The Fourth of the Seven Deadly Sins of the Construction Industry: Not Knowing Your True Cost

The Fourth of the Seven Deadly Sins of the Construction Industry:  Not Knowing Your True Cost

Seven Avoidable Mistakes Construction Businesses Commonly Make

We last discussed how to help your employees avoid making bad decisions for your company.  This week, we look at how to understand your true cost of doing business.             

Control sale and production from pricing to completion. Whether you are a contractor offering pre-construction services, a service operation, or some combination thereof, involve all of the necessary parties before commencing the sale output.  Know the costs to be incurred on the job, the hours your staff will put into the job, material requirements, material buy-out gain, delivery requirements/costs, and labor scheduling needs.  All of these make the difference between a proper valuation of your actual cost versus the revenue you will realize in the end.  Simply put, measure what the true profit on the job is supposed to be, so that ultimately, you can measure performance on the job. 

Get everyone on the same page.  Start with a clear understanding of what your profit will be after the direct costs of the job are paid.  If you use overhead or general conditions in your estimating process, have your accounting department measure your profit or loss based on the absorption rate of those costs.  If you attribute a labor overhead rate to the hourly cost of labor, measure those costs inclusive of overtime against hours estimated on jobs.  You may find your labor to be either a profit center (and therefore a tool to price tighter), or you may find it a loss that needs to be better managed.  You may find you are leaving money on the table with your rates, and that you can increase your labor rates without jeopardizing sales.  Review labor schedules, general conditions costs by category, maximization of equipment, the cost of owned equipment versus rental equipment, and the incremental costs of fuel.  All of these items become benchmarks to assist control, the ability of managers to manage more effectively, and to maximize your profit.

Learn to maximize your profit.  Review your profit centers routinely.  Almost every company does something really well.  Identify the product, job type, or service you can use to be more predatory in your sales to increase your bottom line.  Maximize the work you do well.  Correct or avoid the products, jobs or services that are hit-and-miss, or never seem to work out as planned.  If you have production/job controls, accurate and timely reporting, a strong pre-construction process, and a scheduling process linked to the budgeted estimate of costs (which supports your actual ability to produce the job within the estimate), you can focus your sales efforts, and increase the bottom line.  This process will also help when you to take that tightly-budgeted job that you want to do for branding, overhead absorption, or competitive reasons, and drop whatever you make after direct costs to the bottom line.

Make sure the cost of sales on your financials mimics your management reports. All too often information is lumped together on the company’s financial statements.  The categories of direct costs, job overhead, or general conditions are not depicted on the financial statements in the same manner that they are used in estimating.  For example, for a residential builder, the base home revenue and cost should be segregated from the post-sale “selections” revenues and cost or change orders.  The home should be segregated from the land revenue and cost, if any. 

The commercial or purely custom residential contractor should segregate direct costs from general conditions costs.  If there is a separate pricing process for change orders, segregate the revenue, and if possible within your current systems, segregate the cost of the change orders billed or not billed. The service/warranty department should segregate revenue and costs of warranty from service contracts from time and material work, and segregate the materials/parts that are billable from supplies.  Labor and labor overhead should be listed as defined in the pricing, often inclusive of payroll added costs, uniforms, licenses, vehicles costs, radios, pagers, cell phones, etc.  This process avoids surprises when viewing financials versus internal job cost or management reports, and allows for a meaningful reality-check.  In the end, you are in the business of risk management.  The better the information you rely upon, the more strategic and effective your decisions.

Know what your gross profit should be.  In furthering your efforts to mirror the estimate on your financials, the next step is utilizing percentages.  Know your gross profit percentage on revenue after direct costs of labor, materials, subcontractors, equipment rentals, delivery, etc.  If you are primarily a “cost plus fee” builder, your gross profit is based on your real profit on labor after payroll added costs and costs of non-productive time planned, on your general conditions allowances, and your gross profit on materials based on your mark-up.  Variances for all contractors to be aware of are non-billed labor hours from overruns and excessive non-productive time, overtime, missed change orders, material waste and rework, missed parts/material billing, and pricing/estimating errors.  Be careful to segregate “buy-out” gains on materials, early pay discounts, or bulk purchase discounts from standards of cost on fixed priced contracts.  This “profit area” is “profit” from your cash flow, not from general operations.  Don’t let these numbers mask or mitigate operational inefficiencies.

The next topic in this series will help you to analyze whether you are truly working for a profit.  Ideas?  Thoughts?  Questions?  Post a comment and let’s discuss!

Supreme Court Victory for Employers

On June 23, 2011, the California Supreme Court overturned a $22.5 million personal injury verdict from Ventura County in a ruling that will affect any California employer that hires drivers.  In Diaz v. Carcamo (200 WL 2473597), the Court limited how people can sue an employer when an employee causes a traffic accident.  The Court ruled that if an employer is willing to take responsibility for its employee’s bad driving, the employer will not also face a claim of negligent hiring of the employee as a driver in the first place.

In general, a person injured by someone driving a car in the course of employment may sue not only the driver but the driver's employer.  Under California tort law principles, the employer can be sued on two different legal theories:  (1) respondeat superior and (2) negligent entrustment.  Respondeat superior is a form of vicarious liability, which makes the employer liable, regardless of fault, for the negligent driving of its employee when in the course and scope of his/her employment.  Negligent entrustment, on the other hand, is a finding of liability against an employer for its own negligence in poorly selecting an employee to drive a vehicle.

In Diaz, Plaintiff Dawn Diaz was driving south on U.S. Highway 101 near Camarillo. Defendant Jose Carcamo, a truck driver for Sugar Transport of the Northwest, LLC, was driving north in the center of three lanes.  Defendant Karen Tagliaferri, driving in the center lane behind Carcamo, moved to the left lane to pass him.  Tagliaferri failed to signal, and when pulling back into the center lane, hit Carcamo's truck, spun, flew over the divider, and hit Diaz’s vehicle.  Diaz sustained severe, permanent injuries.

Diaz sued Tagliaferri, Carcamo, and Sugar Transport.  She alleged Carcamo and Tagliaferri drove negligently, and that Sugar Transport was both vicariously liable for employee Carcamo's negligent driving, and directly liable for its own negligent hiring and retention of him. When answering the complaint, Carcamo and Sugar Transport denied any negligence.

At trial, Tagliaferri conceded she was negligent.  Carcamo and Sugar Transport contended Tagliaferri was solely at fault; however, Sugar Transport offered to admit vicarious liability if its employee Carcamo was found to be negligent. That admission, Sugar Transport argued, barred plaintiff from further pursuing her claims for negligent entrustment, hiring, and retention.  The trial court disagreed.

In support of her negligent hiring claim, the Ventura County trial court admitted evidence offered by plaintiff of Carcamo's driving and employment history.  Carcamo had been involved in two prior accidents, one in which he was at fault and was sued, and the other occurring only sixteen days before Diaz’s accident. Other evidence showed Carcamo was in the United States illegally, that he had used a false Social Security number to obtain employment, that he had been fired from or quit without good reason three of his last four driving jobs, that he had lied in his application to work for Sugar Transport, and that, when Sugar Transport had contacted Carcamo's prior employers for references, the only response was negative.

Before closing arguments, Sugar Transport stipulated with Diaz to vicarious liability for employee-driver Carcamo's negligence, if any were found by the jury.

After deliberation, the jury found Tagliaferri and Carcamo had both driven negligently, and that Sugar Transport was negligent in hiring and retaining Carcamo as a driver.  The jury allocated 45% fault for the accident to Tagliaferri, 35% to Sugar Transport, and 20% to Carcamo.  The jury awarded Diaz over $17.5 million in economic damages, and $5 million in noneconomic damages.

The Court of Appeal affirmed the judgment from the trial court.  The Supreme Court, however, after an extensive analysis of California’s system of allocating liability for tort damages based on comparative fault (a system created by decisions of the Supreme Court in the 1970's and by the California electorate's later adoption of the Fair Responsibility Act of 1986 (Proposition 51)) held that Sugar Transport's offer to admit vicarious liability for any negligence of its employee-driver required the trial court to withhold plaintiff's negligent hiring and retention claims from the jury.  This withholding also then required exclusion of the evidence Diaz offered to support those claims, including Carcamo's poor driving record and employment history, his dishonesty, his status as an illegal alien and resultant use of a false Social Security number to obtain employment.  The Supreme Court remanded the case back to the Ventura County trial court for a new trial consistent with its ruling.

Specifically, the Supreme Court held that:

(1) the employer's concession that it was vicariously liable for its employee’s negligence rendered evidence of the employer’s negligent hiring and retention of the truck driver irrelevant, disapproving an earlier appellate court decision to the contrary;

(2) the employer's failure to admit vicarious liability earlier did not forfeit its right to the exclusion of the evidence; and

(3) the trial court's error in admitting evidence of negligent hiring and retention, and including the employer on the special verdict form was prejudicial to the employer.

This ruling should plainly be chalked up in the win column for businesses and insurance companies.  This decision eliminates the risk of double liability to the employer:  for the vicarious liability for the negligence of its employee, and then the independent liability for hiring or keeping an employee with known problems.

The Third of the Seven Deadly Sins of the Construction Industry: Avoidable Bad Decisions!

The Third of the Seven Deadly Sins of the Construction Industry:

Seven Avoidable Mistakes Construction Businesses Commonly Make

Together, we've talked about the importance of internal controls, and cash flow in the overall fiscal health of your business.  This week, we look at how to help your employees avoid making bad decisions for your business.        

Let’s face it:  everybody makes a bad business decision now and again.  Occasionally, bad business decisions happen as a result of simple bad luck.  More often than not, however, bad business decisions are the product of uninformed decisions.  Before making any affirmative business decision, your employees should consider each of the following four points.  Failing to consider any one of these four points may undermine a positive outcome, and ultimately lead to anarchy at your office, with each employee devising their own standards of what a “good” decision means to him or her. 

Does the decision support the company’s stated goals of profit and sales growth?  Whether estimating, facilitating buy-out, or communications, all employees vested with decision-making authority must consider whether his/her intended action will move the company closer to achieving its stated revenue and profit goals.  These should be considered together.  You have all likely encountered the scenario wherein a decision may negatively affect profit in the short-term, but support long-term sales growth, which in turn positively affects long-term profit.  Consideration of the full spectrum of impacts is critical to good and thoughtful decision making.

Is the decision consistent with the company’s promises to the customer?   Each employee with customer-contact must know the specific commitments made to the customer.  This means:  put the commitments in writing!  Commitments should be in writing so that expectations between your company and the client are clear.  Those expectations can then be communicated throughout your organization to all employees who interact with that customer.  Scheduling issues, changes, job site meeting follow up, etc. should be shared and reinforced at each level, with practical input from employees interacting with that customer. A promise is nothing more than an agreement upon a standard of performance made between your company and the customer.  If there is no record of the standard of performance, the customer may believe the standard to be different, or not accurately recall the conversation.  If your employees aren’t in the loop, the customer may be given a different story depending upon with whom they interact.  In either of these situations, rest assured, this avoidable problem will impact your revenue, profit, and reputation.

Is the decision consistent with good teamwork?   Be sure that decisions include consideration of the resulting impact upon other departments and team personnel affected by the decision.  Get their input.  The decision may be good for one area, but not another.  The bottom line is, don’t “kill” someone critical to your business by not letting them know what you are about to do.

Is the decision compliant with local, state and federal law, and all regulatory requirements of your industry?  While this may seem like common sense, all businesses want to prevent negative interactions with regulatory agencies.  Whether the issue relates to taxes, insurance, certified payroll requirements, or local sound and dust abatement ordinances, simply ask the question of someone who should know the answer…and “I don’t know” or “I think so” are NOT acceptable answers!

Ideas?  Thoughts?  Questions?  Post a comment and let’s discuss!

The next discussion in this series will look at how to analyze your true project costs.  Stay tuned!