THE PROFITABILITYOF

AGILE

CONSTRUCTION®

8 CFMA BP January-February 2006

BY PA RVIZ DANESHGARI & MICHELLE T. WILSON

A construction jobsite is a very fluid work environment, in a state of constant change, both planned and unplanned.

Customer needs and requirements alter, often frequently. Resources and experience levels change with every person- nel reassignment. Schedules change, and people learn from ongoing experience.

Using Agile Construction, you can adapt to change, react to jobsite changes rapidly, complete projects efficiently, and capture more profit.

Lower overhead. Increased flexibility. Higher margins. More satisfied customers. These are the promises of Agile Construction, a type of project planning and schedule management that facilitates rapid response to changes on the j o b s i t e .

Responsiveness to each construction jobsite is the key to the profitability of any contractor. As such, agility in construction requires a thorough understanding of resource management and usage. It also makes a distinction between pro- duction and productivity, and allows contractors to respond more nimbly to the jobsite’s ever- changing needs.

In this article, we’ll discuss the ambiguity of con- struction, relate two profitability models exam- ined in previous articles to Agile Construction, and provide a case study that illustrates these principles.

Three Distinct Ambiguities

Every undertaking has elements that are: 1 )

Known, 2) Unknown, and 3 ) Uncertain.

Uncertainties and unknown facts are ambigui- ties that, if left unchecked, lead to increased risks for contractors. Converting unknown ele- ments into known elements reduces risk, and its associated costs, by allowing time to create and implement a reaction plan.

Many different factors with various levels of uncertainty constantly influence ambiguity on the jobsite. Such factors as weather, change orders, labor quality, physical space, material flow, trade interferences, and absenteeism create uncertain environments and require quick responses.

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Increasing the visibility of all aspects of the project is one method of converting uncertainties into known or pre- dictable results, allowing proactive steps instead of reactive responses .

Situational awareness – or a thorough understanding of the circumstances, the uncertainties, and unknowns – allows contractors to respond as needed to maintain profitability. To manage ambiguity, the PM and CFM must know where, when, and how their resources are utilized. By identifying bottlenecks in resource usage, the PM and CFM can surgi- cally improve their responsiveness to jobsite changes.

Fixed & Variable Costs

Profitability results from operating as a low-cost provider, and it is very difficult to do so without understanding cost drivers. To be a low-cost provider, contractors need to know the job- site situation, its cost drivers, and its productivity.

To manage profits, costs need to be visible. Through correct allocation of fixed costs to the customer, project, subcontrac-tor, and resources, contractors can become more agile and more profitable.

The first step toward understanding the profit opportunities

in any project is closely tied to the basic financial model of the activity. As discussed in “Customer Positioning Model for Contractors” in the May/June 2005 issue, a contractor’s pri- mary cost drivers vary by the type of operation.

Usually, GCs, construction service companies, and distribu- tors can be classified as fixed-cost operators. The majority of their cost structures are fixed costs that typically remain more or less constant throughout the year. These costs include SG&A expenses, salaries, insurance, property taxes, carrying costs of inventory, and other fixed expenses.

Most subcontractors are variable-cost operators. Var iable costs increase as sales increase because of the overhead required. This point becomes much more pronounced in the case of unionized subcontractors using labor from union halls .

Higher costs yield lower profits, especially on a hard-bid or negotiated fixed- price contract. Price-based costing allows the market to set the price on the contract. Only by manag- ing and minimizing unnecessary costs is the contractor able to maintain or build the profit margin, because profits are only recognized when the revenues exceed all costs, both fixed and variable.

Two models, Job Productivity Assurance and Control (JPA C ) and Customer Positioning and Control (CPAC), have a direct bearing on the identification of cost drivers, and contribute sig- nificantly to a contractor’s agility.

Job Productivity

Assurance & Control

J PAC is a practical approach for variable cost operators to better contain their primary variable business risk: labor uncertainty.

J PAC measures productivity as a supplement to the usual meas- ures of production on a con- struction project. Under this model, CFMs measure a job’s observed percent complete in conjunction with the reported hours to gauge how productively

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the work was performed.

This model works when labor is a variable cost on a specific job for a specific period of time. For example, a subcontrac-tor’s human capital is among the most visible of the quasi- variable factors in a fixed-cost operation. By measuring the contributed effort of the internal human capital to any spe-cific activity or project, CFMs can compare the resource usage of that activity, in terms of both time and cost, with the resource requirements of other comparable activities.

Here’s how JPAC works: PMs monitor the progress of each task by breaking variable costs into cost codes and defining visible, measurable tasks. When a task requires more (or less) time than originally planned for completion, the variance needs an explanation.

To qualify variances, foremen predict, schedule, and track deviations in terms of both labor hours and root causes. As an ongoing measure, JPAC tracks labor productivity by combining the field perspective (the observed percent complete) with the accounting perspective (the hours charged ).

J PAC predicts the job’s productivity at the end of the job , based on current productivity rates. With JPAC, subcontractors can evaluate the variations in productivity, identify root causes, and determine if a root cause results from a “common cause” or a “special cause” that requires immediate attention. (For details on common and special causes, see “The Impact of Job Planning on Profits” in the November/December 2005 issue.)

Because fixed-cost contractors use resources across various assignments and projects, the application of JPAC is not practical. Other existing methods of cost tracking, such as Activity Based Costing (ABC) and Weighted Average Cost of Capital (WACC), are even more cumbersome and inaccurate for calculating the correct costs and pricing strategies.

However, the CPAC model is a practical, reliable approach to examining the quality of production by identifying the demands placed on a contractor’s fixed-cost resources rela- tive to the value produced.

Customer Positioning & Control

Using CPAC, contractors can convert fixed-cost operational resources into quasi-variables allocated to particular cus- tomers, and measure the impact of the performance of cus- tomers, projects, and subcontractors, as well as company divisions and resources.

C PAC is invaluable as a model for increasing situational awareness and improving response time. It allows contrac- tors to clearly identify the cost drivers of any particular cus- tomer or project. Under CPAC, managers determine a breakeven point, establish a goal, and plot the performance of a subcontractor, job, or customer according to situation- specific variables

With a four quadrant positioning method, managers evaluate such fixed-cost drivers as overhead and salaries to position customers, projects, and subcontractors according to their resource demands vs. recognized revenue or profits.

A customer or project that falls into the first quadrant gener- ates high profits or revenues with respect to resource invest- ment and allocated fixed-costs. Customers or projects that fall into the second and third quadrants generate lower profits or revenues per resource investment due to higher time or cost requirements.

If a customer or project is positioned in the fourth quadrant, both time and cost are low – and neither generate sufficient profits or revenues for the investment. (For more information on the four quadrant positioning method, see “Customer Positioning Model for Contractors,” in the May/June 2005 issue. )

The Bottom Line: CPAC measures how efficiently resources are applied. To better illustrate this point, let’s examine proj- ect, subcontractor, resource, and customer positioning.

PROJECT POSITIONING

Just like customers, project elements can be positioned in four quadrants and evaluated based on aggregate company resources or on categories of work, type of bid, PM, or com- pany division.

In this case, the project is the customer, placing demands on the resources of the contractor. Failing projects show losses or minimal profits, despite high revenues. These projects lie in the fourth quadrant, with many of the contributing activi- ties also appearing in the fourth quadrant.

Once managers identify the significant drivers for the poor profit ratio, they can develop a plan to address each driver. By repositioning projects on a regular basis, they can moni- tor trends to determine whether the implemented plan has had the intended effect.

SUBCONTRACTOR POSITIONING

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With this approach, contractors can also position subcon- tractors – either within a job, job by job, or for the entire company. This approach helps identify preferred subcon- tractors and enables contractors to create (improve?) t h e statement of work for the subcontractor’s performance requirement.

By positioning each of the subcontractors working on a par- ticular project, a contractor can easily identify those who provide the best return, as well as those who add significant cost to the project. When there is a resource drain, the con-

Contractors can distinguish high-margin projects, divisions, subcontractors, and customers from less profitable ones with CPAC ’s eight-step process:

1)Establish the frame of reference.

2)Position the user of resources.

3)Identify the highest user.

4)Breakdown expended resources by their activities .

5)Identify low-efficiency activities.

Increasing the VISIBILITY of all aspects of the PROJECT is

ONE METHOD of CONVERTING UNCERTAINTIES into KNOWN or PREDICTABLE results...

tractor can help the subcontractor address those issues causing the resource drain or alter its pricing in the future (whose pricing?)

Resource Positioning

Resource positioning compares a company’s internal depart- ments, divisions, and branches by evaluating performance and ROI based on resource usage.

Contractors can improve resource usage by increasing pro- ductivity in several ways:

Improve the first-time pass.

Remove unnecessary activities and reduce waste.

Improve the customer point of entry into the process. (What does this mean? Need an example.)

CUSTOMER POSITIONING

A customer who places high demands on a contractor inevitably costs more to service. The most profitable cus-tomer is the happy customer who pays his bills in a timely manne r. The happiest customer is the one whose work is completed quickly, correctly, and efficiently.

To achieve quality in construction and keep customers happy, a contractor must effectively use all resources on a project, without sacrificing one at the expense of others.

Getting Limber, Lean & Agile with CPAC

6)Identify the waste in low-efficiency activities.

7)Eliminate the waste to improve time-to-detect and time-to-react.

8)Use the increased capability to improve productivity.

Let ’s look at each step in the process.

ESTABLISH THE FRAME OF REFERENCE

Contractors can establish a positioning baseline against a number of different values, including profit and revenue. However, before positioning anything, contractors must determine the frame of reference for comparison. Possibilities include:

The company as a whole.

A division of the company.

Particular groupings of customers or projects based on similar types of work, location, or job size.

POSITION THE USER OF RESOURCES

To position projects, PMs, subcontractors, customers, or company divisions, it’s important to set a breakeven point (or minimum standard of performance). For example, a con- tractor measuring the net profit of his projects could estab- lish abreakeven point of $1,000.

Any job that did not create $1,000 in net profit, compared to cost or resources used, would fall below the breakeven point.

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Then, the contractor would place each project in the appro- priate place on the chart.

Contractors and CFMs can also set goals beyond the break- even point. After establishing baseline expectations, they can measure a multitude of variables in any desired combination.

IDENTIFY THE HIGHEST USER

Once the chart is complete, contractors can identify the cus- tomers, projects, subcontractors, or departments that draw most significantly on both capital and human resources.

They can also see the elements that require less money or time than the rest of the group. In addition, they can discov- er those with an acceptable return on either time or cost. The case study on page 15 shows how CFMs can identify profit-generating elements.

BREAKDOWN THE RESOURCES

C PAC positioning allows each point representing a draw on resources to be broken down further to evaluate the compo- nent costs. For example, a customer (or group of customers) may be broken down into individual projects. Individual proj- ects can be further divided according to project resources, including estimation, project management, field supervision, and administrative. A job or the project may also be posi- tioned according to its subcontractors.

IDENTIFY LESS EFFICIENT ACTIVITIES

Each grouping or activity can be evaluated against the resource use. For example, the activity “billing” often involves PMs as well as administrative staff. If the PM tracks

down and verifies subcontractor invoices, material purchases, deliveries, addresses, and tax informa- tion, the cost associated with billing will be much higher than if an administrative support person addresses those issues.

In another example, an experienced PM may be able to hold coordination meetings in half an hour per week. A less experienced PM may need two to three hours to receive and relay the same informa- tion to his subcontractors. The question at hand is how the difference in cost allows for differences in time .

IDENTIFY WASTE

Each project or customer can be analyzed to deter- mine those that create the most waste. For example, contractors could further categorize project manage-

ment according to the resources allocated to:

Labor Planning

Material Planning

Jobsite Coordination

Office Coordination

Administrative Activities

Safety

IMPROVE TIME-TO-DETECT & TIME-TO-REACT

True agility requires careful management of the window of opportunity: the time between one event and the next. For every urgency – and jobsites have many – staff requires a certain amount of time to detect the situation. Then, they require time to react, or time to formulate and implement a response to the situation.

Time-to-detect and time-to-react are inversely related. The longer it takes to identify a problem, the less time is available to formulate an appropriate response – and the higher the probability that the response will be costly.

The earlier a situation is recognized, the more time is avail- able to react to it. For example, a GC needs to coordinate schedules with multiple trades, each of which is coordinating its own materials, manpower, and financial situation. If one subcontractor is delayed for any reason, it will affect several others through a ripple effect.

Suppose excavators are delayed one week due to broken

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Where’s the Profit? A Case Study

Suppose the CFO of XYZ Construction wants to compare the revenue of the company’s top 10 projects. After establishing a baseline for performance, the CFO plots each project’s net rev- enue over cost, as well as its net profit per hour.

First, the CFO learns that Project F brings in the highest rev- enue per effort and cost (Exhibit 1). Comparing profit vs. cost and hour, the CFO observes that Project F also brings in a high net profit for the expended effort and cost (Exhibit 2).

The CFO then investigates Project F’s performance by subcon- tractor. As Exhibit 3 shows, the mechanical contractor provides XYZ with the most net profit per hour and cost, relative to other subcontractors on the project.

From here, the CFO examines the effort XYZ spends on mechanical contractors across all top 10 projects (Exhibit 4). In this case, the mechanical contractor working on Project F

leads all mechanical contractors in net profit per cost and per h o u r. This data confirms that the mechanical contractor on Project F is very productive, compared to other subcontractors at the same jobsite and other mechanical contractors overall.

N o w, the CFO asks specific questions to learn from XYZ’s good fortune. The CFO wonders, “Why is this mechanical contrac-tor bringing in a higher dollar volume for resources used?”

After some inquiries, he learns that this particular contractor consistently turns in accurate, up-to-date schedules and requires the smallest amount of periodic cleanup.

With this information, the management of XYZ has good reason (and substantial motivation) to require all subcontractors to submit correct schedules in a timely fashion and to encourage better cleanup on its jobsites.

Exhibit 1 – Revenue from Top 10 Projects

 

Exhibit 2 – Net Profit from Top 10 Projects

Compared to Company Average

 

Compared to Company Average

 

 

 

Exhibit 3 – Project F

 

Exhibit 4 – Net Profit of

Resources Allocated to Subcontractors

 

Mechanical Contractors by Project

 

 

 

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equipment. Every subcontractor waiting on the excavation is also delayed, as is every subcontractor with work contingent on the first group. In some cases, manpower requests and material deliveries will no longer be timed appropriately, leading to wasted time.

Though an equipment failure may not be known in advance, providing the information that replacement equipment will be available in one week will significantly improve the other subcontractors’ ability to adjust accordingly and plan alter- nate work.

IMPROVE PRODUCTIVITY

Each resource has a different cost associated with both the type of work being performed and who is fulfilling that role. As waste is removed, the contractor will recognize a two-fold improvement: productivity will increase and capability will expand, freeing the contractor’s resources to manage addi- tional projects and operate more proactively.

By improving capability, the throughput increases, resulting in a better pace of work, reduced cost, and increased profits. Please provide an example.

Conclusion

Agile Construction is at its best when a contractor is able to bring together diverse elements and create visibility, flexibil-ity, and responsiveness. CPAC and JPAC provide a practical and reliable approach for GCs and subcontractors to exam- ine production quality relative to their fixed and variable costs, and to measure the value produced.

With Agile Construction, contractors can clearly identify cost drivers – and opportunities for their improvement. When contractors are able to appropriately respond to changes and urgent situations, they can manage, maintain, and even reduce costs. BP

PA RVIZ DANESHGARI, President of MCA Inc. in Flint, MI, consults with clients in the construction, banking, automo-tive, medical, healthcare, and insurance industries regard- ing process implementation and product development, waste reduction and improved labor productivity, project management, estimating, accounting, and customer care.

He is an established

author and researcher for such

o rganizations as the

National Electrical Contractors

Association (NECA) and The Electrical Distributor (TED).

He has spoken at NECA Conventions and the International Project Management Convention in Toronto , taught classes for the Management Educational Institute (MEI), and was interviewed by Alexander Haig on Wo r l d Business Review.

Currently a professor at the University of Michigan- Dearborn, Perry has taught throughout the U.S. and Germany. His education includes a BS in Civil Engineering and BS in Mechanical Engineering from Northwestern University, Evanston, IL; an MS and PhD in Mechanical Engineering from the University of Karlsruhe , Germany; and an MBA from Wayne State University, Detroit, MI.

He is a member of CFMA’s Saginaw Valley Chapter. Previously, he served on several CFMA national commit- tees including Education, Construction Industry Liaison, Accounting & Reporting, and Certification Oversight.

Phone: 810-232-9797

E-Mail: perry @ mca.net

Web Site: www.mca.net

MICHELLE T. WILSON is an Associate Implementer at MCA Inc. in Flint, MI. As such, she translates and imple- ments system design principles, and streamlines process- es to increase client productivity.

Michelle teaches mathematics and statistics at Franklin University in Columbus, OH. A frequent speaker, she has p resented at NECA Conventions and MEI seminars, and is published by the University of Michigan. She was also the owner and COO/CFO of Metropolis Motorcycle Works.

Michelle received her BS in Mathematics from the University of Michigan, Ann Arbor and her MS in Mathematics, from Nort hwestern University, Evanston, IL.

Phone: 810-232-9797

E-Mail: mwilson@mca.net

Web Site: www.mca.net

 

Wikipedia: Agile Construction®

Agile Construction, Job Productivity Assurance and Control (JPAC), and Customer Positioning and Control (CPAC) are trademarks of MCA Inc. All rights reserved.

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