A Model for Profitability Analysis of a Construction Companywpvcemweb01.itap.purdue.edu/glf/2015/Hastak_presentation.pdf · 6/18/2015 5 SPARC LAB –Division of CEM “Solutions for

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Makarand (Mark) Hastak, Ph.D., PE, CCPProfessor and Head, Construction Engineering & Management

Professor of Civil Engineering, Purdue UniversityEditor-in-Chief, ASCE Journal of Management in Engineering

A Model for Profitability Analysis of a Construction

Company

Purdue University

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West Lafayette, Indiana

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Purdue University

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Purdue College of Engineering13 Schools and Divisions

Aeronautics and Astronautics

Agricultural & Biological

Biomedical

Chemical Engineering

Civil Engineering

Construction Engineering and Management

Electrical and Computer

Engineering Education –First-Year

Engineering/Multidisciplinary/Interdisciplinary

Environmental and Ecological

Industrial

Materials

Mechanical

Nuclear

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Introduction to CEM

• Established in 1976 (38 years)

• CEM Faculty – 6 tenure track CEM/CE faculty– 7 Faculty of Engineering Practice and Lecturers– 2 tenure track ME faculty (Courtesy Appointment)– 2 tenure track NE faculty (Courtesy Appointment)

• One of the largest Construction Engineering faculty in the U.S.

CEM Curriculum

80% Engineering, 20% Management

Focused on construction industry requirements

Areas of specialization

Students can Minor in any areas of Engineering

Three 12-week paid internships with CEM sponsor firm

Minor in CEM available for students in other majors

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The Purdue Construction Graduate Program in CE is one of the top graduate programs in the U.S.

Over 50+ construction Ph.D.s have graduated in CE over the past 20 years. Purdue dominates construction education in the U.S. in terms of faculty presence.

CEM Graduate program

Research Focus: Discovery and innovation in construction engineering and management including:

Faculty Research

• Augmented Reality/Virtual Reality

• Contract Management with IT

• Construction Safety

• Cost control and risk management

• Risk in International Construction

• Dispute Resolution

• Profitability and Risk Management

• Simulation

• Disaster risk reduction

• GIS

• Infrastructure management

• Net Zero Buildings/Energy Efficient Buildings

• Project management and decision-making

• Strategic planning

• Facilities Engineering

• Lean Construction

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SPARC LAB – Division of CEM

“Solutions for Profitability and Assessment of Risk in Construction”

RESEARCH IMPACT - SPARC Lab

Global Construction Project

Micro Level

Macro Level

Project Components Level

Micro Factors Impacts

Macro Factors Impacts

BENEFITS TO THE INDUSTRIES• Capital Rehabilitation Planning

• Post Disaster Housing• Disaster recovery/rehabilitation of

industries/communities• Resilience and Capacity Building• Profitability of construction firms• Dynamic interactive risks in global

construction• Composites in Construction

InfrastructurePrimaryImpact

Inter-relationship(Indirect Impact)

Natural Disaster

OtherInfrastructure

OtherInfrastructure

SecondaryImpact Industry

Other Industry

Communities




ASPIRE

200 Houses in 1 Month

Impact Analysis on Industries /Communities

Innovative Manufactured Homes

RESEARCH AREAS• Infrastructure Management• Housing Industry• Disaster Risk Reduction• Profitability and Strategic Planning• International Construction• Contemporary Issues

Profitability

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Risk Assessment

Infrastructure

Housing Industry

Profitability

International Construction

SPARC LAB – Division of CEM

Infrastructure Planning

Infrastructure Rehabilitation

Impact on Communities and industries due to flood

damaged critical infrastructure

SustainabilityWater Management

Systems

Disaster Risk Reduction

Capacity Building

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Infrastructure Finance

Background

• Construction industry has unique characteristics and financial aspects (Oberlender 2000, Tserng2011):

– produce unique products that often have long project durations and being project-oriented compared to process-oriented manufacturers.

– contractors operate without centralized production

– contractors have unique payment terms, which make them prone to insufficient liquidity.

– Contractors also heavily use subcontractors

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Background

• The construction business process includes multiple stakeholders that are mutually reliant on the financial stability and operational performance of each other, making contractors vulnerable to external changes and increasing their operational risks.

• These characteristics contribute in many ways to a high business failure rate in the construction industry (Kangari et al., 1992) and a relatively high proportion of insolvencies compared with the rest of the economy.

• lack of liquidity is one of the main reasons why construction companies fail (Singh and Lakanathan 1992; Navon 1994).

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Need

• Cash overdraft of each project and the overall cash overdraft of the project portfolio are also highly dependent on the cost schedule of each project.

• Therefore, effectively forecasting the financial outcome of proposed, planned, and uncompleted projects is the key to a contractor’s financial decisions.

• Current methods do not consider the effect of internalentities (organizational units inside the general contractor)and external entities (owner and subcontractors) althoughthey obviously have high levels of influence on the profitrealization process.

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Profitability Analysis

Profitability analysis determines how profitable a company is and is likelyto continue to be so. A company’s profitability determines its future payoffs(the benefits that are expected to be returned to capital providers in thefuture), a key factor that determines the value of a company (Ro, 2013).

Profitability ratios are the main metrics that are generally used tocomparatively assess a company’s ability to generate earnings ascompared to their investments during a specific period.

Profitability Ratio = $Return (profits)/ $Invested Capital= ROI (Return on Investment)

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Protocol for Profitability Analysis

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Step 1: Identify Cost and Profit Centers


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A B C D

A : Relationships among cost centers

B: Relationships among profit centers

C: Relationships between cost and profit centers

D: Relationships with external entities

Step 2: Investigate all relationships among the entities

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Step 3: Performance assessment of the relationshipsStep 4: Locate the change in profit on the WBS of a profit center


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Step 5: Find solutions and calculate the overall profitability of the construction company

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Profitability Protocol in Action

Application of the Protocol

• A private Construction Company, Kuwait

• This project consisted of the construction of sixdifferent parks in six different areas ofKuwait. These areas are called: Jabriah, SabahSalem, Qurain, AbuHlifa, Zahr, and Jaber Al Ali.

• The Designated Gardens Area K project wasestimated to cost $10,200,000 with an 8%overhead. The bid price for the project was$12,546,000 and its duration was 24 months.

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iOC iPMPMPM ),3,2,1(

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• Designated Gardens Area K project (Profit center)

– Bid value: $12,546,000

– Project cost: $10,200,000

– Overhead (8%): $816,000

– Estimated Profit: $1,530,000

i



• Relationships

i


RelationshipType

Reason

[HR↔D 0,-1]Unqualified engineers resulting

in delays in design

[HR↔ST 0,-1]Delays in providing a qualified

construction manager

[B↔P 0,-1] Material cost increased

[D↔ST 0,-1] Mistakes in surveying

[ST↔PC 0,-1]Not-considered long distance to

commute for workers

[E↔PC 0,-1] Unanticipated breakdowns

HR: Human Resources, D: Design, ST: Site Team, B: Bidding, P: Purchasing, A: Accounting, E: Equipment

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• Profit margin changes

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RelationshipType

Incurred Cost by Relationship ($)

Profit Margin Change

(%)

[HR↔D 0,-1] -15,000 -0.120

[HR↔ST 0,-1] -50,000 -0.399

[B↔P 0,-1] -255,000 -2.033

[D↔ST 0,-1] -8,400 -0.067

[ST↔PC 0,-1] -150,000 -1.195

[E↔PC 0,-1] -30,000 -0.239

Total -508,400 -4.053



WBS of the Project

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• Relationships

i


RelationshipType

Reason

[HR↔D 0,-1]Unqualified engineers resulting in

delays in design


construction manager

[B↔P 0,-1] Material cost increased

[D↔ST 0,-1] Mistakes in surveying


commute for workers

[E↔PC 0,-1] Unanticipated breakdowns

HR: Human Resources, D: Design, ST: Site Team, B: Bidding, P: Purchasing, A: Accounting, E: Equipment, PC: Profit Center


• Total Profit margin changes

i


RelationshipType



(%)

[HR↔D 0,-1] -15,000 -0.120

[HR↔ST 0,-1] -50,000 -0.399

[B↔P 0,-1] -255,000 -2.033

[D↔ST 0,-1] -8,400 -0.067

[ST↔PC 0,-1] -150,000 -1.195

[E↔PC 0,-1] -30,000 -0.239

Total -508,400 -4.053


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WBS of the Project


• Total Profit margin changes

i


RelationshipType



(%)

[HR↔D 0,-1] -15,000 -0.120

[HR↔ST 0,-1] -50,000 -0.399

[B↔P 0,-1] -255,000 -2.033

[D↔ST 0,-1] -8,400 -0.067

[ST↔PC 0,-1] -150,000 -1.195

[E↔PC 0,-1] -30,000 -0.239

Total -508,400 -4.053


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• The actual profit of the company:

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Estimated Actual (+,-)

Bid Value 12,546,000 12,546,000 0

Project Cost (Direct+Indirect)

10,200,000 10,708,400 508,400

Gross Profit 2,346,000 1,837,600 -508,400

Office Overhead 816,000 816,000 0

Profit from operations

1,530,000 1,021,600 -508,400

Gross Profit Margin (Gross Profit/Bid Value)

18.70% 14.65% -4.05%


• Possible solutionsRelationship

TypeReason Solutions

[HR↔D 0,-1]Inexperienced personnel resulting in

delays in designSelection of qualified engineers or train the

engineers


construction managerStaffing plan in advance

[B↔P 0,-1] Material cost increased Add contingencies

[D↔ST 0,-1] Mistakes in surveying Train the engineers


commute for workersFind experienced engineers

[E↔PC 0,-1] Unanticipated breakdownsReestablish the repair and maintenance

strategies for equipment unit


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• Possible solutionsRelationship

TypeReason Solutions

[HR↔D 0,-1]Inexperienced personnel resulting in

delays in designSelection of qualified engineers or train the

engineers


construction managerStaffing plan in advance

[B↔P 0,-1] Material cost increased Add contingencies

[D↔ST 0,-1] Mistakes in surveying Train the engineers


commute for workersFind experienced engineers

[E↔PC 0,-1] Unanticipated breakdownsReestablish the repair and maintenance

strategies for equipment unit


Benefits of this Protoc0l

• Construction companies can utilize this protocol to:– recognize the changes in profit margins of

projects

– improve their overall profitability by identifying the root cause of the problems

– improve their future cost estimations based on the analysis results of the protocol

– be selective of more profitable projects in future jobs

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An Alternative Approach

• The Protocol helps us identify root cause of the problems as an ex-post analysis.

• Protocol does not consider time and profit realization process as a dynamic process.

• Time has a significant effect on cash flow and profitability.

• Dynamic interaction between project realization process and external entities (owner, subs) needs a different approach.

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System of Systems Approach

• A “system of systems” or “collaborative systems” is an assemblage of components, which may be regarded as individual systems, and these building components have operational and managerial independence.

• Operationally-independent components are those which fulfill valid purposes in their own right and continue to operate to fulfill those purposes if disassembled from the overall system

• Managerial independence of the components means that these component systems are managed for their own purposes rather than for the purpose of the whole.

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Development of a Platform for a System of Systems Approach (Profit Realization of a Project Portfolio)

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GC

S

O

P1

P2 P3O

OO O

O O

GC GC

GC

GC

P2P3

P1

P1P2

P3

S

S

S

S

S

S S

S

S

SS

S

P1

Development of a Platform for a System of Systems Approach (Profit Realization of a Project Portfolio)

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GC

S

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P1

P2 P3O

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GC GC

GC

GC

P2P3

P1

P1P2

P3

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Profit Chain (Firm Level)

The profit chain defines the flow of profits and theperformance of the profit chain reflects the profitability ofthe construction firm.

Cui et al., (2005)

Profit Chain (Each Project)

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Based on the profit chain concept developed by Cui et al., (2005)

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Profit Chain (Each Project)

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$M

Time (weeks)

Profit Chain (Project Portfolio)

O

P1

P1P2

P3

GC P1S

P1S

O

P2

P2

P3

GC

P2S

P1

O

P3

P3

P2

GC

P3S

P1

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Profit Realization Process (Project Portfolio)

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Profit Realization Process (Project Portfolio)

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Future Research

• Assessment of the overall financial performance of GCs by looking at the contributions of the internal and external entities to the flow of profit between key players in the construction market

• Projection of a contractor’s operating profit by simulating the projected schedule of costs

• Projection of project portfolio cash flows and its effect on a contractor’s cost of capital and overall profitability

• Examination of the effects of different scenarios on the financial performance of a firm based on the current status of the business and the known constraints in the model boundary

• Analysis of different financial management decisions on a firm’s profitability forecast

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Makarand (Mark) Hastak, Ph.D., PE, CCPProfessor and Head, Construction Engineering & ManagementProfessor of Civil EngineeringEditor-in-Chief, ASCE Journal of Management in EngineeringPurdue [email protected]

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Documents

A Model for Profitability Analysis of a Construction Companywpvcemweb01.itap.purdue.edu/glf/2015/Hastak_presentation.pdf · 6/18/2015 5 SPARC LAB –Division of CEM “Solutions for