Here is a structure that you can provide to your trades to help them think about Cost of Quality in their business.
Cost of Quality is 3% of revenue, what is that in your company in $
Trust me, it is. Slippage is the silent killer, our unwanted partner, the overpaid ghost that steals our net profits. All contractors experience slippage between their hypothetical gross margins and their produced margins. The difference in the percentages, expressed as a percentage of the job total, is the slippage percentage.
Most professional remodelers shoot for at least a 33% margin on a 50% markup. But when they join networking groups that require members to report financials in a standard fashion, using percentage-of-completion accounting, their produced margins come in below 30%. That's 3% or more slippage. Nobody is immune, not even those using subcontractors only. So if we must live with it, how can we make it manageable?
Know your true costs
Start by knowing your "normal" slippage. All of us need to have a job-costing system that catches and categorizes all of the labor, labor burden, materials, subcontractors, equipment, permits and other costs that occur on each job. For most jobs, especially unfamiliar ones, compare in like fashion the results in the field with the assumptions in the office. After determining your normal slippage, you can raise your markup to capture this margin loss or get to the root cause and fix it, thereby staying more competitive.
Most remodelers guess the labor burden of their field crews and support staff. They also don't break out production management in the estimate, yet they charge it to jobs. Our firm calculates burden to within a few cents for everyone who works for us. We apply a multiplier to base pay to get a burdened cost for regular hours, overtime hours or the next marginal hour. The bad news is that it ranges from 103% of salary for a heavily benefited, low-paid carpenter to 74% for a highly paid lead. On average, my company pays 87 cents in benefits/costs for every 100 cents in base pay. If we're off only 10% in actual benefits taken, that's a 2% job slippage.
Your estimating program must assign burden to specific people working on specific jobs. A spreadsheet is ideal and allows for changes for raises or new benefits. Even assigning a companywide burden and averaging it out over the course of all jobs done in a year is better than doing nothing and not knowing at all.
So if we know our true costs well, where else do we find slippage? Several culprits are obvious. Some involve not planning for the real world, and others are personal habits that promote slippage.
Eliminate Murphy's Law
The most blatant cause of slippage is your unpaid partner Murphy. A favorite expression I heard as a framer was "Cut it tight and kick it in." In reality, your crew is cutting it twice, and it's still too short. When workmanship errors are noticed, the resulting overages in materials, trips to stores and delays in schedules are bad enough, but those errors usually are discovered during building inspections. Of course, the electrician and HVAC guy need to come back after you replace the offending wood. Add that cost to the labor to hide and then rework and, well, you get the idea. Murphy is in our labor hours and errors, probably accounting for 50% of slippage.
Not getting detailed estimates from subcontractors: Murphy is also in our laziness. We might not use a checklist to make sure a job includes all of its components. Most of us do not get firm, detailed quotes from subs, thus subjecting ourselves to the same game we play with customers. Was or was it not included? The discussion and fact finding waste time, and we often end up splitting some differences. Slippage.
Outdated product pricing: The estimator uses an old book or one that is "nationwide." Or your firm updates its custom database only every 18 months or so. That right there can be 5% slippage when you include seasonal factors, regional issues, bad buying and buying from a supplier other than the one used in the estimate. All make the job impossible to produce for the quoted price.
I'm not saying you need to get a quote for every stick and every brick before you price a job. You could use a yearly sliding scale. In January, you might estimate jobs with a 1-2% up-charge for "normal slippage," but in December, you might include a 5-6% up-charge to cover cold weather, the holiday spirit and/or the increase in oil costs that are a huge part of our materials and transportation costs.
If you know slippage exists, plan for it and have the client help pay for known and unknown slippage until you get a better handle on pricing.
Wasted time: Most of us think of time as money, but we routinely allow 45-minute lunches and 15-minute morning and afternoon breaks, and then wonder where all the production went. You just gave away 10% of your billable labor hours each day. A 2% slippage is your reward.
Poorly written contracts, poorly drawn plans, poorly documented schedules and contact lists of subs all foster a "team approach" to figuring out the missing links. Three-person crews can waste an hour each day arguing about a solution.
Undocumented time: Timecards (another must-have, ideally sent in daily for accuracy) often "lose" cleanup, setup and materials runs. Estimators constantly underestimate these expenses. With today's concerns about lead, mold, etc., we spend more than an hour more per day per job in site protection and containment. The client should pay for this, so document, collate, average and get accurate costs to add to the next job of that type.
Fraud: Outright fraud occurs occasionally. Materials end up at side jobs, or time spent at a side job winds up on an employee's timecard. Good supervision, accurate ordering and daily job logs unmask this behavior. Petty theft is virtually impossible to detect but certainly should not be tolerated if discovered.
Poor purchasing: Buying right, from the right source and from a commissioned salesperson, with all freight and discounts accounted for, makes the estimator's pricing ring true. Buying at the nearest source, while convenient, can be costly. Delivery scheduling is a key in keeping pricing in line. Damage to delivered product also causes slippage. Having a system that includes inspection, sign-off, storage and the use of surface-protection products for installed items blunts materials slippage.
Time-and-materials billing: Another institutionalized cause of slippage is the use of T&M billing. Say what? The revenue is guaranteed, and the costs are passed through! The problem lies in the markup. With T&M, clients see all the pricing parameters and tend to freak out, so markup on T&M jobs is usually much less than on lump-sum work, usually at or below 30% for a 23% gross profit margin. For every dollar of sales produced using this billing system, that's 10% off your 33% completed contract hypothetical margin.
Some of us get lazy and use T&M to bill for extras and change order items. If changes become more than 10% of your jobs, plan on slippage of 1% (10% of 10%).
The only way to protect your margin on T&M is to jack up the markup on labor to 100% or more to make up for the inevitable loss of margin on subs and materials markups. This holds true in other situations in which clients provide materials or their own subs and you lose out on markups. For our firm, this scenario requires an hourly labor rate of more than $100 an hour. Not an easy sell!
The obvious solution: Don't do T&M and don't allow owner-provided materials or subs without a "supervisory" and/or "warranty" fee added. We use 30% or just don't do it at all.
Slippage is here to stay. You can raise your markup, update your cost book, slide pricing up as the year goes by, get well-spec'ed quotes and prices from subs, provide well-written and well-spec'ed plans for your staff, and get all materials delivered and stored safely. Going forward, develop controls and systems with timecards that reflect reality in hours and jobs worked on and account for the cleanup and protection levels that make you the best. Your future estimates must make the client pay for your professionalism. Don't let profits slip away.