Welcome to our "Profitable Projects" series, designed to help Architecture, Engineering, and Construction (AEC) firms boost their bottom line. This three-part series explores critical aspects of financial management in the AEC industry:
- Setting the Right Fee for Success (You are here)
- Managing Cash Flow in AEC (Coming soon)
- Winning the Right Projects (Coming soon)
Each article in this series provides in-depth insights and practical strategies to help your firm become more profitable. Let's dive into our first topic: the art of setting the right fee.
Profitable Projects: Mastering the Art of Fee Setting in AEC
In the Architecture, Engineering, and Construction (AEC) industry, profitability hinges on a delicate balance of cost control, precise project management, and effective client communication. One of the most critical factors in this equation is setting the right fee—a task that can make or break a project's financial success.
The Foundation: Getting the Fee Right
Percentage-Based vs. Bottom-Up Calculation
Traditionally, many firms have relied on percentage-based fees, using industry standards as a guide. However, this approach often falls short, especially for complex or unique projects. A more reliable method is the bottom-up approach, which ensures your fee directly relates to the project scope.
Simon Berry, founder of Fresh Projects, notes, "We can see from our data that where bottom-up fee calculations are used, the profit margins achieved are consistently better than percentage-based fees." This observation underscores the importance of detailed, project-specific fee calculations.
Defining the Scope of Services
Clearly outlining your scope of services is crucial for ensuring fair compensation and managing client expectations. A well-defined scope acts as a safeguard against scope creep—a common profit-eroding factor in AEC projects.
"In projects where a detailed scope was defined, changes due to scope creep leads to net profit generation rather than the accepted margin reduction," Simon Berry adds. This insight highlights the financial benefits of thorough scope definition.
Calculating Delivery Costs
Precise cost calculation involves accounting for every direct and indirect cost in project delivery. This includes estimating labour efforts and applying accurate hourly rates that factor in utilisation and overheads.
Quantifying Project Value
When using bottom-up fee calculations, it's important to consider more than just basic costs and profit margins. As one industry professional aptly put it on Twitter, "Value pricing isn't about charging what you're worth. It's about charging what the client values." This perspective encourages firms to quantify the long-term value their expertise brings to clients, potentially justifying higher fees for innovative or cost-saving solutions.
[Image: X (Twitter) - @mwmoedinger]
Take an engineering firm that designs a sustainable office complex that reduces energy consumption by 30%. By quantifying the client’s future savings, the firm can charge a premium fee.
Tracking Projected Costs
Monitoring costs throughout a project's lifecycle is critical for maintaining profitability. Many firms face reduced margins due to inadequate real-time cost tracking.
Direct Project Costs
This includes tracking expenses such as supplier invoices and travel, ensuring all costs are documented and billed to the client where applicable. Tools like Fresh Projects can simplify this process by categorising and linking direct costs to specific projects.
Time Costs
Labour typically represents the most significant cost for AEC firms. Tracking salary costs, including overheads and project-specific hours, helps ensure efficient time management and early flagging of overages.
Tools like Fresh Projects offer powerful visualisation capabilities that can reveal surprising insights about how time is spent across different roles within a firm. For instance, scatter charts can illustrate the distribution of time across various activities for different job roles.
These visualisations can be particularly revealing when it comes to understanding why key staff might not be as focused on project delivery as expected. For example, a scatter chart might show that partners or directors in smaller firms are spending a disproportionate amount of time on administrative tasks rather than billable work.
Pro Tip: In many firms, especially smaller ones, we often see partners and directors spending a large portion of their time running the business. Administrative tasks and financial management can consume hours that could be spent on billable projects. Given that these individuals are typically the highest earners per hour, it's often more profitable to delegate these tasks to staff with lower cost rates, freeing up senior personnel for high-value project work.
By leveraging such insights, firms can make informed decisions about task allocation and potentially uncover significant opportunities for improving profitability.
[Image: Fresh Projects Scatter Chart]
Managing Scope Creep
Scope creep—the expansion of project work beyond the original agreement—can quickly erode profitability if not managed properly. Effective management starts with prevention through clear contractual agreements and includes actively tracking any out-of-scope work.
Prevention Strategies
To effectively manage scope creep, firms should implement a structured approach that involves clear communication, established processes, and diligent tracking. Here are key steps to consider:
- Agree and Sign: The foundation of scope management lies in crystal-clear contracts. These should explicitly outline what work is included and, equally important, what isn't. It's crucial to include provisions for additional work, clearly stating the hourly rate for any tasks that fall outside the agreed scope. This transparency sets expectations from the outset and provides a solid basis for managing any future changes.
- Establish a Process for Out-of-Scope Work: Before the first blueprint is drawn or foundation laid, create a standardised process for handling out-of-scope requests. This process should be communicated to both the client and the project team, ensuring everyone understands how changes will be managed, tracked, and billed. Having this system in place preemptively can turn potential conflicts into smooth negotiations.
- Track Out-of-Scope Time Separately: Leveraging software tools like Fresh Projects allows firms to meticulously track out-of-scope time and resources in a separate category. This granular tracking enables transparent invoicing for extra work and provides valuable insights into project profitability.
The Profit Timeline: Design vs. Construction
[Image: Fresh Projects Dashboard showing profit distribution across project phases]
A common pattern emerges when analysing project profitability: the design phase often generates profit, while the construction phase can erode it. This dashboard visualisation illustrates this trend, highlighting the importance of vigilant scope management throughout the project lifecycle, particularly during the later stages.
Visualising Out-of-Scope Work
[Image: Fresh Projects Dashboard showing out-of-scope time and expenses tracking]
This dashboard exemplifies how firms can track additional time and expenses in a separate category. This detailed tracking serves two crucial purposes:
- It provides a basis for requesting additional budget from the client when necessary.
- It offers insights into project profitability, helping firms understand why a project might have underperformed financially.
Best Practice: Turning Scope Creep into a Profit Center
[Image: Fresh Projects Dashboard showing scope creep as a profit centre]
Forward-thinking firms are transforming the challenge of scope creep into an opportunity for additional profit. By meticulously tracking out-of-scope work and charging appropriately for it, these firms maintain or even increase their profitability despite changes to the original project scope.
Consider this success story: A construction firm working on a multi-use development implemented rigorous tracking of all out-of-scope design changes. Armed with detailed data, they successfully negotiated additional compensation for these changes, ultimately keeping the project profitable despite significant scope expansions.
By adopting these strategies and leveraging the right tools, AEC firms can not only manage scope creep effectively but potentially turn it into a source of additional revenue, ensuring projects remain profitable even as they evolve beyond their original parameters.
Conclusion: The Path to Profitable Projects
Ensuring project profitability in the AEC industry requires careful planning from the outset. By adopting bottom-up fee calculations, implementing real-time cost tracking, and effectively managing scope creep, firms can safeguard their margins without compromising on quality or client satisfaction.
Tools like Fresh Projects play a crucial role in this process, providing real-time data and automation that enable firms to focus on delivering value while maintaining a keen eye on profitability. In the complex world of AEC projects, this balanced approach is key to long-term success and sustainability.
Ready to dive deeper into AEC profitability? Don't miss the next articles in our series:
- Managing Cash Flow in AEC: Learn strategies to keep your projects and firm financially healthy.
- Winning the Right Projects: Discover how to select and win projects that align with your profitability goals.
Stay tuned for these upcoming articles to complete your journey towards more profitable projects!