Late one October 2020 evening, while discussing work war stories (dispute resolution) at a bar, a senior construction executive / QS colleague said to me, “ I don’t buy into your way of seeing that issue.” I was taken aback. Last year the Covid-19 lockdown taught me a harsh lesson. I had spent a lifetime under-recovering off-site overheads. Have I also failed to convince a respected senior peer of my foolishness? or am I wrong in trying to change his viewpoint? I re-plead my case for your consideration and feedback.
Variation / EoT Overhead Recovery Options
There are two ways you can calculate the overhead related component of a variation involving an extension of time claim.
[1] Take the cost of the scope change and multiply it by a % rate for P&G (on-site overheads) and then multiply it again by a % rate for Margin (off-site overheads and profit).
[2] Take the cost of the scope change and add to it, an amount, calculated by the period of time for the extension, multiplied by the Working Day Rate.
Q. Why is it we get to choose between the greater of the two results?
The Overhead Recovery Rationale
Where a variation is long on time and small in quantum of scope change, percentages, per [1] above, will not recover enough overheads. Where a variation is short on time and large in quantum of scope change, percentages will lean towards recovering enough, (but not all), overheads.
As we deal mostly with scope change with no time adjustment, we rarely think beyond % recovery methods of overheads. As a result, we tend to believe a % of value is all that overheads relate to. We have conditioned ourselves into thinking Margin is always and only proportional to the value turned over.
The Margin Fallacy
Margin is classically thought of as Profit, but Margin is two things, living in the same house. Off-site Overhead together with Profit.
a) Profit, in isolation of Off-site Overheads, is intangible and is directly related to turnover, a % of value.
b) Off-site Overheads, in isolation of Profit, is tangible and directly related to time, a dollar amount per day.
The Law of Overheads
· Overheads march on relentlessly through time, despite production levels.
· If you are seriously behind schedule on a project, without excuse, you are going to burn the same amount of Off-site Overhead Dollar$ per day, after you have run out of budgeted project programme time. And
· You cannot turn off overheads when a project comes to a sudden, unexpected, complete stop!
Overhead Recovery Worked Example.
Your construction company turns over $100M pa. Overheads are $2.5M or approx. 2.5% of BAU turnover. IF your overheads support 10 project teams then your project average Off-site overhead recovery required per month is $2.5M / 12 / 10 = $21K per project per month.
P&G runs at 8% or 69k per project per month. The margin for variations is 7.5%. Note, Margin is “Off-site overheads and Profit”. [ref 3910]
Example A - Time lost – no change in scope obligations
If the principal stops the project for a month, will you claim?
[1] P&G $69k plus 7.5% (margin) = $74K;
OR
[2] P&G $69k plus $21k (offsite-overheads) plus 5% (Profit) = $94K;
Example B - Time lost – with increased scope obligations
If the principal adds a month’s worth of scope and time as a variation, will you claim?
[1] Scope $861k + P&G $69k plus 7.5% (margin) = $1.0M;
OR
[2] Scope $861k + P&G $69k + $21k (offsite overheads) plus 5% (Profit) = $1.0M;
Percentages work for off-site overhead recovery ONLY when the scope rate of production increases by equal proportion to the original scope / time obligations ratio. Example B, demonstrates the two methods of calculation get the same result. We have immunised ourselves into believing percentages are equitable because, by limited specific example (above), they can be proven to be so.
Example A, highlights the inequity of a project delay where there is no corresponding uplift in scope value to apply a % recovery for off-site overheads. 2.5% recovery of nothing = nothing, but $21,000 off-site overhead recovery for no progress on site is equitable.
Raising the Working Day Rate, as a matter of principle
Typically, we take P&G and using the same example data, monthly project P&G is $69K (ignoring fixed costs) divide by 21 working days per month and add 7.5% OH+P = $3,500 per working day.
Alternatively, we should take monthly project P&G is $69K (ignoring fixed costs) add monthly project related off-site overheads $21K divide by 21 working days per month and add 5% Profit = $4,600 per working day.
Summary Guide to Equitable Overhead and Profit Recovery
1) Separate Off-site Overheads from Profit;
2) Define Off-site Overheads, as both a % of turnover and a dollar rate per day, recoverable on the greater sum, determine by each method;
3) Define On-site Overhead similarly, in separate parts that recognise fixed, variable, time and turnover attribute combinations;
4) Apply Profit as a % of turnover.
If you have a question or a point of view to share, please contribute to this discussion. Thank you.
By Matthew Ensoll
Life Member NZIQS. Reg.QS.
Editor New Zealand Building Economist.
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