Cost Management Considerations

Cost management is a large portion of a project manager’s role, and for projects that require, proportionally, a large amount of raw materials, supplies, equipment, or parts, focus on cost management can be the difference between a project that is completed at, over, or under budget.

One benefit that can be contributed to the economic downturn is the increased efficiency which businesses were forced to implement to remain profitable. Instead of uncontrolled spending that was offset by endless contracts and a steady flow of cash, businesses found themselves with limited cash flow and the need to become extremely efficient and find every possible way to save money.

This need for efficiency and getting the most out of every dollar was further exacerbated by companies bidding work so cheaply to maintain some form of cash flow that staying profitable became, and still is, almost impossible. The role of cost management within project management became even more important with this trend.

The idea of cost management seems simple enough; make sure once you have subtracted out profit and overhead that you spend less than this amount on labor and materials. With the influx of government stimulus money, wages are preset for contracts that are paid for utilizing this stimulus money. With wages set, the focus for reducing the cost of labor then falls to efficient production or output, however if we are considering a general contractor model, then the ability to lower labor costs falls to selecting the most cost efficient subcontractor. 

With stimulus contracts, profit margins are typically set at 10-12%, and the amount of overhead you are able to claim is produced by submitting supporting financial claims.  This is typically only relevant to jobs that include a “time and material” clause for unexpected items, or RFP’s for items that a definitive cost cannot be determined.  So what are we left with?  Consideration of the indirect costs associated with product procurement and efficient subcontractor use and make or buy decisions. 

Let’s first consider product procurement.  For the sake of the length of this post, and your time to finish reading it, I propose the below table to show the breakdown of an RFP from 2 vendors for products A, B, C, D, and E. 

Product	Price p/ unit	# of units	Total Cost
A	$           125.00	2100	$      262,500.00
B	$           119.00	1800	$      214,200.00
C	$           375.00	1600	$      600,000.00
D	$           622.00	1500	$      933,000.00
E	$           189.00	3000	$      567,000.00
	Total Cost		$  2,576,700.00	Vendor ABC
Product	Price p/ unit	# of units	Total Cost
A	$           136.00	2100	$      285,600.00
B	$           112.00	1800	$      201,600.00
C	$           325.00	1600	$      520,000.00
D	$           640.00	1500	$      960,000.00
E	$           201.00	3000	$      603,000.00
	Total Cost		$  2,570,200.00	Vendor 123

Which one are you going to go with?  The difference in price is less than ½ a percent.  Essentially they are identical in price.  How do we choose?  Let’s start with the list of items we aren’t considering.  Shipping costs, financing terms, restock fee (maybe during the course of the project there is an ASI producing a change in the CCD’s and now the amount of materials has shrunk.  Although you can submit a response to the RFI sent out, you may not be able to bill for unused products even if you have them stored), and estimated delivery time.  Is this a comprehensive list?

Let’s expand the tables out and include some of these details and see if we can then make a decision. 

Product	Price p/ unit	# of units	Shipping Fee	Total Cost	Financing Terms	Restock Fee
A	$    125.00	2100	8%	$      283,500.00	1/15 N45	12%
B	$    119.00	1800	8%	$      231,336.00	1/15 N45	12%
C	$    375.00	1600	8%	$      648,000.00	1/15 N45	12%
D	$    622.00	1500	8%	$  1,007,640.00	1/15 N45	12%
E	$    189.00	3000	8%	$      612,360.00	1/15 N45	12%
	Total Cost			$2,782,836.00	$2,782.84	Savings
Product	Price p/ unit	# of units	Shipping Fee	Total Cost	Financing Terms	Restock Fee
A	$    136.00	2100	7.25%	$      306,306.00	1/10 N30	17%
B	$    112.00	1800	7.25%	$      216,216.00	1/10 N30	17%
C	$    325.00	1600	7.25%	$      557,700.00	1/10 N30	17%
D	$    640.00	1500	7.25%	$  1,029,600.00	1/10 N30	17%
E	$    201.00	3000	7.25%	$      646,717.50	1/10 N30	17%
	Total Cost			$  2,756,539.50	$             2,756.54	Savings

So now who are you going to use?  The pricing structure still has them within 1%, and the savings on financing terms is nearly identical.  Although the first vendor does provide a discount for 15 days and N45 payment term, however the second vendor is cheaper overall. 



What are other items to consider?  Let’s consider the shipping method.  This is where we can start getting into the true hidden indirect costs.  Let’s consider the first vendor is sending these units on a flatbed semi-trailer that is enclosed.  The access to remove is rolling racks to a drop gate and then unloading the racks by hand to pallets that can then be moved via forklift or skid-steer. 

The shipments can be of any size or combination and the delivery cost does not change.  This allows for several things.  First, the financing discount is per purchase; If it is a staged install and will cover several months or even years to use all the units, this could provide a huge advantage by not tying up cash flow in stored goods. 

Although a great shipping model allowing JIT inventory management on-site, the product handling is immense.  There are 10,000 units, and handling each one by hand, depending on what the product is, could cost large amounts in labor for the downloading, restacking, and movement of the materials. 

The second vendor provides a drop ship method; the products will be dropped on site, palletized, and enclosed with shrink wrap.  The entire product order must be delivered at once.  There are advantages and disadvantages to this process.  Let’s consider that the project could cause you to hold stored materials for months and perhaps there is a project delay (this never happensJ) causing the materials to be held even longer than expected.  Do these products expire or have a shelf life?  Although there are many unknowns, the consideration for the amount of labor you will save by not downloading and repacking the units could be substantial. 

One could become very detailed and dive into statistical analysis, utilize a risk analysis and apply a risk category or rating to each possibility. This could be further extrapolated to consider the cost-of-money during the 30 or 45 day payment period, or perhaps the staggered delivery and payment of the product.  This example is posed simply to elicit thoughts about considerations related to cost management. 

Another area of cost management is whether to make or buy a product.  This can apply across many specialties, and finds a great home within manufacturing.  The decision to make or buy lends itself to extremely complex calculations considering not only the topics mentioned above regarding product procurement; but instead are for raw material procurement.  It then also considers capital investment to outfit the production line with the ability to create the new product, the time needed and cost associated with R&D efforts to develop the product, and a host of other considerations.  Once all factors have been considered, a decision to make or buy can be made.

Relating to the use of subcontractors, consider that the management of those subcontractors is also a factor to consider as an indirect cost.  What about the ease of utilizing one subcontractor for the completion of many tasks.  It may be possible to find many contractors to perform several tasks, and it is conceivable the pricing structure might be cheaper than utilizing one subcontractor for the same list of efforts.  What is your indirect cost associated with vendor management?  What happens if they don’t perform?  What type of contractual obligations or financial obligations do you have if your subcontractor doesn’t perform?  Do you hold a performance or bid bond for each subcontractor?  Does it cost you per bid bond making it cheaper to use fewer or is it based on contract amount? 

The point here is to make you stop and think of all the areas you can potentially be spending more than you think because you are simply looking at the direct costs shown on the RFP, and not considering your specific indirect costs.  It may also be an area of focus allowing you to squeeze every amount of value out of every dollar contained in the contract amount. 

Remember that running $100Million in revenue a year turning a 1% profit is no better than running $10Million at a 10% profit margin.  Don’t get caught spinning your wheels to make the same amount of money you could have if you had considered all the possibilities.

-      Chris Thompson PMP, SSYB