A/E firms: What is more important to manage – the firm’s profitability or the projects profitability?
The way to improve profitability begins with managing the projects profitability. God is in the details, and if you don’t have the full picture of each project, it’s impossible to be 100% efficient. A/E firms must (1) manage projects profitability (2) make sure the hourly cost (including the profit margin) is correct (3) track projects’ efficiency on real time basis (4) recognize change orders, etc.
A/E firms that are not doing all the above will not reach their profit potential. It’s impossible to be efficient if you do not manage the details that make the big picture, but is it enough?
“If all of my projects are profitable, then the firm is profitable” well…. it’s not always true…
For example, a firm had a few big projects that started in 2017, and the initial phases showed 30% profit in 2017. In 2018, the firm is now working on the next phases in those projects. Let’s say that in those phases the firm loses 15%. If we will check the projects profitability, we will see that the project is still profitable. The problem is that the firm is losing money in 2018…
Another example: If the hourly cost rate was calculated according to 1,800 billable hours in a year (per person) and all the projects combined showed profit in a current year (let’s say average profit of 10%) but the actual average billable hours were 1,400 instead of 1,800, then it means that the firm will lose money. To explain the same point from a different angle: let’s say that the hourly cost per hour is $100 and we have one person working on one project. This person spent 1,400 hours on the project. Therefore, the cost of the project is $140,000. The firm revenue is $154,000 (10% profit), so the project shows a profit of $14,000. The problem is that there are additional 400 non-billable hours and the cost of that is another $40,000 (400 hours at $100/hour). So, in total there is a loss of $26,000.
Meeting the firm revenue objective (while not exceeding the expense budget) will assure that the firm is profitable.
If the firm’s monthly break-even point (monthly expenses) is $800,000 and the firm revenue objective is $1,000,000, then once the firm meets the revenue, billing and new contracts objectives every month, it will assure that the firm will have a year-end profit of 20% ($12,000,000 revenue vs $9,600,000 expenses). It’s obvious.
There is no conflict between the firm’s profitability and projects profitability. However, sometimes we need to choose, and my suggestion in these cases – choose the firm.
For example, if your utilization is down, and according to your projections in the next few months you are not meeting your billing objective, then it will make sense (from a financial point of view) to take a short-term project to “close the gap” (assuming you want to keep the existing team intact). Financially, it would be the right choice even if your revenue per hour from that project will be lower than your cost per hour! Basically, you are just using “spare hours” and increasing revenue without increasing expenses. This is just one example of a “losing project” that is increasing the firms’ profit.
The director of the firm needs to take similar decisions almost every day. The real decision-making process in the firm must look on the big picture in any given moment and not just on the specific project.
My point is not to stop managing the projects profitability. The contrary – it is super important, but it’s not enough! When it comes to managing the firm, you should focus on meeting the firm’s financial objectives (revenue-billing-new contracts) and key performance indicators while managing it on a real time basis. It is the only way to make sure that the firm will meet its profit objective.