How does a projected 28% gross profit margin on a second-story addition slip to 6% by job's end? That's what Houston remodeler Leslie King wanted to know five years ago, when it happened to her. "Our wake-up call," the president of Greymark Construction calls it. "We'd never done that poorly, and it forced us to make some changes."
Slippage occurs when something on the job causes unrecoverable costs to extend beyond the limits of the estimate. Such deviations are usually thought of in terms of materials or labor miscalculations or waste -- or are perhaps even attributed to extra customer service efforts.
Defined as the difference between estimated and actual gross profit, slippage runs about 5%, on average, in residential remodeling, where "there is high potential for errors, miscommunication, and unexpected costs," says Jim Strite, president of Strite Design+Remodel in Boise, Idaho.
Put another way, 5% is $50,000 out of every $1 million in revenue. That's nothing to sneeze at.
King has since refined and implemented several processes to help her company reduce slippage, most notably instituting a "post-mortem" review of costs at the completion of every job. Other remodeling companies use similar evaluations, in addition to upgrading their accounting and estimating practices, instilling accountability at every level (including subs and suppliers), and building contingencies into the budget estimate or contract amount.
What they've discovered is that solving the slippage problem is a step-by-step process.
Step 1: Know Your Numbers
You can't find slippage, much less correct it, unless you have numbers in front of you. Namely, you need methods of accounting, estimating, and job costing per job that are consistent across every project. Those numbers, in turn, transfer to a profit/loss statement that includes your markup on direct costs and calculates your expected gross profit.
Strite, for instance, is a stickler for such numbers, encouraging remodelers in industry seminars and other forums to adopt and practice the percentage-of-completion method of accounting as a critical first step to solving slippage. "Before you can zero in on slippage, you must understand the difference between markup and margin, and when a job is considered a sale," he says. "There are million-dollar firms that still don't use this [percentage-of-completion] method, thinking that the numbers will work out."
More often, however, the numbers just get lost, hidden, swept away, or ignored, despite their individual and collective impact on the bottom line.
Strite points out that, unlike cash, progress billing, or completed-jobs accounting methods, tracking costs and revenue by percentage of completion forces a continuous review of each project, as well as review between various projects, to effectively identify specific areas of slippage.
One key is to begin with a detailed estimate of costs applied to a project. "The risk [of slipping] is much lower for a remodeler who is accounting for all of the potential variables that go into a project or phase of work," says Steve Watt, vice president and director of estimating products for Timberline Software Corp. in Beaverton, Ore.
Step 2: Use Your Numbers
Numbers mean nothing unless you use them. "We had the data; we just weren't looking at it or doing anything with it," recalls King. Since taking a more watchful approach, the company has identified -- and rectified -- slippage in framing labor, trim carpentry, and paint.
Remodelers who leverage their numbers beyond a periodic review of costs and revenue stand a better chance of stemming the slide. Strite and his project managers, for instance, use the company's estimating program to develop a detailed scope of work for each phase and each job, which is passed along to subs and suppliers as the basis for their bids on labor and materials.
The project manager then compares bids with the scope of work to ensure an apples-to-apples estimate before the numbers are plugged into the budget. As invoices for labor and materials are received, they're compared with the estimate (calculated on a percentage of completion) to identify specific areas of slippage as early as possible.
Halfway through every job, project managers at Deimler amp; Sons Construction in Harrisburg, Pa., perform a full dissection of the work in progress. "One of the key things they check is whether cost updates have been entered and the budget adjusted accordingly," says vice president Craig Deimler, referring to change orders. "They also bring in the lead carpenter for the job to discuss any slips and why they occurred."
King's post-mortem review at the end of each job, in addition to periodic checks of costs and revenue in progress, helps her identify both slips and surpluses to projected profit margin. "If we save money on something, we want to know why just as much as if we slip," she says. "Maybe a sub gave us a special price to get the job, but we shouldn't rely on that price in the future."
Using numbers from current or past jobs to forecast future estimates is vital to controlling slippage, especially for remodelers who specialize in small, short-term work. "A large job over several months should provide enough time to respond to and recover slippage," says Watt. "Smaller jobs give you less time to respond, but that experience can be used to create better and more accurate estimates the next time."
When higher costs for finish work started to cause slippage at The Remodeling Company in Beverly, Mass., president Gary Moffie began reviewing his numbers daily and meeting with his production team at the end of each project to avoid similar overruns in the future. "There's always something new to incorporate into the next estimate," he says. "We use our past work as a template."
Step 3: Sweat Everything
Forget about not sweating the small stuff. All aspects of every job need constant attention if you want to maintain your profit margin.
For Max Isley, president of Hampton Kitchens of Raleigh in Raleigh, N.C., staying on schedule is as critical to profits as staying on budget. "Timing is the biggest opportunity for slippage," he says. Estimating mistakes can be corrected, but delays not only cost money, they erode customer satisfaction. "That means they'll want something back, which eats away at your profits."
To keep that from happening, Isley is meticulous about scheduling materials and labor, using only reliable sources and making sure deliveries are complete and undamaged. He assembles and stores complete inventories for upcoming jobs, enabling Hampton Kitchens to start and finish projects on time and as promised.
Isley also has a healthy respect for numbers but knows his limitations. "I'm more focused on making $1,000 than losing $50," says Isley. "Someone has to be watching the details, and it isn't me."
Bean-counting responsibilities at Hampton Kitchens fall to Isley's wife and partner, whom he describes as tenacious about reconciling estimated and actual costs. "If a $30,000 job is $150 off, she wants to know why."
Step 4: Add Contingencies
For remodelers who understand that slippage is as much about the unexpected as it is about accurate estimates and diligent accounting, contingencies that cover unknown costs are an effective hedge against sliding profits.
John Sylvestre, of Sylvestre Construction in Minneapolis, takes precautions against specific areas of potential slippage. He always adds a 10% cushion to supervision and lumber costs and 12% to 15% on all labor estimates. "Even with the best estimate, we still tend to slip a bit," he says. "It gives us an opportunity to cover our tail."
Some remodelers are even more specific with contingencies. Ed Bartlett of Edward Bartlett amp; Sons, West Valley, N.J., identifies aspects of a project he thinks might cause a glitch in his initial estimate and communicates them in person and in writing to homeowners. "I try to give an allowance for anything unexpected, instead of nickel-and-diming my clients," he says. The strategy works for Bartlett particularly because he contracts with seasonal residents in his market, often performing work when those homeowners are living elsewhere. "I need to be precise on the budget but also explain the need for a contingency so the client is prepared," he says.
Another area of concern is the unpredictable cost of placating or simply managing a difficult homeowner. To hedge that bet, Strite creates an internal line item for "client maintenance," which is kept out of the estimate shown to the homeowner but accounted for in-house throughout the job.
Step 5: Manage Change Orders
In remodeling, change orders are almost inevitable. But change orders alone can undo any other efforts aimed at solving slippage. The key to keeping profits in line is to manage change orders by estimating and accounting for them as the job progresses. "Our policy is to document an agreed-upon scope for every change order, with the amount we're charging attached," says Strite. "We profit-share [among our staff], so if you do something extra without a change order, it eats right through the profits."
Change order markup also directly affects the profit potential on each adjustment to the budget. For instance, Moffie uses a 50% markup (and a resulting 33% margin) on his direct costs to create an initial project estimate, but he often has trouble achieving the same level on change orders. "If a customer wants one more recessed light, it might cost $50 for the fixture, but it's billed at $225 with labor and markup," he says. "It's hard to charge someone that much for just one more light when they know its retail price at Home Depot."
To hedge a bit, Moffie makes sure homeowners understand that any change order requests will carry a minimum of one hour's worth of labor at $75. "That allows me to at least get some money back on labor for smaller change orders," he says.
For Bartlett, who frequently works for seasonal homeowners, change orders can be especially problematic. His policy is to bill promptly and require payment as they occur and to build trust with his clients so that small changes don't delay jobs. "I don't want to hold up a job for a $200 variance," he says. "If I can build trust in the beginning, finishing the job on time will be worth more to the homeowner than haggling over a change order."
Step 6: Communicate
Controlling slippage requires good communication, from making sure plans and specs completely reflect the homeowner's expectations to facilitating forums between the sales staff and production crew. Bartlett maintains regular contact with off-site clients via phone, fax, and e-mail. "I'll e-mail them digital photos showing progress or the extent of a problem we've uncovered," he says. The images provide a visual reference for unexpected, but necessary, repairs or replacements that require an adjustment to the agreed-upon budget.
Deimler has refined communication between the home office and the field to make sure both are on the same page with regard to estimating labor and materials. "We were able to pinpoint slippage to our scheduling practices," he says, such as properly matching a subcontractor to a given phase of work. "Our lead carpenters now take a more active role in determining which subs are assigned to what jobs."
Remodelers can also benefit by estimating conditions for each job realistically rather than assuming ideal or even consistent conditions across all phases or projects. One hitch in a perfect scenario -- whether it be a delay in a materials delivery, damaged goods, or difficult site access -- will put a dent in your profits. That means requiring subs to visit the site before they offer bids, and taking into account site access, material storage, changing weather, and other factors that affect productivity.
Step 7: Maintain Accountability
Despite efforts to reduce slippage and maintain projected profits and revenue, Deimler amp; Sons Construction still wasn't making its numbers. As a result, the company couldn't follow through on a bonus plan, which was causing morale to slip.
Without warning, Craig Deimler sequestered his production staff in a room and required them to explain why their jobs had made or lost money. "My theory was that they were not being held accountable, despite all my ranting and raving," he says, noting that bonuses are earned and shared by the whole team, not for individual performances. "When they had to defend it in front of their peers, it was a different story."
Deimler now requires his sales staff to sit in on the meetings and contribute to the discussion. "They need to hear if they are missing something so they don't repeat that mistake on the next estimate," he says. "We used to dissect a job only if something was really off. Now, we do it at every production meeting."
Deimler's "jury system" helped the company reduce slippage from a steady 6% to less than 2% in just one quarter. "They earned a bonus last quarter for the first time, and we're on track to do it again this quarter."
Step 8: Stay the Course
Often, remodelers struggling to control slippage find they are their own worst enemies because they step away from the systems they create. "Every time I go outside the norm, I think it's going to be OK," Max Isley says. "And it never is." Case in point: A project was delayed recently when Isley allowed the owners to extend appliance selection beyond his scheduled deadline.
Isley also tries to stay the course with a reliable batch of suppliers and subs that help make sure his jobs stay on schedule. "We've found better prices and even better performance [among products] in the past, but when the supplier doesn't want to follow our program, we've got real problems," he says.
Staying on a track toward solving slippage issues also involves a commitment to continually refine your processes. "You've got to constantly improve your systems and commit to it as a value among your team," says Strite.
As for remodelers who continue to turn a blind eye to slippage, Watt considers it inevitable that they'll sooner or later take a more diligent approach. "As markets get more competitive, remodelers will be forced to do it, or get shut out of jobs." --Rich Binsacca is a freelance writer in Boise, Idaho.