Secret #81: The Path to Profitable Contracts

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Profits.  Is there anything more important for the success of a company?

path_to_riches This critical factor determines if bills can be paid, if growth is achieved – it is the very essence of survivability.

Ask any business owner and they’ll tell you they make every effort to protect their profit margin.  They are careful about choosing the right contracts, vendors, and employees.  When construction companies pursue competitively bid projects (municipal, state and federal), they meticulously calculate the cost estimate to assure a healthy profit upon completion.

For many firms, competitively bid work is their bread and butter. The plain truth is that such jobs are difficult to win.  All the proposers want the revenues but only the lowest bidder wins. The others get nothing for their effort. In this lean and mean environment, contractors must calculate the minimum profit that is sustainable for their firm.  With so much at stake, good management practices require a diligent effort to protect the company’s financial interests.

Everything we’ve said so far probably seems obvious.  No one would dispute the importance of protecting the life blood of a company’s future. However, over the course of our years bonding contractors, the reality may be slightly different…

Fallacy #1: “If I bid it right, the job will be successful.”  This seems like a good strategy.  But what’s wrong with it?

The problem is that a project estimate is just that, an estimate. The contractor may be confident that all labor and material costs are correct. The company may have successfully completed similar projects. But unpredictable factors such as weather, variances in productivity and outside factors like a subcontractor’s performance can all contribute to the financial success or failure of the job.

Fallacy #2: “If the architect approves my monthly pay requisitions, the job must be on track.”

This fails to consider that the architect is the owner’s representative. The architect wants a completed project even if there is no profit left for the contractor!  It is not the architect’s (or project owner’s) job to protect the contractor from taking a beating.

Fallacy #3: “When I get to the end of the project that’s when I find out about the profits.”

The problem here is the lack of oversight during the life of the job, when the outcome may still be managed.

Bonding companies intend to support well-managed, financially successful construction firms. One very important element is the analysis and management of incomplete contracts.  This process must be performed during the life of the projects.

To be successful, this oversight process depends on three elements:

  1. The accumulation of project specific cost data (labor and material utilized).
  2. The data must be analyzed with sufficient frequency (such as monthly).
  3. The remaining “Costs-to-Complete” must be periodically re-estimated based on actual contract performance.  This means not relying on the accuracy of the original project estimate but instead reviewing the actual labor and material cost experience.  When this is compared to the original estimate, enlightened predictions can be made regarding the ultimate profitability.

By following these three steps, construction companies can effectively predict their revised profit estimate and manage open contracts during their life – while there is still time to affect the outcome.

We can say with certainty, all well-managed construction companies utilize such procedures.  Equally, all surety underwriters expect to see this management approach and can readily detect if it is not being utilized.

Contractors must use these procedures to protect profitability and assure their future success.

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