Eyes on the Prize

This has been a decade of unusual circumstances that no one could have predicted. Runaway inflation, materials shortages, supply-chain disruptions, job delays and cancellations, atypical weather events and a tight labor market have made it difficult, if not impossible, to estimate costs accurately. With profit margins lower than most contractors are comfortable with, job costs must be as accurate as possible.

Although it is common practice for estimators to pad bids to cover increases in materials, labor and operating expenses, companies may need to do more than this to turn a profit. They must also examine how to mitigate risks, reduce costs and better manage jobs.

MITIGATING RISKS

A construction company needs to conduct a detailed project analysis before getting started, including assessing resources, materials and labor costs. Then, obtain quotes from different vendors and contractors for the best prices.

Owners should create a project management and communication plan describing potential risks and mitigation strategies. Include information on the chain of command, what needs to be done in what order, who is responsible, who needs to be contacted and pertinent data about the project.

An escalation clause can help both owners and contractors manage costs by stipulating when and if a price increase or decrease can occur. Generally, an escalation clause establishes baseline, ceiling and floor prices. The baseline is the price in the contract, the ceiling is the highest price that can be charged and the floor is the lowest. Both can be stated as a percentage when a triggering event occurs. For example, if the price of a good or service increases by 5%, the contractor has the right to increase the price by no more than 10% above the consumer price index, producer price index or another objective index agreed to in the contract.

Some contractors use an escalation clause as a sales tool. For example, to win government contracts, which generally are awarded to the lowest bidder, a contractor might submit a bid with the actual price instead of the inflated price.

REDUCING COSTS

Implement lean-builder construction principles to optimize projects for efficiency and reduce waste. Both will help to reduce costs and improve performance on the job. In addition, regular cost reviews throughout the project’s duration can help identify potential overruns and prevent them from getting out of hand.

Consider the cost versus the benefit of purchasing materials ahead of schedule. Buying products beforehand can reduce costs, but there are risks. For example, materials could be damaged in storage; defects can go undetected and discovered when the product is out of warranty; and/or prices could decrease. Furthermore, storage and handling costs could be more than any savings, especially if construction is delayed.

Take the time to know the vendors that supply goods and services on the job. The ability to secure materials and supplies is often based on variables like a vendor’s size, storage capacity, location and financial health. Do not assume that a company is what it says it is from its website. Perform due diligence to uncover the truth. It could make the difference between having the products when needed or not.

MANAGING JOBS

Good project management is essential. Every detail must be examined during each construction phase and for everyone—employee, subcontractor, supplier—on the job. Consider all possible scenarios and solutions. Run what-if scenarios using past, present and future data.

Historical numbers are available from company financials and similar-company and industry data. Future projections can be made with data from inflation guides from the U.S. Bureau of Labor Statistics and industry associations such as Associated Builders and Contractors. Index inflation to project the impact of price increases on costs over time. Base prices on costs-plus metrics from the Turner Construction Index, the Mortenson Construction Cost Index or the DCD Cost Escalation Index Table & Regional Cost Modifiers. The Construction Financial Management Association also offers a financial benchmarking tool for CPAs and contractors to compare a company’s financial performance against the rest of the industry.

Implement internal controls to reduce the risk of fraud and decrease waste on the job. This will require reviewing and revising policies and procedures on purchasing, accounting/bookkeeping, payroll and inventory control. The Association of Certified Fraud Examiners offers resources and recommendations on fraud prevention techniques in its biannual “Occupational Fraud: A Report to the Nations.”

Implementing a change-control process can help manage project scope and prevent scope creep, which can ultimately lead to increased costs. Ensure that any changes to the project are reviewed, approved and documented before implementation. Project management software should be used to manage and control every aspect of a job. Options are available for contractors working on any number of projects. Real-time dashboards, collaboration and communication tools can provide valuable data and metrics to track and measure results.

While it may be impossible to accurately estimate job costs with all the variables to consider, it is possible to mitigate risks, reduce costs and better manage jobs. Contractors who invest the time and resources to control their environment will be better prepared to absorb price increases without sacrificing profits (too much). Even so, having a contingency plan is always a best practice.

Finally, watch inflation trends to help project and mitigate costs. Industry trade associations, the U.S. Census and the U.S. Department of Labor are good data sources on changes to regulations and standards that can impact project costs. By leveraging these strategies, a construction company can manage and mitigate escalating construction costs in an inflationary economy.