Don't Let Profit Fade Wipe Out Your Bottom Line
Updated: Dec 21, 2017
Many construction projects fall prey to what's known as "profit fade." In many cases, this costly problem comes into play when a job goes awry, taking with it the expected profit margin.
Most contractors have a good idea of how this can happen. For example, an owner goes change-order crazy or a job extends way beyond the scheduled finish date. So the question is: How can you prevent profit fade from wiping out the bottom line on your next project?
Expect the unexpected
The profit you calculate when bidding a job can fluctuate dramatically as work progresses. For every phase you finish under budget, there may be an unexpected problem waiting to wipe out the savings. If you want to end at the top of the arc, you need to stay on top of each project's swings.
Every significant cost increase should be accompanied by a change order that increases the value of the contract. If it isn't, determine why. Was your initial estimate off? Or have you done extra work that wasn't covered by a change order? In either case, you're headed for profit fade, and you need to find ways to get the job back to "profit friendly" status.
Do your homework
In addition to monitoring works in progress, study your estimating and profit histories. Review some good jobs and some that didn't work out so well to determine where the jobs didn't meet budgets and whether expenses were allocated properly.
Discuss with your supervisors whether the assumptions you used in estimating the projects were valid. Did you, for example, realistically calculate the number of bricks your crews could lay in a day? Were your average labor costs accurate?
Also consider direct and indirect costs, and compare your estimates on jobs that lost money to those you used on profitable projects. Then use the results to improve estimating procedures on future projects. If, for example, projects were delayed because you expected your project manager to obtain final foundation design approvals and shop drawings while also getting the job under way, you may need to revisit your staffing estimates.
Look, too, at whether certain owners cost you money. If one owner consistently moved walls or added doors, you may want to be sure any future contracts with that owner include specific language regarding scope and specification changes, change orders and schedule revisions.
Make the contract clear
Before work begins, understand fully what you're contracted to do. Contract language is often unclear, resulting in differences in interpretations that can disrupt and delay projects. Conducting a careful review of the contract and clarifying any uncertainties at the start of the job can help prevent disruptions and delays going forward.
Also make sure your project managers understand the contract language fully. Meet with them before every project to discuss not only the contractual provisions for scope of work and change orders, but also what you bid and why.
As work progresses, meet with your project managers regularly to make sure they're comparing their actual costs to the bid cost amounts. If a problem arises, they can address it with the owner immediately. They should also note the reason for the issue. For example, if you're typically plagued by weather delays during a certain time of year, you may need to build a little more time into your bids.
If there's a problem, remember that your leverage is strongest before the project is finished. Owners need your help to meet their goals, and they may be more amenable to approving change orders while you're still on the job. If you wait until the project is done, an owner will have use of the facility and may not release your retainage. In other words, they're holding all the cards.
Make profit fade fade away
Profit fade can be perilous to any size of construction company. It's simply something you can't ignore. But there's an upside to proactively combating profit fade: By adhering to the advice offered in this article, you'll make your surety more confident in your ability to make a profit.