Readers' forum

Dueling estimating systems
In his June column (“Why are my bids too high?”), Jim Huston outlined his problems with the dual overhead recovery system (DORS) as a method to bid jobs. Frank Ross, a proponent of that system, disagreed. This is an edited version of their conversation. You can read the full version at www.lawnandlandscape.com. – Editors 
 
I have read your June article in Lawn & Landscape and am stunned. For you to infer that our firm is the reason that some company’s prices are too high is outrageous. Further, I completely disagree with the smug attitude of the article as well as the assumptions and statements you make. It is clear to me that the book you so readily quote from in your article – “Pricing for the Green Industry” – is not one that you have read, or, if you have you did not grasp what you were reading. 
 
In a global sense, it might be interesting to you that the pricing processes you so quickly bash have been utilized in the construction and services industries since their inception. The concept is commonly referred to as “component pricing” – not DORS. It gets its name from the premise that the components of a job (materials, labor, subs, etc.) do not each require the same amount of overhead to support a dollar’s worth of its cost. Simply stated, each category of direct cost should be marked up differently to recover its support expenses (overhead) and to apply an appropriate return for profit.

You infer unfounded credit to our firm for having originated this method of overhead recovery. Alas, but if it were true. The concept has been around for quite some time – far longer than our 40-plus years in the business – and is promoted by some pretty reputable accounting and consulting firms – McKinsey, Boston Consulting, Fails Management, to name a few – and endorsed by some pretty substantial construction associations – AGC, ABC, MCA.

Because you say you have read our text, you know that there is no single pricing method which will address all situations – but the unifying thread is that whatever the pricing process, it must integrate with the company’s costing, accounting and budgeting processes — literally, there must exist an audit trail of financial intelligence for the system to be successful.

More to the issue of your article. I believe you discuss three issues with which you have a problem: 

1. Overhead is not a function of direct cost
2. Equipment utilization on the job is not considered in component pricing
3. The process is simply too complex

You are correct that overhead is not a function of direct cost. Direct cost is, however, the basis for recovering overhead at the job level. The example you give of the three jobs each of which requires the entire monthly labor capacity, albeit unrealistic, supports the theories of component pricing nicely. In your example, you say job one is fairly priced and recovers overhead correctly. But, you say, that jobs two and three are underpriced and will not recover all of the monthly overhead. The inference is that the prices on two and three should be raised to cover the shortfall. Good on paper, but I question whether you would actually sell those jobs – by my calculation, were you to look at the price per hour sold in job one – say $27, (a price you propose is competitive) – job three would require per-hour pricing in the $38 area in order to carry the entire burden of overhead.

The labor priced in job one at $27 is fairly priced, period. That component did its job – it covered the requirements assigned to it – it was the other components that fell short of goal. This is not a pricing issue, this is a management issue – your example company simply undersold its requirements for the month – it’s a silly example. 

Issue two concerns applying equipment to jobs based upon utilization. I have no problem with this concept if it is installed correctly and in the right circumstances. Had you actually read the “Pricing” text, you would have seen an entire section devoted to establishing internally driven hourly rates for equipment and the situations appropriate for charging equipment to jobs. 

In case you inadvertently overlooked that section, I will give you the executive summary version: equipment charging to jobs makes sense in those instances where equipment costs are a substantial portion of a company’s cost structure – think 20 percent or more against the revenue stream – or, in the case where a company utilizes highly specialized equipment to perform its work. 

I don’t have a statistic here, but I doubt seriously many of the readers of Lawn & Landscape have equipment costs in excess of 20 percent to revenues. Excavation, fine. Road builders, fine. Heavy generals, fine. Landscape installation, maintenance, lawn care, tree care, irrigation, etc., ... doubtful.

But, let’s say there were a few companies who had legitimate and recoverable equipment cost surpassing 20 percent of revenues. Here’s what you need to establish: 

1. Internal equipment rates for each piece in the fleet. This is relatively easy. 
2. A tracking capability whereby you can capture the use of equipment on each job (job costing) – this requires treating each piece of equipment as if it were another person on the payroll (figuratively speaking). I dare say that the grand majority of Lawn & Landscape’s readers are challenged to track just labor hours to jobs much less equipment by piece by the hour. This is not easy
3. Next, you will want to set up a reconciliation process to verify that all of the identified equipment costs are being recovered by utilization charges to jobs. Most sophisticated firms will actually set up an internal equipment division to collect the revenues coming from equipment charges to jobs (contra accounting) and the costs required to support the fleet. The reconciliation of this process is the basis of “accurate equipment costing to jobs” – not doing so exposes the company to a significant under-recovery of equipment costs, an unfortunate event often not realized until it is too late. This step also is not easy.

So, on paper, equipment costing is a good idea and makes great barroom conversation – in reality, not practical for most green industry companies because of the complexity of the systems required to track the process. To not install the entire system is simply too dangerous, if not irresponsible.

Issue three says that component pricing is too complex. Sorry, nothing in this world is easy, particularly when it comes to making money, least of all financial management. The industry, before its recent economic collapse, generated only one half of one percent net profit to sales and possessed the third highest failure rate of any industry according to government statistics. Today, I dare say, we are big time upside down. So, to say anything about how making money is easy is sheer quackery. Short cuts have no place in this game. It’s hard work – it is now and it always has been. Our job as advisers is to teach solid concepts of financial management that are practical, sound and usable in hopes of taking some of the risk out of this game – we are not on this earth to confuse – and shame on us for doing so.

And, to Lawn & Landscape magazine, I say shame on you as well for allowing such an article on your pages – I have never known you to practice yellow journalism. In fact, you are the premier magazine to the green industry – your readers build their companies on the research and information you print – they trust the filters you put your writers through. It is clear that the editors did not understand the content of this article. How they allowed such a slanderous blindside attack on me and my associates is beyond comprehension. The entire experience flies in the face of the mission statement of your magazine. 


Frank H. Ross III
Ross-Payne & Associates
Barrington, Ill.


Huston’s response:
I appreciate Mr. Ross’ response to my June article. Whenever the various green industry cost estimating methods are critiqued in an open and scientific manner, the contractor benefits. As I state in my new book, A Critical Analysis of the MORS Estimating System (CAMORES), cost estimating is the science of determining the costs in a project or service being priced. If cost estimating is to be a science, its formulas, principles and mathematics must be open to duplication by other “scientists.” This open verification process is referred to as being “peer-reviewed.” I would also add that the objective of cost estimating is very simple: to accurately calculate costs for a project or service being priced.

While I welcome and appreciate Mr. Ross’ input, I unfortunately cannot find anything good to say about the arithmetic in his manual, “Pricing for the Green Industry,” which I find to be faulty and full of erroneous mathematical assumptions. I pointed out in my article how these false assumptions can and do cost contractors jobs and erode profitability.

Mr. Ross calls my three job examples “silly.” I beg to differ. I would prefer to use the word, “simple.” It is well within acceptable parameters to use an example of a job (or jobs) that employs a company’s entire work force for a period of one month. It is also perfectly reasonable to vary the cost of the materials used on such a job.

As I state in CAMORES, there are three important points that we need to make regarding general and administrative (G&A) overhead costs: First, G&A overhead costs, as I define them in my books, total approximately 25 percent of a company’s sales. Second, G&A overhead costs do not vary much from month-to-month. This doesn’t mean that they can’t, just that they normally don’t. Third, more than 90 percent of G&A overhead costs are paid based on a time unit (usually monthly or weekly): overhead salaries, payroll taxes, rent, telephone and related utility bills, etc.

This being said, it is safe to stipulate that the sample company in my article has a monthly G&A overhead cost of $20,000. And here is the critical point in this discussion. If G&A overhead costs are $20,000 per month, a cost estimating system must calculate and allocate $20,000 of G&A overhead cost to each month’s work. If it allocates more than that, you have a problem; you’ve overstated your costs and you’ll lose work. If it allocates less than the monthly goal, you’ll probably get lots of work because you’ve under-priced it.

The three job examples in my article simply and clearly show how a percentage-based G&A overhead recovery system quickly runs into trouble when the duration of the job is held constant and the material costs are varied. Using the Dual Overhead Recovery System (DORS) or Dual Overhead Rate Method (DORM), the total cost for G&A overhead allocated for the month varies almost $10,000. Call it silly if you will; but if your costs are $20,000, your cost estimating methodology should tabulate a cost of $20,000. DORS (DORM) doesn’t.

Mr. Ross goes on to say, “(Component pricing) [I call it DORS or DORM] has been around for quite some time … and is promoted by some pretty reputable accounting and consulting firms….” Didn’t our mothers teach us that just because everyone else is doing it, doesn’t mean that we should do it, too? And when did accurate cost estimating become a democracy? Cost estimating is a science, not a popularity contest. Tell McKinsey, the Boston Consulting Group, Fails Management, etc., to study my arithmetic. They’ll find that it’s solid and scientifically self-evident.

I appreciate the “executive summary version” in which Mr. Ross says that “equipment charging to jobs makes sense in those instances where equipment costs are a substantial portion of a company’s cost structure – think 20 percent or more against the revenue stream – or, in the case where a company utilizes highly specialized equipment to perform its work.”

On page 70 of his manual he states, “As a guideline, I will suggest to you that if the total of the equipment expenses in your company amounts to less than ten percent of your revenue historically, your bidding prowess will probably not be hampered by leaving equipment cost in your overhead markups. Nevertheless, do what you are most comfortable with and what is best for your company and its situation.”

Is it ten percent or twenty percent? And how do you analytically quantify one’s “comfort level?” I’ve analyzed thousands of green industry financial statements during the past twenty years and equipment costs for 98 percent of these companies range between 10 and 14 percent. According to Mr. Ross’ advice, they’re in an equipment expense “no-man’s land.” What should they do?

Herein lies another significant problem with DORS/DORM. Equipment costs are not calculated accurately. I’ve seen a $5 million green industry contractor in the New England market go broke by putting field equipment and vehicle costs in G&A overhead costs as Mr. Ross recommends. It’s easier doing it this way. However, expediency is no replacement for accuracy – especially in the current market conditions.

As I stated earlier, cost estimating is a science. Those who practice and teach it are smart to treat it as such. For those who critique the various cost estimating systems, it is not just wise to treat it as science, it is imperative. In today’s market, it is critical that green industry contractors use the most accurate cost estimating methods available. It is also critical that the mathematics in all estimating methods be subjected to rigorous analytical scrutiny and the peer-review process. The arithmetic in these systems must be proven to be accurate using job models.

My test for critiquing any estimating system is quite simple: Is it accurate? Does the system accurately calculate all costs included in a project or service being priced? As I have pointed out in CAMORES and in my article, DORS/DORM falls short of this standard in at least two important areas.

The first involves its method for calculating and allocating G&A overhead costs.

The second involves its method for calculating and allocating equipment costs. For me, this is a much-needed scientific discussion. Let’s keep it at that level.


J. R. Huston
J.R. Huston Enterprises
Englewood, Colo.

On a sartorial note
I was wondering if we could get some t-shirts from Lawn & Landscape to wear at our expo – four shirts, all XL. I would really appreciate it. Myself and the crew really enjoy the mag. I use info from it during meetings every week on Mondays and Saturdays. God bless you.


Andy Reese
Owner, Yard Artist
Medina, Tenn.

We don’t have any extra shirts to pass along, but we’re glad to hear you like the magazine. – Editors