on the West Coast, asked me, “Why can’t I just put all of my equipment (and vehicle) costs in my G&A overhead costs and bid them into my jobs that way?” A $5 million contractor in New England, on the verge of going broke, hired me to help him figure out what his problem was. He told me, “I’ve been in business 27 years and I’ve never made more than 2-3 percent net profit on the bottom line. The more sales I do, the less money I make.” As it turned out, his problem was the method by which he included equipment costs in his bids.

As I travel around the country, this is one of the most common bidding mistakes that I see. Unfortunately, for the contractor in New England, it was too late by the time that I arrived. He was at the end of his landscaping career and unwilling to make the necessary adjustments to correct the flaws in his estimating system. If experience is the best teacher, here’s what we should learn from this contractor’s mistakes.

It was inevitable that our Boston contractor would continue to see his margins erode. I say inevitable because he had a fatal flaw in his estimating methods.. The sad part of this story is that a consultant taught him to bid this way. For our purposes, we’ll refer to this contractor as Ben Hadd because he definitely had been had, and for a lot of money.


The rest of the story.
The year before I met with Ben, his sales were roughly $5 million. However, he had barely broken even. How would you like to do $5 million in sales and have nothing to show for it? Numerous other contractors in the area, with whom I was working, were making money. Net profit margins for them were well above 10 percent. Ben should have had a 10 percent net profit margin too, but somehow he was missing about $550,000 in profit. As I delved into his financials and then his estimating system, the problem became obvious. Here are the numbers:

  • Sales $5,000,000 (should have been $5.5M)
  • G&A overhead costs $1,000,000 20% of sales
  • Billable field-labor hours 80,000
  • Equipment, truck and auto costs * $800,000 16% of sales
  • G&A overhead cost per hour $12.50 ($1,000,000 ÷ 80,000 = $12.50)
  • Equipment cost per labor hour $10.00 ($800,000 ÷ 80,000 = $10.00)

* This figure includes: depreciation, fuel, repairs, insurance, mechanics’ pay, etc.


The fatal flaw.
Ben’s company primarily did large commercial and government installation work. The estimators would calculate the material costs, labor hours and cost (to include labor burden) for a job. Subcontractors were handled separately. Equipment and vehicle costs for each project were calculated by multiplying the total number of labor hours in a bid by the $10 equipment cost per labor hour. The total of these three equal what we call total direct costs (TDC). Theoretically, if you sell 80,000 field labor hours per year at $10.00 per hour, you should recoup your $800,000 in equipment costs.

Once calculated, the estimators would add G&A overhead to the bid at $12.50 for each field labor hour, similar to how they calculated equipment costs. Adding G&A costs to your TDC gives you your break-even point (BEP). A net profit margin would then be added to the BEP to arrive at a final price for the project. Let’s zero in on two specific bids to illustrate the mathematical problem with Ben’s estimating system.


The fatal flaw illustrated.
Ben’s installation crews were comprised of three men and a one-ton pickup truck and trailer working four ten hour days per week. The cost per hour for the one-ton pickup and trailer calculates to be $12.00 per hour. Both jobs require 1,000 labor hours and should take approximately 33 crew-days to complete (1,000 hours ÷ 30 Mhrs per day = 33.33). Job A requires just the pickup truck and trailer as it entails a lot of hand work, and planting of small plants and ground cover. Job B, however, requires the pickup and trailer, a skid steer and mini-excavator running six hours per day each for the duration of the project.

Here’s the fatal flaw caused by averaging equipment costs into a bid.

Job A

Equipment costs included in the bid: 1,000 hours x $10.00 = $10,000

Specific costs for equipment used: Pickup truck and trailer: 33 days x 10 hours per day x $12.00 CPH = -$ 3,960

Estimated costs are too high by………………………………………………….. $ 6,040


Job B

Equipment costs included in the bid: 1,000 hours x $10.00 = $10,000

Specific costs for equipment used:

Pickup truck and trailer: 33 days x 10 hours per day x $12.00 CPH = $ 3,960

Skid steer : 33 days x 6 hours per day x $25.00 CPH = $ 4,950

Pickup truck and trailer: 33 days x 6 hours per day x $35.00 CPH = $ 6,930

Total costs - $15,840

Estimated costs are too low by…………………………………………………….- $ 5,840


The fatal flaw analyzed.
Remember what Ben told me at the beginning of our time together, “the more sales I do, the less money I make?” His estimating system guaranteed that result.

Ben’s estimating system was designed so that, in his competitive market, he would only get the work that he luckily priced correctly or that he under-priced. Put another way, he could not be competitive on labor-intense jobs because he erroneously included too much cost for equipment in them. Unfortunately, he was very competitive on equipment-intense jobs because he would charge too little for the equipment that he used on them. The problem with averaging a direct cost is that the market will always exploit this error. If your averaging overstates a cost, the market will tell you to get lost. However, if you understate a cost, the market will buy, buy, buy!


One final word.
Ben had two very sharp bookkeepers working in his company. I asked them a question that I did not think they could answer. It was, “Of the $800,000 in costs for equipment and vehicles on your profit and loss statement, how much of that was actually recouped in your jobs?” They told me that they had just calculated that very number a few days before I arrived. The answer: $257,000. We just found the missing $550,000!

Unfortunately, Ben was unwilling to make the necessary changes to his estimating system. However, the two mid-western contractors and the one in California did change. Their bidding accuracy and bottom line improved significantly. It’s also not too late for you or anyone else who includes equipment costs in G&A overhead costs for bidding purposes. To the adage, “Experience is the best teacher” should be added, “Preferably someone else’s.”

For a free copy of my equipment cost per hour (CPH) calculator in MS Excel, email me and I will email it to you.


JIM HUSTON runs J.R. Huston Consulting, a green industry consulting firm. See www.jrhuston.biz; mail
jhuston@giemedia.com.

 

x