Profitability by Project
Feb 20, 1995
It is widely accepted that any well-managed A/E/P or environmental consulting firm should monitor and report on the profitability of the projects it undertakes. Pick up practically any management newsletter, or look in the practice section of industry trade magazines, and you’ll see that statement being made. While, I’m not suggesting that companies abandon this practice, I have learned that it can be as harmful as it can be beneficial.
Sounds almost blasphemous, eh? Especially coming from a management consultant who is supposed to help firms improve their profitability. Don’t get me wrong. I am interested in helping firms. I just don’t think that stressing project profitability is necessarily the best way to have a profitable company. Let’s look at some of the problems associated with tracking, reporting, and emphasizing profitability by project. Then you’ll understand what I mean.
The job cost/status reports, which are supposed to indicate profitability (or lack of it), are not accurate. This is a huge problem, and not one that you should lightly dismiss. No matter what your accountants are telling you, the reports coming out of your computerized project cost accounting systems are almost certainly inaccurate. There are many reasons for this. It starts with the people who are working on jobs and filling out time sheets. Unless they continually record everything they do as they do it, they are, at best, estimating where their time went during the day. Many folks in this business don’t even write down their time on their time sheet daily— they do it weekly, or bi-weekly— and sloppily at that. Or, how about people working on multiple projects with the same client? It’s not at all unusual to discover that they have exceeded their budget on one job, yet still have work to do. So they charge their time to another project that still has some budget left to burn, and rationalize it because the source of the budget for both jobs is the same. To top it off, the more open job numbers a firm has and the more people it has working on projects, the more these problems are compounded. Time sheet errors become almost impossible to detect unless the job number, task code, or activity code recorded aren’t valid, and the system doesn’t accept them during data entry.
You can have a situation where reports indicate that the firm is making money on every one of its jobs, yet the company loses money. A few years ago, we were part of a due diligence team studying the potential acquisition of a major, multi-office engineering firm. What we discovered was fascinating. The firm’s top management had a practice of calling project managers in front of a “Spanish Inquisition” committee whenever its target multiplier eroded by more than five percentage points. Like a visit to the dentist for root canal treatments, it didn’t take too many of those sessions for their PMs to figure out that wasn’t a lot of fun. So what did they do? They (and the others assigned to their project team) worked on the job, but didn’t charge their time to it. Eventually, the project management system showed every job coming in under budget, yet, the firm lost money because of its 49% utilization rate!
It rewards under-utilized work groups and penalizes those that produce beyond their capacity. This is a concept that only a few people in this business really understand. Most accounting systems charge overhead to projects in the form of a multiplier on raw labor. This multiplier is based on the company’s overall overhead. The largest part of this overhead is untillable staff time. Therefore, any group that has less job-chargeability than the “average” work group in the firm will have the hours of its people under-costed, and therefore show higher profitability on its jobs that it should. Conversely, any work group that regularly works beyond its mathematically derived 40-hour per week maximum capacity has its hours over-costed, and will show less than the “real” profitability on the jobs it turns out. This situation is compounded in cases where people are salaried and working more than 40 billable hours per week. The fact is, any job they work on after they have hit their 40 hours shouldn’t be charged with anything in the way of cost. All costs, including overhead, were accounted for in the first 40 hours!
It encourages short-term thinking that may hurt the firm in the long term. I have seen countless situations where short-term profitability on every project was considered so important that a long-term repeat client was lost over a few dollars. I have also seen situations where contract employees are hired because the overhead burden that would be applied to a “regular” employee would not be applied to them. Meanwhile, the firm has under-utilized regular employees that could do the job! That’s crazy.
Sure, it’s a good idea to look at where your projects are in terms of how much you have spent and what remains to be done in relation to the budget. But you’ll get a much more accurate picture (though never completely accurate) if you look at groups of people and the profitability of their efforts in total. What’s really important is how the firm does in its entirety. And that’s something that we too often forget.
Originally published 2/20/1995
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