Different Types of Costs on Construction Projects and How to Manage Them

Different Types of Costs on Construction Projects and How to Manage Them
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Construction is a business where revenues are largely fixed.  Yes - there are change orders on hard bid jobs, and there are cost reimbursable contracts, but even taking those into account, the overall project budget/contract value is generally fairly static.  

Once the contract is awarded, or a work package is signed off by the owner, the pot of money we have to play with is pretty much set and we don't have much control over it beyond that point.

What we can control, are costs. If I was to boil down the job description of a project manager in construction to a single line it would be this:

Project managers reduce costs on projects they manage

(by the way, this applies not just to people with the title on their business card - this applies to anyone on a project who manages some aspect of it: superintendents, foreman, project coordinators, construction managers, ...)

It doesn't really matter what the contract delivery model is, or what the owner's payment model is - your job is to reduce costs.  When you really get to thinking about it almost every task you do day-to-day is either managing risks (to prevent cost overruns) or maximizing efficiencies/opportunities (to drive down costs).  It's not hard to understand why:

Profit = Revenue - Costs

If revenue is largely a fixed number, how do you increase profit?  You lower your costs.

It stands to reason that we should understand the types of costs we will encounter, what they look like, how they behave, and what we can do to course correct them if we think they aren't headed in the right direction.  

For a general contractor, there are four different buckets that costs fall into on any given project: overhead costs, time based costs, unit based costs, and subcontracted costs.  Let's take a look at each one individually.

Overhead Costs

Overhead costs are the things that are tied to the revenue coming in from the project, typically as a percentage of project value.  Common overhead costs in commercial construction include things like bonding, insurance, building permits, and some software products.  Assuming the same jurisdiction and overall risk profile, bigger jobs have overhead costs compared to smaller jobs.

These costs are pretty simple to understand, and as long as you have these costs included in your budget from day 1, you'll be pretty well set.  

It is worth remembering that if the overall contract value increases, the cost of overhead items can go up too.  Keep that in mind when preparing change order quotes and be sure to include specific markups for these items.  On a contract that allows "overhead and profit" markups on changes, the "overhead" amount there should be your corporate overhead, NOT project overheads.  

Insurance, bonding, Procore fees, etc. are direct costs associated with the revenue of a specific project and should be included on every change request to the owner (unless this has been specified otherwise in the prime contract).

Time Based Costs

For general contractors, many of the costs on our projects come in the form of time based costs. These are the costs that are tied to our time on site: ie - the master schedule and the calendar.  Most of the Division 1 - General Requirement activities fall into this bucket.

When looking for ways to reduce time based costs, we should look for ways to maximize the master schedule.  This often means trying to reduce the overall length of the project, but it could also mean looking for ways to better sequence the schedule to take into account seasonal impacts.  I live on the Canadian prairies - winters are very cold and temporary heating is a very real cost that is directly linked to the activities you choose to do during the winter months compared to the summer months.  

If the team is doing a good job of managing site labour such that the crew size is as small as possible to maintain a safe and effective jobsite, then the number of labour hours that accrue in time based activities will be directly linked to the number of days we spend on site.

Many time based costs are also multiples of a fixed price for something - think about port-a-potties or temporary fencing.  Costs for these items show up as regular invoices from our suppliers for the same amount each month (assuming the quantity doesn't change).  On long term projects, negotiating favourable pricing at the outset can make a big difference because the savings is multiplied several times over.

Course Correcting Time Based Costs

If you are doing your regular cost forecasting exercise and realize that you are headed for an overrun on time based codes, there are a few things you can do to help get back on track and improve the budget:

  • Look for ways to reduce time or compress the schedule
  • Look for recurring bills, where we could use less (one heater instead of two)
  • Buy vs. rent tools/equipment for long duration rentals
  • Switch to less costly utilities (grid power instead of generator; natural gas instead of propane; etc.)
  • Reduce the crew size for the general requirement activities

Unit Based Costs

The most common unit based costs for a general contractor are when there is a task that we choose to self-perform with our own forces instead of subcontracting.  For many GCs, the direct work is 100% subcontracted, and their sole role is to oversee the work of others and manage the schedule.  For many other GCs, especially those that started out as a trade contractor and evolved into general contracting, self-performance of one or more scopes of work is something that is considered on every project.

Even if you are a pure construction management firm, its still good to understand unit based costs, as some general requirement activities, and some subcontracted scopes fall into this bucket.

Unlike the time based costs discussed above, unit based costs are often disconnected from the larger project schedule because the costs are based on the number of installed units and not the number of days on the calendar that it takes to complete the task. Here's an example to illustrate this:

We have two projects where we are responsible for installing doors with our own forces.  Let's say it takes a carpenter 4 hours to install a door, and that we work 8 hour days.

Project A has 10 doors and a crew of one carpenter
(10 doors x 4 hours/door) / (1 carpenter x 8 hours/day) = 5 working days
Project B has 20 doors and a crew of four carpenters
(20 doors x 4 hours/door) / (4 carpenters x 8 hours/day) = 2.5 working days

Project B requires less days on the calendar, even though there are twice as many doors to install.  

When working with unit based activities, understanding quantities and productivity rates is incredibly valuable in helping to manage and reduce unit based costs.  To lower the labour portions of unit based these costs, we need to improve crew productivity.

Self performed work also often involves large quantities of material.  Strategic sourcing decisions can help reduce unit based costs.  If you are going to make a purchase of a large quantity of material, look for best value that includes competitive pricing AND logistics that suit project needs.  Good and timely logistics will help to maximize crew productivity and may offset minor increases in purchase price.

Course Correcting Unit Based Costs

You're tracking your installed quantities,  comparing that to the dollars going out to complete the work, and you see trouble on the horizon - following the current trend will result in you losing money... Here's some ideas for things that can be done to improve productivity to get unit based costs back on track:

  • Adjust the crew mix.  Changing the ratio of apprentices:journeyman or adding/subtracting labourers will change the crew cost and production rate per hour and can improve cost per installed unit
  • Optimize site conditions for increased production.  Rearranging travel routes, hoisting material to key locations, or prefabricating somewhere with ideal conditions, are ways that you can optimize your site to get more production from every hour worked.
  • Subcontract some or all of the remaining work.  Often times a speciality contractor can be found to take on a portion of the remaining work.  If they are able to complete the work at a lower price point, then you can reduce the likelihood of overages.

Subcontracted Costs

The final type of costs that show up for general contractors are subcontracts.  The vast majority of subcontracts are fixed price - once they are negotiated and bought out, the value of the subcontract shouldn't change a whole lot.

If our goal is to minimize subcontract costs on our projects - the opportunity to do that happens prior to award.  Once the deal has been signed, whatever we agreed to is set, and the cost of the subcontract can basically only rise from there as we write change orders to account for things that we missed.  Since subcontracts add up to 80%+ of the total project value for most general contractors, the initial buyout period is incredibly important for the financial success of a project.

Use the buyout period to negotiate favourable pricing and payment terms, as well as to close scope gaps in a subcontractor's bid or between two different scopes of work performed by different subcontractors.  It is always a good idea prior to awarding a subcontract to do a thorough review of the bid and any exclusions, as well as the scope of work in the contract documents, so that you are negotiating from a position of strength.  

When buying out subcontracts - know the project better than the subcontractor!

After a subcontract has been awarded, the risk for non-performance and for subcontract default falls to the general contractor.  From this point forward, the best way to manage subcontract costs is to oversee the installed work of the trades to ensure that the quality is high and that they aren't overbilling.

Wrapping Up

As general contractors, revenue on our projects is fairly static and if we want to maximize our chances of making money we need to look for opportunities to lower costs.  

By understanding the four types of costs - overheads, time based, unit based, and subcontract costs - we can set ourselves up for financial success on our jobs.  

Always keep tabs on project costs and where they are headed!

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