Why actual margins may be different than paper / desired margins
The health of your construction business depends entirely on how successfully you translate your estimated costs into actual costs preserving your profits. Material cost inflation, errors in estimating, lower than expected labor productivity and increased labor rates can all affect your bottom line.
The first step therefore is to make sure you track and compare the cost of each project post completion to your estimate and final bid. The details of tracking the cost of each project separately depend on the size and nature of the business but it is beyond the scope of this blog. I will instead focus on what to do with this information to protect and improve your margins while still maintaining bid win rates / revenue.
Lets look at each of four main sources of margin erosion highlighted above one by one.
Material Price Inflation / Difference
Depending on the job and the construction trade there can be a wide gap between when the bid is won and when the project starts. This can lead to differences in estimated costs versus actual costs of material when procured during job execution.
First thing is to compare your estimated material prices at bidding vs. Actual material prices. This will give you the average material cost inflation. Then look at material cost as a percentage of your overall costs. Multiplying the two gives you the average erosion in profit margins due to material cost inflation.
There are a few ways to mitigate this. One is to either have a cost escalation clause with the contractor or lock in prices with your supplier as soon as the bid is won. Now both may negotiate a slightly better deal to take the risk themselves but it takes away the risk from your business.
Another way is to include expectations of an estimated material inflation at bidding. But this still doesn’t take away the risk entirely.
Construction businesses with higher percentage of material costs vs. Labor and overheads need to pay more attention to material cost inflation.
Estimated Quantity vs. Actual Material Used
Estimating is not Exactimating. Exceptions may be counting lighting fixtures, where you may expect exact counts. However for most trades, like painting, flooring, roofing, concrete etc. There is an element of waste that needs to be estimated on top of the measured area or volume where the material will be used.
This is where feedback to your estimating team as well as project managers / supervisors becomes very important. Feedback needs to be constructive. Efforts must be made to identify how much waste was unavoidable and how much was. Sometimes some material may be desirable to improve labor productivity and save labor costs and time.
Either way this will improve both future estimates of material quantities as well potentially reduced waste or optimize material usage.
Labor Rates and Estimated Labor productivity vs. Actual
The same process and considerations given above for Material inflation and Estimated Vs. Actual needs to be repeated again for Labor rate inflation and Estimated labor productivity vs. Actual labor productivity.
Identifying more profitable jobs vs. Less profitable ones
A big benefit of comparing actual vs. Estimated profits can lead to identification of the types of jobs which are more profitable and maybe types of jobs that are loss making even.
Based on this information you will be able to win more jobs that are profitable. Either by avoiding jobs that are less desirable or bidding for them by applying a higher profit margin so if you win its still profitable.
You may also seek out more jobs that give you good margins and bid more of such jobs.
Creating a virtuous cycle of feedback and improvement
If done right (especially with right spirit of constructive feedback and assessment) comparing actual costs vs. Estimate costs can give your construction business a big competitive advantage.