John Keohane has kissed the design giveaway goodbye. Over the past seven months, he has separated design from construction. He tracks costs and fees on a separate P & L and contracts in three agreements -- feasibility, design/documentation, and construction -- to guarantee payment for design work. Keohane, who runs the $2 million Keohane Construction in Dedham, Mass., is easing into fiscal responsibility, tracking obvious design costs first.
In contrast, consider Geno Benvenuti. Benvenuti stands as a model contractor running his design shop as a profit center, using the same three agreements as Keohane. In 2001, design billings of $681,000, with overhead, associated fees, and direct costs of $463,080, left a 32% net profit of $217,920. That meant half of the $7 million, 42-employee company's profit, in a "remarkable year," came from the labor of seven design center employees.
Yet the owner of the 25-year-old Benvenuti & Stein of Evanston, Ill., remembers when design was a loss leader. Although he's run a design profit center for 17 years, only in the past six has design been a steady profit winner, with typical net profit of 20%.
Getting to that point took careful planning and meticulous tracking. Benvenuti has 60 cost codes for design. He knows his design staff drank $306 in coffee last year. He calculates that for every design hour there's $22 in design overhead.
Both remodelers, however, know that to make the transition to a design profit center, there are some basics to keep in mind:
- Recognize design is valuable.
- Hire the talent to sell and deliver superb design.
- Develop a sales approach, tied to ironclad contracts, that gently shuttles a client into a construction agreement.
- Increase design fees gradually.
- Track all costs and fees.
The Profit Pie
The move isn't easy. The first step is recognizing design's worth. Then, recognizing the tons of costs associated with design.
Mindset, too, is crucial when selling design, as is charging what you need to cover costs. Many remodelers don't feel their design efforts are worthy of pay. Our Reader Panel survey indicates 19% of design/build remodelers don't charge for design, and 29% credit design fees toward construction. Benvenuti would say they're missing opportunities to take control of the process and to use design as a powerful sales tool.
He'll never forget the day in 1988 when his architect collected a $20,000 design fee. "A huge amount of money," he says. "I realized, in this market, people pay for a service."
Designers Who Sell
Before that milestone, however, Benvenuti swung a hammer by day and sketched designs at night. He knew he had to hire talent for superb design, and he knew he had to complete design before construction, locking plans in with few changes. His firm, however, had always looked for ways to improve designs throughout the construction process. Benvenuti realized to be profitable, that habit had to stop. "The transformation came when I hired an architect who was really good at selling the job to clients," Benvenuti says. "The architectural department is the No. 1 sales tool I have."
Benvenuti's new design employees learned how the company worked. Getting to know its construction capabilities -- its carpenters could build anything designers cooked up -- inspired confidence. Confidence in design allowed the firm to sell clients in steps and not worry about homeowners taking plans elsewhere.
Benvenuti was so committed to design as the driver of his business that he carried designer salary overhead through slow design years, and when the design staff wasn't busy, he had them market the firm's broad capabilities as a design/build firm. His client base improved, as did company reputation, and consequently, he could charge more.
"We went with what the market would bear," he says. In the past few years, he has increased fees by 1% to 2%. In the future, any increase will be based on what the market dictates.
His lead architect focuses on selling and overseeing design, not drafting. He's rewarded with a bonus, like any other employee, based on what Benvenuti feels the employee has contributed.
Keohane has employed a designer for two years, and he says evolution to a design/build shop charging solid fees takes time. "When you get more sophisticated, people come to you for the design," he says. "It's a progression. And at the design stage, it's a different sell. At construction, you sell that you're good at construction."
But he agrees that to move to design as a profit center, you need to commit to an in-house designer. "It's part of the sales process," he says. "Our designer is a salesman for us all, through design."
Contracts and fees The next step is to structure the design process so you can charge a fee as early as possible.
At Benvenuti & Stein, a feasibility agreement costs between $1,000 and $10,000 and provides a preliminary budget, floor plan, construction timeline, and property and zoning analysis (See " Making Money With Design" below). The process of delivering on the agreement sells the company's next contract: construction documentation. It's billed on a sliding scale, from 12% of construction cost (for a $50,000 project) to 7.5% (for a project $1 million or more). Construction is the last contract phase, sold while plans are developed.
Keohane charges $1,500 for his feasibility study, which is limited to three client meetings. He bills design at $75 per hour and suggests the client budget for design at about 6% of construction cost, based on the ballpark construction figure established in the feasibility study.
In Benvenuti's early days, he too charged a $1,500 fee, then moved to 1% of construction costs, then up from there.
In feasibility, Benvenuti reports losing about one or two out of every 10 jobs. Whatever the outcome, however, he has covered costs. From design contract to construction contract, he reports almost 100% crossover.
Opponents of this segmented contract approach argue you could spend time in design and not land a construction contract or have the client exit, plans in hand. But Benvenuti says design is an easier sell. And if it doesn't move to construction, he still makes his net profit. Plus, there are other benefits.
"If a client knows they're hiring you for architectural services, they're not locked into construction," he says. "They don't feel over committed, and they're less likely to commit when they feel like they're up to their neck." He charges 2.5% more for plans created, but not built, by his company.
Tracking the Numbers
Once the design staff, sales approach, and contracts are in place, the next step to securing a design profit center is true financial separation from construction.
"I had to do it to get control over knowing how to bill clients properly and to see if we were making money," Benvenuti says of his design center.
Keohane says moving to a design profit center was partially prompted by clients who brought plans and asked if their jobs would subsidize his design center. Without a separate P & L, he'd have to say yes, because he was supporting design in his construction markup.
Although Benvenuti now tracks 60 line-item costs, he says allocating costs to design was a gradual process. But even when he was costing just office space and secretarial expenses and design was a loss leader, he made a conscious effort to make it profitable.
The easy answer to making design a profit center, Keohane says, half-seriously, is to "charge more than it costs."
But you need to explore those costs. For now, Keohane's taking a stepped approach, tracking fees and salaries. He envisions some day boasting a 35% net profit on design, like Benvenuti does. "At a minimum, if we're making 5% to 10% net in construction, we want to do at least that in design," Keohane says.
These charts show a typical design/build process for a $100,000 addition, including contracts in place and examples of costs. It is illustrative only. One track shows design supported by a construction contract; the other shows design run as a profit center.
|Track 1: Design as a Function of the Construction Contract|
|Step 1: Initial Client MeetingDiscuss scope. Sell client on design/build. Agree to prepare contract with a ballpark estimate.Contract: NoneDesign Billings: NoneDesign Costs, Direct: UnknownOwner, 1 hour sales callDesign Costs, Indirect: UnknownInsurance, marketing, gasPayroll benefitsIf Project Dies: Job lost. Costs uncertain||Step 2: ExaminationInformal examination of project, in preparation for design/build contract.Contract: NoneDesign Billings: NoneDesign Costs, Direct: UnknownOwner, 3 hours, worryDesigner, 4 hours, researchDesign Costs, Indirect:Payroll benefitsCAD, computer timeIf Project Dies: Nothing gained. Costs uncertain|
|Step 3: Design/Build ContractClient signs design/construction contract for addition. Down payment credited toward project on go-ahead.Contract: Design/build agreement, $2,500Design Billings: Built into construction markupDesign Costs, Direct: None trackedDesign Costs, Indirect: None trackedIf Project Dies: Paid: $2,500. Spent: Unknown. Design Net Profit: Unknown||Step 4: ConstructionClient OKs design. Construction down payment: $33,333. At construction start, second payment: $33,333.Contract: Signed, Step 3Design billings: 5% of $66,666, or $3,333, minus $2,500 from Step 3Design Costs, Direct: In construction markupDesign Costs, Indirect: In construction markupIf Project Dies: Paid: $833. Spent: Unknown. Design Net Profit: Unknown|
|Step 5: Construction Contract CompletionClient signs off on punch list. Makes final payment.Contract: Signed, Step 3Design Billings: 5% of $33,334, or $1,667Design Costs, Direct: 140 hours @ $45/hour, $6,300Design Costs, Indirect: none trackedIf Project Dies: Paid: $1,667. Spent: $6,300. Design Net Profit: -278%+|
|Design Fees, Total: $5,000; Design Costs, Total: $6,300+; Design, Net Profit: In the negative. Who knows how much?|
|Track 2: Design as a Profit Center|
|Step 1: Initial Client MeetingSalesman/architect discusses process, schedule, square foot cost ranges. Client OKs feasibility study.Contract: NoneDesign billings: NoneDesign Costs, Direct:Architect, 1 hour sales call, $45Design Costs, Indirect: $22/hour*If Project Dies: Job lost. Cost: $76.35* Based on cumulative analysis of 60 line item costs, such as insurance, marketing, gas, coffee; examples in Steps 2-4.|
|Step 2: Design Feasibility StudyArchitect presents preliminary plans, budget, schedule, zoning analysis. Client approves scope, budget, schedule. With go-ahead, retainer applied toward construction documentation.Contract: Preliminary design agreementDesign Billings: $2,500Design Costs, Direct:Architect, 8 hours concept drawings, 1 hour presentation: $405Designer, drafting, research, 32 hours: $736Production super, estimates, 1 hour: $38Design Costs, Indirect:Architect, designer, production super, benefits @ $9.35/hour: $393 CAD hardware/software for document prep, presentation: $65Rent, office expense: $347Miscellaneous, insurance, marketing, gas: $114Coffee: $5If Project Dies: Paid $2,500. Spent $2,103. Net profit: 16%.|
|Step 3: Construction Documentation/ Contract PrepClient signs construction document and prep contract (11% of construction cost, or $11,000). 35% paid at signing, 35% paid when permit is applied for, 25% paid when permit is issued. Remaining 5%, plus design fees incurred via upgrades/changes invoiced during construction.Contract: Construction Documentation/Contract PrepDesign billings: $10,450Design Costs, Direct:Draftsman, 120 hours: $2,760Architect, 24 hours: $1,080Production super, 6 hours: $228Design, indirect costs:Architect, designer, production super, benefits @ $9.35/hour: $1,402CAD for document prep: $65Office expense: $1,041Miscellaneous, insurance, marketing, gas: $346Coffee: $19If Project Dies: Paid $10,450. Spent: $6,941. Net Profit: 34%||Step 4: Construction ContractContract presented. Deposit, 20% of construction, received.Contract: Construction ContractDesign billings: 11% for change orders requiring architectural time. Structural deficiencies found during demo. Client decides to remodel and redesign bath, total cost $22,000. Fees: $2,420Design Costs, Direct:Draftsman, 10 hours: $230Architect, 14 hours: $630Design Costs, Indirect: $528If Project Dies: Paid $2,420. Spent: $1,388. Net Profit: 42%|
|Step 5: Construction Contract CompletionClient signs off on punch list. Final 5% paid.Contract: Signed at Step 4Design Billings: $550Design Costs, Direct: noneDesign Costs, Indirect: noneIf Project Dies: Paid: $550. Spent: None. Net Profit: 100%|
|Design Fees, Total: $11,000, plus $2,420 design fee (change orders) = $13,420; Design Costs, Total: $6,152 (labor) plus $4,875 (indirect, direct costs) = $11,027; Design, Net Profit: $2,393, or 17.5%|