Reining in Runaway Costs

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Hurricanes in the south, unprecedented levels of construction material demand in China, record oil prices and a host of other issues drove up material costs in 2004. Ongoing increases in labor, insurance and general overhead expenses squeezed margins from another angle. How do you generate an acceptable profit when pricing seems out of control?

"If price pressures keep up, I don't know where else I can go but to take some of it out of the margin," laments Tim Thompson, president of Thompson Building Associates in Columbus, Ohio. For the time being, Thompson is maintaining profit levels because of substantial operational changes he instituted three years ago that helped maintain control during a highly volatile year for construction costs.

Talking with a number of remodelers reveals a variety of cost-control methods that paid real dividends in 2004: upgrading software, instituting bonus systems, balancing in-house work with subcontracting and paying more attention to scheduling. Assessing and implementing some of these approaches may help you avoid cost creep and margin loss this year.

Invest in job costing

Sometimes spending money up front saves money in the long run. That's what Thompson determined when he upgraded his company's software to improve job costing. As a firm specializing in insurance restoration and handling between 700 and 900 insurance projects a year, TBA needs to monitor cost especially carefully.

"Insurance companies apply considerable pressure on contractors to limit costs," says Thompson. "They specify how much we are allowed to charge, and if you want any work, you have to agree to their pricing." After Sept. 11, insurance companies increased cost pressure to the point Thompson knew he needed to make major changes.

"We dramatically upgraded our accounting systems and how we track employees' time to get detailed cost control," Thompson says. "We used to look at jobs at the end, and only then did we know if we made money. So we broke a job into many segments, and track each segment so we know if we are on budget for each segment. Now we know very quickly if a job is going over budget."

TBA adopted Timberline as its accounting system and also made more robust use of its existing estimating software, Xactimate. Thompson also added a controller, instituted a time-card system to track employees' time in 15-minute increments, and coded project phases. TBA now ties all material expenditures and work orders to a project phase.

Sharing profits cuts costs

Educating employees on the true cost of doing business — and offering them a chance to share in the profit realized by keeping costs down — also worked for Thompson. He established a quarterly bonus program for employee profit sharing.

"The first year we were 4 percent over budget, so there was no bonus pool," Thompson says. "After a year of looking at the system closely, the associates started talking with each other about how they could bring the projects in under budget."

Since that first year, there has been money in the bonus pool every quarter. In 2004 Thompson paid out approximately $80,000 in bonuses to his 65 employees, a number that has increased 35 percent since the cost control overhaul took place.

"If you don't have the numbers you can only focus in on behavior," Thompson says, noting it is hard to set goals on generalities such as "work harder" or "get better." "After getting good at managing numbers, we don't have to manage behavior. If you have x doors and they are scheduled to take 5 hours to install, if it takes 4 hours and you take more time at lunch, I don't care."

The bonus plan also encourages ad hoc training. "Now, experienced associates will help new people learn how to operate within the company," Thompson says. "They will look at the new person's time card and say, 'Let me show you how to do that the TBA way.' I didn't know there was a TBA way for so many things, but it is good to hear the associates providing each other with assistance and the incentive to improve quality."

Like Thompson, Wendell Harmer, partner and general manager of The Wills Company Inc., in Nashville, Tenn., credits his company's profit sharing plan as a major means of controlling costs. "As with any company, if you take your eye off the ball, it can get away from you very quickly," Harmer says. "Profit sharing helps us to naturally govern ourselves."

By having an open-book company, Harmer feels he has an additional 25 sets of eyes on the ball. The profit sharing provides staff additional incentive to watch costs. The company produced $3 million in renovations in 2004 and has already sold $6 million for 2005 and only added one employee.

"We have an open book company and every one knows our overhead. It helps our staff understand when you have to make a difficult business decision," he explains. Wills Company employees earned an additional 11 percent of their salary as a 2004 bonus — not bad, although that was down from 15 percent in 2003.

Insurance savings

Engaging employees in controlling costs via open books and profit sharing can help reduce insurance premiums as well. "For example, it was hard to convince people to wear safety glasses," Harmer explains. "But insurance statistics show how much it costs the company by not wearing safety glasses on a regular basis. When insurance, which is a very expensive piece of overhead, was shown to impact profits, people started wearing safety glasses."

The Wills Company also reduces insurance costs through a drug-free workplace policy. "By abiding with the Tennessee Drug Free Workplace Program and having drug testing we save 10 percent on our workers' compensation insurance," Harmer says.

The Wills Company also has safety programs every six weeks that emphasize common sense to further reduce insurance costs and to help reduce claims that could drive up expenses. There has also been company-wide CPR training.

Steve Schliff, president of On the Beam Remodeling in Oakland, Calif., has a full-service company with six employees. He belongs to the local Contra Costa Builders Exchange mainly for the group rate on workers' compensation insurance. According to Schliff, the cost of membership is offset by the dividend the Exchange awards for low or no claims. On the Beam Remodeling has had no claims in six years.

Employees versus subs

Adjusting who does the labor on your jobs can also help control costs. Schliff brings as much work in house as possible. On the Beam Remodeling averages 25 to 30 projects a year, ranging from $15,000 window replacements to $500,000 whole-house remodels.

"It is not so much material costs that impact me as it is the subs," he says. "I think subs are a source for scope creep and dollar creep. Right now it is a struggle finding subs that fit within an acceptable percentage of the total cost of construction."

Therefore, Schliff pays for additional training of his staff. For example, after his staff gained the appropriate experience, Schliff obtained a California license as a tile contractor. "That has paid us back in spades. Not only do we do all of our own tile work, our discount rate for tile is 30 percent instead of the 20 percent we were getting as a general contractor," Schliff says.

Schliff's administrator, in addition to running the office, also jumps into the shop and helps build cabinet carcasses when the need arises. "My staff has multiple skills, and I use them all," Schliff says.

The Wills Company has had the exact opposite experience: subbing out more portions of jobs has brought significant returns. Known as Nashville's high-priced remodeler, the company was losing a significant amount of the larger jobs it bid, according to Harmer. A devoted past client's rejection led to significant rethinking of the system.

"A former client wanted to hire us for a whole-house remodel, but our first bid came in at $610,000 and he said, 'I want to hire you, but I think you are too high priced, and I think your subs are charging too much,'" Harmer says. In the interest of maintaining construction quality, The Wills Company consistently had used the same subs without requesting competitive bids for every line item. Because this client relationship was important, Harmer obtained bids from three subs for every item and brought the cost of the project down to $550,000, almost 10 percent lower than the first bid.

"We are now managing our subs more effectively. We are not beating them up, but we are showing them the other prices and seeing what can be worked out, if anything," Harmer says. Taking the idea to the extreme, he has even tried to see if other carpenters bid lower prices than his own in-house carpenters. If the sub has a better price and his crews are busy, he will let out the contracts to the lowest qualified bidder to maintain the best margins on the project.

Harmer has even outsourced bookkeeping to his accounting firm, eliminating the need for an in-house bookkeeper. "Our accounting firm has someone come in four hours a day for four days a week, and another person comes in once a month to close out our books," Harmer says. "It helps us control overhead and be more nimble. When we need more time, they give it to us." Sales of remodeling projects are projected to surpass the company's highly profitable handyman services in 2005.

New purchasing patterns

Bringing all material purchases in-house was the most cost-effective solution for Keith Steier, president of Knockout Renovation. Located in Brooklyn, N.Y., the company specializes in condo and apartment renovations and expansions in Manhattan. "The cost of doing business in a metropolitan area has gone up. Getting rid of debris, gas, parking, almost everything," Steier says. "My favorite way of dealing with increased costs is improved efficiency."

To that end, Knockout only accepts projects in which it supplies all materials and appliances. This caveat, instituted a few years ago after the company had been in business for eight years, helps Steier maintain tight schedules in an area where it can be difficult to operate. "If everything is measured right and prepared right and brought in at the right time, just doing a project in 20 days instead of 22 or 23 days can make all the difference in profitability," Steier says.