By: Luis Gile -- Global Category Leader - Design, Construction, & Capital Projects - IBM
23 August, 2018
Procurement professionals frequently ask one question: What are the cost reduction levers in construction?
Cost reduction in construction technically means cost avoidance. When we consider how to save costs in construction, we are essentially trying to avoid paying extra costs. This distinction colors how we consider cost reduction.
With this in mind, let us consider the high-level concept of cost reduction and briefly discuss how they are applied.
The first high-level concept is demand management. This concept addresses ways to reduce the amount of required construction work, as well as the ways in which needs are expressed and controlled.
Reducing demand in construction involves how a real estate portfolio is managed. This can be tied to a number of factors, but ultimately ties back to the organization’s culture.
For organizations that experience frequent moves, adds and changes (MAC) in their office environments, a number of real estate strategies can mitigate or eliminate construction.
Some strategies eliminate moves by creating a uniform desking system, while others transfer the cost of construction into leases. Other strategies use unassigned seating to avoid construction altogether.
For more complex structures, such as warehousing and manufacturing spaces, there are similar ways to reduce or eliminate demand.
Regardless of the strategy you choose, you can reduce or eliminate construction costs simply by rethinking the real estate approach.
Another strategy under demand management involves the quality of your scope of work.
Costs increase when your scope is poorly defined.
The most common example of a poorly defined scope is where the design may be clearly defined, but the scope of services is unaddressed. Scope of services describes what the owner expects in the way of reporting, meetings, and deliverables. This level of scope definition is often completely missing from solicitations. Taking the time to consider this is essential to ensure expectations from both parties are properly aligned.
A poor scope of work may also cause misinterpretations. An architect’s drawings are not intended to be step-by-step instructions for construction. Architectural drawings show design intent. It is the builder’s job to interpret those drawings, and turn them into reality. If your drawings are unclear, their interpretation could be open-ended. A design that is unclear may result in a wide spread across your quotations (quotes will be more than 10 percent apart).
A supplier may perceive risk from poor scope and assume there are many hidden conditions. An elevated perception of risk will lead to higher contingency in a builder’s quote.
Finally, a poorly defined scope impacts cost because missing information leads to change orders. Change orders are by far the most contentious issue in construction. Once the work has begun, negotiating a change order is nearly impossible. Therefore, the best way to deal with change orders is to ensure you have a good scope of work.
Quality in construction can be interpreted to mean a number of things. However, quality in the context of cost reduction means aligning the quality of materials to your budget.
In simple terms, this may mean using laminate countertops instead of granite or vinyl flooring instead of tile. It is best to optimize the quality of materials to suit the building’s use.
There are many ways to optimize quality to help meet a budget. Often, this level of evaluation is best led by an architect with input and guidance from the owner, builder and Procurement team.
Another high-level concept to help reduce cost in construction is supply management. Supply management ensures demand is properly addressed, planned and executed.
Under supply management, you must first begin by forecasting and identifying the demand. This allows for a strategic view of how the demand will be addressed.
This can be challenging because organizations often lack forecasts that look ahead to their construction needs. If this describes you, one way to deal with this is to look back at historical usage.
Though it may be imperfect, looking back at demand (especially over multiple years) may help develop insights into potential future demands.
Once you have a point-of-view on what your demand might be, you can begin developing a category plan. Your category plan should consider the full range of demand from small incidental repairs to large capital projects.
A good category plan will set clip levels to differentiate between strategic and tactical spend. It will also identify where master agreements are needed and how spot buys will be handled.
A pipeline of strategic projects should also emerge, so you can align resources well in advance.
As discussed in a number of previous articles, there are numerous sourcing strategies in construction. Supply management involves choosing the right sourcing strategy. You should not expect one sourcing strategy to work for every circumstance. You must ensure your terms and conditions are suited to your approach.
A sourcing strategy should be evaluated and intentionally selected for every strategic project in your pipeline. Low dollar spend can be allowed to operate using a single straight-forward approach. However, for larger projects, taking the time to consider your approach could save significant time and costs.
The third high-level concept for cost reduction involves process efficiency. Inefficiency in construction increases cost throughout the supply chain. In addition, a poorly managed process can elevate risk.
There are a number of layers of supplier management in a construction project.
The first and most commonly overlooked layer is a process to govern supplier behaviors during engagements. The need for a scope of services is referenced under “Scope Control” above. This type of document is significant enough to be worthy of a second mention.
It is common to assume your general contractor (GC) or construction manager (CM), will manage all of the suppliers on site and no additional management is needed. Unfortunately, this is not the case.
In the same way a GC oversees subcontractors, an owner’s representative or a project manager is essential for managing the GC.
Unfortunately, owners often overlook this role, causing the responsibilities of a project manager to either be ignored or transferred onto the owner. This can have detrimental effects on a project, often resulting in mismanagement and added costs.
A clear structure to your project is also essential for avoiding extra costs.
This structure should be well defined as part of your sourcing strategy. Executing against your strategy is the next step.
Be sure you understand the structure of your project team. Who reports to whom and what each party’s role is must be clear. One professional should not step into the role of another professional.
Nothing can grind the progress of a project to a halt more rapidly than not paying your resources.
Be sure that you have a well-defined payment application process. Most third-party contracts (AIA, CCDC, and Consensus) already include a standard process for reviewing payment applications. Be sure you understand this process, and coordinate with your accounts payable team so they understand what is required of them.
The construction industry is hypersensitive to payment terms these days. The catastrophic failure of Carillion in the UK has been closely tied to extended payment terms. Keep in mind that net 30 payment terms in construction means the GC will not see the money for at least 45 to 60 days. Thus, if your Accounts Payables (AP) team delays payment, the GC may exercise his or her rights to charge interest or stop work.
Lost time from work stoppage or interest added to late payments could mean thousands in extra cost. Thus, you must ensure the efficiency of your invoicing and payments processes.
The cost reduction levers for construction mentioned above are aimed at avoiding additional costs rather than saving on recurring costs. This is why traditional savings levers, such as aggregation, are less relevant. If your organization has consistent recurring demand some aggregation certainly can enhance savings. If your construction spend is recurring, your category plan should include plans for master service agreements with volume rebates.
For the most part, construction spend is non-recurring, thus procurement strategies for construction are generally focused on avoiding added costs. The goal is to have a well-defined, well-managed, optimized design suited to the specific needs of the organization and the project.
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The opinions expressed in this article are the author's own and do not reflect the view of Beroe Inc.
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