Control Equals Profit in the Construction Industry (Introduction)
Minimum Bottom Line Profit Should Average 9.4%!
For Trades & Subcontractors, at Least 11%
After Income Taxes Are Paid!
With manufacturing, production of high quality, properly priced widgets is done under an exacting process. The product is highly engineered and tested; even the production systems are tested too. The final outcome is the perfect product built to a high standard and within cost. How do they do this? Manufacturing uses cost accounting to accurately define the final price to produce the best widget. Cost accounting is about control, control the inputs to get an output that is exactly as defined.
Just like manufacturing, construction uses control to earn a profit. However, unlike manufacturing, the contractor is not going to produce thousands of the exact same model (widget). The end product was a vision beforehand and it is unlikely a second will be built. Every building is unique; each project faces its own set of restrictions, variables and inputs. Manufacturing uses the law of large numbers, i.e. they are going to produce millions of the exact same product, thus making the science of control cost-effective. How can a contractor do the same thing when each product is unique?
The answer is ‘Control’. Control the outcome and the contractor will earn a profit from the project.
This article will cover the general areas of control with construction. This is an introduction to a series of articles that go into the respective details for each of two areas of control. They all tie back to the one ideal goal, earn a profit in construction. There are two areas of control that set the tone for the company. The first and most important is organizational control, sometimes referred to as the front office control. Here control is put in place via corporate culture, structure, policies, systems, processes and feedback to the management team. The second is production control, also know as field operations. Similar to organizational control, the company creates a culture and uses policies and procedures to ensure quality construction, timely compliance and an overall sense of accomplishment. When these two areas of control are properly put in place and followed, profits will flow.
Think of control as a pyramid. At the top sits the owner(s). The owner or management team sets the culture. What is this company about? How do we define success? Where do we want to be in five years? This is where control starts. Without the answers to the these questions, it will be nearly impossible to implement controls to achieve goals. The goals must be defined or set in place. The beginning of it all starts with culture. Under the tip of this pyramid sits the structure and other supporting systems along with policies and of course the hundreds of procedures everyone follows to support the structure.
Marty owns a new home construction company called ‘Nailed It’. Marty is in his 30’s and has decided to set his culture and goals as follows:
- Culture – an environment whereby every employee feels needed and respected for their work. Hard work and dedication is rewarded. Those that demonstrate these characteristics are welcomed as associates and Marty wants to give them a piece of company to tie them to him for the long haul. In addition, he wants every employee to learn and expand their knowledge beyond their respective skill or trade. Employees that want to advance shall be given the chance or are supported to transfer to another company where they can prosper. The key is that all employees are respected and a relationship is built. The company wants the best for each employee whether that is with the company or with another organization.
- Company Mission – Marty wants the mission of the company to impress upon all employees three important goals. First, is profit. The company must be profitable in order to continue existence and thrive. A reasonable profit is determined to be 8% after taxes. Secondly, Marty wants to build good homes, built to last and not require repairs due to natural aging in the short-term; i.e. a homeowner can have confidence that the earliest any problems will occur will be 15 years later or longer. Finally, Marty wants the customer to experience a mutually beneficial relationship with his company. The customer should have a sense that their home is theirs and not the company’s during construction. The customer’s input is important and it is the company’s job to educate the customer about relevant issues so the customer understands WHY the company does what it does in the field.
- Success – Marty’s concept of success is different from most owners; Marty defines success as the ability to go to work in the morning knowing he can leave at 4:30 to go home and spend time with his wife and children. He doesn’t want to have to work on Saturdays nor Sundays. Marty should be able to go away for two weeks in a row and come back to the office without having to make any decisions while away; the company just continues to operate as if he is not needed. Secondly, Marty wants to be rewarded for starting and owning the company. He has put up the initial capital, he wants to be properly rewarded with a reasonable salary and dividends at the end of each year. Finally, he wants to be able to take his children to a house and say to them ‘I built that house’; the family residing there feels safe and secure in their home knowing it is built to a high standard.
- Five Year Goal – Currently the company has seven employees and builds 14 houses per year. Marty’s five-year goals are to quadruple the number of employees and build 30 or more homes per year. The homes built will vary from the starter ranch model all the way up to customized projects. Marty would like to ultimately branch out into commercial office construction and possibly get involved in development.
With the culture set, Marty makes sure by writing a culture statement as the first page in the corporate manual. Once the culture is set, Marty must now design a structure.
To achieve the above Marty must first create an organizational structure whereby all within this structure understand the goals. Thus Marty breaks the company out into the respective functions. Naturally, field operations is one. This is covered further below. Marty’s front office structure is set forth as follows:
- Legal – this is how the entity is legally organized and how any interactions with third parties is set out whether contractually or as set by law. In addition, the legal aspect of the company fulfills compliance with not only local governments, but with other third parties requiring information.
- Insurance – Marty has eight different insurance requirements including:
- General Liability
- Contractor’s Bond
- Error’s and Omissions
- Workers Compensation
- Employee Benefits:
- Key Man
- Human Resources – This is one of the key controls as this sets forth the employee/employer relationship. It is here that employee compensation and job descriptions are documented. Benefit programs are created and set in motion. Grievances are addressed and employee training is performed.
- Business Development – The function of sales and creation of deals etc. are the responsibility of development.
- Front Office – from the receptionist to office supplies, this part of the company manages the facilities and ensures easy access to all information including technology.
Notice how the structure has six departments. There can be more, some larger contractors have an engineering/architectural area and finance. Smaller contractors combine areas into three or four such as:
- Compliance – Legal, insurance, human resources and accounting are one combined area.
- Business Development, engineering and customer relations are combined together.
- Front Office
Others outsource particular areas such as legal and/or accounting.
No matter how the organization is structured, corporate policies are created within the design of the structure set in place.
Once the culture is set and the structure laid out, the company can now create policies. Policies are merely written statements of how the company will fulfill the culture. In general, each of the respective departments within the structure create their own policies. They each build a policies and procedures manual for that respective department. For example, the legal department will have policies for the following:
A) Board Meetings and Communications with Board Members
B) Standard Contracts for:
(i) Home Construction
(v) Land Purchases/Offers
(vi) Broker/Agency Agreements
C) Notification Procedures (customers, vendors, disagreements etc.)
D) State/Local Government Licensing
E) Shareholder/Member Agreements
F) Taxation Compliance
G) Vendor/Supplier Credit Applications
I) Fixed Asset Purchases
J) Loan Documentation
Each of the respective departments within the structure design and draft their respective policies. The policies are customarily disseminated among all the leading managers for review, discussion and final approval by the Board or owner. The goal is to get feedback from all parties whereby everyone keeps in mind the culture the owner advocates. For example, notification procedures may be modified to require no less than two methods of communication and that communication with the other party must be done at least twice with a minimum time separation of two days. Thus, the policy may state that information conveyed may utilize any of the following tools:
- Normal Postal Service Mail
- Registered Mail
- Phone Call
- Court Contact Methods (subpoena, Sheriff’s Office delivery etc.)
- Verbal contact with a witness
- Hand Written Note Hand Delivered
During the policy review process, one of the team members points out the culture requirement of educating those that serve the company and the clients the company serves. Thus, another option of communication is added called a physical meeting with the intended party. The physical meeting is set as the preferred method of communication as it better suites the cultural belief of generating respect and conveying the corporate values.
To augment policies, systems are designed to ensure policies are followed.
A system is an organized method to ensure accurate and timely completion of a preset goal. Above, policies are put in place to document how a company will fulfill its culture. Systems are designed to continuously test and ensure the policies work. Systems are also written and customarily are attached to the respective policy. The goal of a sound system is to alert the respective department that something is wrong, i.e. it is designed to discover flaws. If the flaw is due to the policy, then policy is modified. Sometimes the flaw is normal, if true, a procedure is generated to correct the initial source so that the flaw does not develop. This is explained in the next subsection.
Examples of systems include:
- Vendor/Supplier/Subcontractor Approval – here, the system is designed to have all vendors/suppliers/subcontractors approved prior to allowing them on job sites. The approval system may require a vendor contract, documentation of a license, insurance and federal identification.
- Employee Hiring – in this case, the system may require a formal notice procedure, online application, interviews, referrals and a formal offer of a position, i.e. an employee offer letter. If hired, the employee must go through legal documentation, orientation, training and completion of safety courses.
- Marketing – customer creation may follow a particular system of its own. The company may require a customer contact form is filled out whether done at the front desk or online. The key is to have initial customer input. From there, the system may require a human contact from one of the company’s estimators or project managers to get a better idea of what the customer really wants. Here the system may require more flexibility in order to meet the customer’s requirements. The key is to create a system that will work and not allow a potential customer to fall through the cracks. Find the cracks and seal them.
Each system must stand on its own. Some will be simple while others are more complex, even convoluted. As the system increases in complexity, procedures are used to assist in making sure the system works well and smoothly.
Procedures are documented set of steps to achieve an outcome. Most often a form or a written step-by-step set of actions are used to create a record of the outcome. With a typical construction company, there are literally hundreds of procedures to follow. The key is disseminating this information to all parties; thus, following procedures is ingrained in everyone’s daily routine. For example, if a change order is requested by a customer, there is a procedure followed in the field and in the office to complete the change order. The end goal is to ensure accurate and timely completion of this change order along with prompt payment.
Procedures are customarily documented with the policies. Each department’s set of policies include system designs and procedures to use to comply with the policy. When a new or change to an existing policy is proposed, the corresponding changes with procedures are included if applicable.
Tools used with procedures include:
- Software programs such a time recording systems for payroll;
- Physical Steps (an example is that if there is a field accident causing injury, ALL personnel at that site are tested for drugs);
- communiques with company personnel;
- Common Sense.
The end goal is to reduce error rates and ensure compliance. When an error or negative outcome is discovered, the appropriate manager modifies the respective procedures to achieve a better or more accurate outcome.
Reports are the number one tool used to create feedback to the management team. Of course the most common set of reports are financial and job costing in nature. There are others including production, employee, subcontracting, unit counts and evaluations (analysis). These reports are designed to provide feedback in incremental time periods depending on their respective importance to the short and long-term goals. Here is a short list of the frequency of reporting depending on the nature of the respective report:
Report Frequency of Presentation
Job Costing Monthly
Unit Counts Weekly
After the reports are issued, a few days is allotted to the respected management team members to review, ask initial questions of the preparer, and then a meeting is set to discuss the reports. Field production reports should be the most frequent type and a regular weekly meeting is used to discuss the results and the underlying attributes leading to the results. The quarterly reports should tie to the weekly and monthly supporting data. Thus, making it easy for all to understand the supporting elements of overall performance.
When issues are identified, the management team discusses necessary changes to existing policies and/or corresponding systems/procedures to reduce or eliminate the negative outcomes.
Just as with organizational control, field operations control is used to ensure the end product matches the stated intention of the culture of the company.
Field Operational Control
Similar to organizational control, field operational control has a culture, structure, policies, systems, procedures and feedback to ensure compliance with the mission of the company. In general, the controls are not as well-defined or documented as organizational control due to the multiple variables related to construction. However, they should exist.
Culture is set out by the owner(s) via the mission statement. Structure includes the management team and the associated work crews. Most of the policies are promulgated via the respective organizational control departments. But most contractors have field policies along with systems. Mostly it consists of reporting to the front office, upper management and customers. Procedures are used to enforce the respective policies. Most procedures are focused on production, especially employee production. Reports are commonly a function of the organizational structure. Weekly production and job costing reports are the best tools to provide feedback to field management (project managers).
The number one control device for field operations is the original cost estimate for the project. This single document serves as the overall input as to what it is going to take to build the structure. A good estimate identifies the materials, the volume of labor and subcontracting needed to get the job done. It will also include other costs such as equipment utility, auxiliary costs and of course intangible costs (permits, waste removal, interest, direct insurance, compliance, etc.).
Other field operational controls include:
- The Original Contract;
- Change Orders;
- Plans/Engineering Work;
- Daily Production Reports;
- Photos; And
Naturally there is more than just the above. Training, safety gear and just good old logistics play a role in the outcome out in the field. The key is to have project managers that are more than builders; they are good businessmen and production driven.
Summary – Control Equals Profit in Construction
This particular article is just the first in a series of articles written to help contractors understand what it is going to take to be profitable in construction. There is just one word that equates to profitability – control. Control exists throughout the entire organization. The remaining set of articles in this series walks through all of these control measures to ensure profitability. No single measure will on its own generate profit. Some play key roles in acquiring profitability while others reduce risk thus preventing losses. The key is to create an overall organizational layout with the respective culture, structure, policies, systems and procedures to maximize potential profit. Yes, it is sophisticated, but that is what it takes to be successful. ACT ON KNOWLEDGE.