In any job, there’s a certain “critical path” that must be followed. For example, no contractor would ever schedule the insulation subcontractor before the electrician. Otherwise, the job would move backward, as the insulation would have to be torn out before the electrical work could progress.
The planning required to see the critical path for taking on new business costs isn’t quite as apparent. The main difference is that for a project, the cost (plus markup) will be covered by the customer if there is a change order, so the profitability of the project should be pretty constant despite the additional costs. But there is no equivalent “customer” when considering new costs to the company. The company’s financial resources will need to cover those additional costs (change orders), and the company will need to plan far enough ahead to accommodate them.
WHAT KINDS OF COSTS?
If we look only at production-labor-related costs, the following are the kinds of changes that could inflate your production costs. These either add to your costs or introduce additional non-billable time to employees, so their cost per productive hour will increase.
▪ Having an increase in your workers’ comp rate
▪ Having an increase in your state unemployment rate
▪ Adding health insurance
▪ Giving raises or performance bonuses
▪ Adding a retirement plan
▪ Reimbursing for use of personal vehicles
▪ Providing cellphones or tablets (with monthly subscriptions) to production personnel in order to implement a new time-tracking process
▪ Providing uniforms with weekly cleaning service
▪ Providing professional certification training (CR, CLC, CAPS, and the like) to production workers
▪ Providing more paid time off to personnel
▪ Initiating meetings that include production workers
HOW FAR IN ADVANCE?
Let’s assume that all your new production-labor-related costs will be put into effect next year on January 1. Therefore, any job that will be in production next January 1 should be priced to cover the new costs. If jobs are sold with an outdated markup, then obviously the payments received won’t cover the new costs, and the jobs will be less profitable than planned. In other words, the company will be subsidizing the new costs out of profit!
So, how far in advance should you revise your pricing to be sure that by the time your new costs hit, your customers will be paying for them? This requires that you consider the timeline for your company’s sale production process. Let’s look at the example described in the chart below.
In this case, it takes the company an average of 240 days to estimate and complete a job. To that must be added the time required to analyze the job and identify variance. Remember that for this initial job, the new costs haven’t been included. But, they’re coming. Therefore, in addition to the usual job of figuring out where the company lost (or made) money on a project, modifications must be made for the impending labor cost increases.
Let’s assume that there’s an average of 30 days from the day that production ends to the day that all the job costs come in (including those from your painting sub who takes forever to get you a bill) and your production staff can perform the job autopsy, identify slippage areas, and decide how to modify the estimating assumptions moving forward. That means that the entire process takes 270 days.
If the average project length is 150 days, and the first job of the year is sold on January 1, and the revisions to the estimate don’t occur until day 270 (September 27), then the first estimate properly modified to meet the new labor cost requirements would be available no earlier than September 27. If the average job length is 150 days, then that job will be in progress on January 1 of the following year and therefore must be estimated using the new criteria.
If the next job you estimate incorporates the new production-labor-cost figures, you should be OK, right? After all, the job (see calendar above) that you estimated at the old rate is done, and you’re now estimating at the new rate for jobs that will be in production January 1. You’re good, right? Well, that depends.
If you work on only one job at a time, there’s no problem. But what’s been going on in the meantime, between that first estimate on January 1 and when you start using your new estimating criteria on September 27? Why, you’ve probably been estimating and selling more jobs at the old rate, right? If you sell one job a month (using the arbitrary project durations in the chart), then you might find yourself in the situation shown in the calendar above.
The red line represents the date on which the new costs go into effect, so ideally all projects that include that date would be estimated according to the new parameters. As you can see, Jobs 6 through 8 extend into this time period but were estimated according to the old criteria. Given the increase in labor costs, these jobs should produce lower-than-anticipated profit.
The key here is not to get hung up on your selling cycle, job length, or job-cost-analysis schedule, but to understand that if you want to cover costs that will occur at a predetermined date, you should be thinking farther ahead when setting prices. And, the longer the duration of a project, the more critical it is that the job be sold at a price that encompasses intended cost increases implemented within the scheduled duration of the project.
This example was extremely simple, because all cost increases were scheduled to go into effect on the same date (January 1). In reality, cost increases usually don’t conform to such a simple or even predictable schedule. These increases could have been scattered throughout the year, which requires that companies constantly update labor costs in order to estimate with realistic cost information.
Be sure to review whatever calculator you use for figuring out your labor costs for the purpose of estimating. If you know in advance that a particular benefit or raise will be offered, incorporate that information immediately, even if it won’t go into effect for a while. If you get unwelcome information about workers’ comp or payroll tax increases, incorporate those immediately. Be sure you perform a job autopsy on every job as quickly as possible, to stay on top of your crew’s performance. Don’t risk subsidizing your customers’ projects by not paying attention.