In part 2 of our project management series, Joe Knight our CFO talks about why traditional project management doesn’t work. Traditional project management uses accounting that measures revenue earned by the percent complete based on costs. We believe this idea is flawed and Joe explains why. Setpoint measures progress on a project by labor only, or by earned value rather than on a percent complete of materials spent. Stay tuned for part 3…
Catch up on Project Management Part 1
How do you manage projects? The Setpoint way of project management is different from that of most companies. We are a project based company and the standard accounting methods of tracking projects does not work for us. We have seen many competitors go out of business, not because they don’t have good engineers and can make the machines work, but because they are not able to do it profitably. In the first of five video clips, Joe Knight our CFO will talk about how Setpoint manages projects and what makes our way different from other methods.
One of the issues that the founders of Setpoint, Joe Cornwell and Joe VanDenBerghe realized early on was that they did not like the way the accountants did project based accounting. At the crux of the problem was the cost versus budget approach to revenue recognition. Under GAAP (Generally Accepted Accounting Principles) the rule for project revenue recognition was percent of cost complete. For example, if one spent $1,000,000 on a project and the total project cost budget/estimate to complete was $5,000,000 then the project would be considered 20% complete for revenue recognition purposes. So to complete this example if the project revenue was $7,000,000 then 20% of revenue would be $1,400,000. So the period profit and loss statement for that project would look as follows:
Revenue $1,400,000
Expenses $1,000,000
Profit $ 400,000
The Joes questioned the validity of that profit. They debated with their accountant. They struggled with the concept. Their issue was with the way their automation equipment business operated. A large machine can take 6-9 months to complete. A lot of the work is at the end of the project when the machine is starting up and being debugged. The problem with the GAAP accounting method is that the profit is recognized before the real tough work is completed. As an example say Setpoint builds a $3,000,000 machine that will take about 9 months to complete. In the first 3 months the machine’s materials are received and design is complete. Let’s say that material costs on the machine are $1,500,000 and the design cost another $100,000 in labor. So by the GAAP accounting method the machine is $1,600,000/$3,000,000 or 53% complete. Therefore, 53% of the projected profit can be recognized in the first 3 months. One the other hand, a small fraction of the total labor to complete the job has been incurred at that point.
Let’s assume that Setpoint estimates that the total labor costs will be $1,000,000. So by labor measures Setpoint has spent 10% of its labor budget or $100,000/$1,000,000. Yet the accountant will say that the machine is 53% complete. This discrepancy can create a false sense of safety early on in a project when little work is done. Furthermore, if there was large labor overruns later in the project during the startup/debug process those past profits could be overstated.
Because of this issue Setpoint decided to measure revenue in a different way. At Setpoint, we measure percent complete by labor only. We evaluate how much labor was spent on a project every week and then we estimate labor required to complete the work and use labor only to recognize percent complete for revenue recognition.
Setpoint uses two methods for estimating labor. First, for smaller projects we look at labor by discipline and estimate how much will be needed to complete the project relative to what has been spent. For our larger projects we look at these numbers based on schedule based earned value tools. We update these projects on a weekly basis so our project engineers can stay close to the performance of our projects and to make it possible to communicate our profitability to the entire company on a weekly basis. We will talk more on project tracking and earned value in a later blog.
We also have a white paper that talks more about our project management techniques, feel free to download it.
In any organization that intends to exist for an extended time period, learning is critical. Not repeating mistake allows a business increased profitability. Someone once said (I can’t remember who) something like - “the school of hard knocks is a hard school to go through, but only fools return”.
Over the years Setpoint has been, is, and will continue to be an engineering centric business. Most of the projects we build have never been built before; most are completely clean sheet designs, meaning that no one is quite sure what this machine will end up looking like. This means that there will be multiple iterations as we develop the machine. It is critical to our success that we discover our mistakes as soon as possible to reduce our costs. The table below illustrates how critical it is to discover the problems as soon as possible.
|
When Mistake is Discovered and Fixed |
Relative Cost to Fix |
| Designing at the white board | $1.00 |
| Designing in CAD system | $10.00 |
| During build of machine | $100.00 |
| During debug phase | $1,000.00 |
| After installing at customer site | $10,000.00 |
Over time we have developed some unwritten rules that we use to help us down the development path. For this blog we sat down and wrote down the ones that matter to Setpoint. These are in no particular order:
Whether your business is building wooden pallets or designing nuclear power plants (or anything in between), it’s safe to say that you’ve had to share bad news with some of your customers at one point or another. And who likes to do that?!? Human nature is generally to avoid these negative situations as long as possible, and consequently the problem only continues to get worse. In my experience, if you follow a few simple guidelines in delivering bad news, you can make life more manageable for yourself, your company, and particularly your customer. The news itself can be anything from a schedule slip to budget overrun to a technical catastrophe, but the rules for handling the news really do not change much.
Here are some of the guidelines that I have adopted over the years to help deliver ‘less than stellar’ news to my customers:
I’m sure there are dozens of other rules and guidelines that could apply to this list, but these are the mainstays that I use to try and keep problematic project issues from becoming business-killers. If you are able to utilize some or all of these methods the next time you’re faced with explaining a catastrophic setback to your customer, I think you’ll find the situation can not only be more manageable, but your customer ties will only get stronger. True partnership demands the whole truth be shared in a timely manner, and anything less will only complicate your problem. And one last point to remember: In our modern world they seldom execute the bearer of bad tidings anymore like the old Roman custom, so you have that going for you, which is nice!
If you have some additional rules or guidelines of your own that you’ve refined over the years for delivering bad news to your customers, please share them here! We can all use all the help we can get when we have to be that bearer of the dreaded news.
Bidding on large projects is bittersweet. If you have an opportunity to bid on a project that could be either a blessing or a burden, it is important to manage the cash flow. Because cash is King, it has the ability to put you in a castle or a shack. What kind of living quarters you live in can be decided by cash flow. A significant number of companies go out of business because of lack of cash, not a lack of great ideas.
When bidding on large projects there are a few questions that need to be addressed. First, when are the costs of the project due? Second, when will the majority of the labor be needed? Third, what size of a down payment do I need? When do I need progress payments? Most companies think the down payment question should be answered first, but that is not always the case. It is necessary to know when your costs are going out so you know what size your down payment needs to be and when your progress payments need to come in.
Let’s assume some facts for our example:
|
Project Cash Flow at a 30% Down Payment |
|||||||
|
|
Jan-10 |
Feb-10 |
Mar-10 |
Apr-10 |
May-10 |
Jun-10 |
Jul-10 |
|
Income |
|
|
|
|
|
|
|
|
Invoiced |
900,000 |
|
|
1,500,000 |
|
600,000 |
|
|
$ Rcvd |
|
900,000 |
- |
- |
1,500,000 |
- |
600,000 |
|
COGS |
|
|
|
|
|
|
|
|
Estimated COG |
|
450,000 |
450,000 |
450,000 |
150,000 |
|
|
|
Total COGS |
- |
450,000 |
450,000 |
450,000 |
150,000 |
- |
- |
|
Est OE |
|
10,000 |
10,000 |
10,000 |
10,000 |
5,000 |
3,000 |
|
Total Cost |
- |
460,000 |
460,000 |
460,000 |
160,000 |
5,000 |
3,000 |
|
Net Effect |
- |
440,000 |
(460,000) |
(460,000) |
1,340,000 |
(5,000) |
597,000 |
|
Cum Effect |
- |
440,000 |
(20,000) |
(480,000) |
860,000 |
855,000 |
1,452,000 |
|
Project Cash Flow at a 50% Down Payment |
|||||||
|
|
40,179 |
40,210 |
40,238 |
40,269 |
40,299 |
40,330 |
40,360 |
|
Income |
|
|
|
|
|
|
|
|
Invoiced |
1,500,000 |
|
|
900,000 |
|
600,000 |
|
|
$ Rcvd |
|
1,500,000 |
- |
- |
900,000 |
- |
600,000 |
|
COGS |
|
|
|
|
|
|
|
|
Estimated COG |
|
450,000 |
450,000 |
450,000 |
150,000 |
|
|
|
Total COGS |
- |
450,000 |
450,000 |
450,000 |
150,000 |
- |
- |
|
Est OE |
|
10,000 |
10,000 |
10,000 |
10,000 |
5,000 |
3,000 |
|
Total Cost |
- |
460,000 |
460,000 |
460,000 |
160,000 |
5,000 |
3,000 |
|
Net Effect |
- |
1,040,000 |
(460,000) |
(460,000) |
740,000 |
(5,000) |
597,000 |
|
Cum Effect |
- |
1,040,000 |
580,000 |
120,000 |
860,000 |
855,000 |
1,452,000 |
Following the tables listed above, if you change the down payment from a 30% down payment to a 50% down payment, you go from needing $480,000 to not needing any additional cash at all during the entire project. This is assuming a progress payment is scheduled four months into the project.
A spreadsheet like this does not take very much time to set up. By putting in that extra time your company can go from living high on the hog to searching the couch cushions for change.
It is way too easy to say that because I’m the boss, I decide. That is a very autocratic approach, and your company will only be as good as the dictator at the top making those decisions, and there has never been a dictator that gets it right all the time.
The opposite view might be that you require consensus with all those involved before a decision can be made. In my experience, very rarely will everyone agree unless the decision has no consequences or you have a team of suck-ups. Have you ever heard the saying, “if two people in a company always come to the same conclusion, one of them is not necessary”. Not making a decision because everyone is not at consensus can be paralyzing to a company. Being unable to decide is a decision also, which can have disastrous consequences
Setpoint is unique in that our culture promotes ideas and debate regardless of who is on the other side of that debate. Pretty much everyone at Setpoint feels comfortable enough to tell me when they think I’m up in the night, and that happens all the way up and down the organization.
I have worked in other places where there were taboo subjects that you could not talk about in front of certain executives or owners. That has an unbelievable stifling effect on ideas and choices that come forward and can be considered. The worst part is that those executives never engage their organizations brains and get the benefit from those that are working closest to the challenges.
Creating the right environment for deciding:
Good luck in creating an environment where good decisions can be made.
You have probably heard a lot about Lean Manufacturing systems like the Toyota Production System and how it can transform a manufacturing plant by eliminating waste, but you may not know that the principals of the Toyota Production System can also apply to the design process.
One of the first steps in the Toyota Production System is to define what adds value for the customer. During the design we try to completely define what the customer wants. What problems are they trying to solve? What needs are they looking for the machine or product to fulfil? By fully defining the scope of the project, you will end up with a set of expectations that are agreed upon so you know what to design and the customer knows what they can expect to receive. This will help eliminate the “Takes What It Takes” (TWIT) attitude that can lead to overages on time and materials.
The next step is to design for manufacturing. Here at Setpoint, we are always looking for ways to make our machines better, faster, stronger, and less expensive both for us and for our customers. We do this by trying to eliminate complicated parts and assemblies, incorporating features like Poke-Yokes (error proofing) and Single Minute Exchange of Dies tooling, and learning from the best practices from past projects.
One of the final steps in the design process is the Post Project Review. This meeting brings together all of the parties involved with the project to reflect upon the things that went right and the things that didn’t go exactly to plan. It includes the design team, project management, purchasing/receiving, electrical and mechanical assembly, the programmers, accounting, and the CEO. These meetings help us to capture all of the “lessons learned” from the project and use that knowledge on the next projects. Reflecting on past projects is a core value of the Toyota Production System and allows Setpoint to build on our successes and prevent us from repeating our mistakes.
At the heart of it, the Toyota Production System is a method to speed up processes, reduce waste, and improve quality. Applying these principles to the design process, allows you to improve quality, become more efficient and provide exactly what the customer is looking for. Happy Designing!
Engineers are typically detail oriented, introverted problem solvers that techno-babble about the latest advances and can’t imagine how the previous generation accomplished anything without the modern tools that are available today. So, what does this mean? If we start with introverted…sometimes I’m certain that our virtual world that has been brought to fruition by engineers is just a selfish result because we really didn’t want to actually talk to each other in the first place. How about latest advances, we spend significant time and effort learning, trouble shooting and maintaining the latest software tools. Remember, engineers are problem solvers, given enough time and money we can make anything work. I’m going to rant for a moment: how often do we end up with an annual software upgrade that requires nearly double the hardware capability that was fine for the previous release along with significant install, debug and training for no real ‘core’ improvements, just new look and feel. Done ranting and back to latest advances, we spend significant effort on the latest CAD tools.
What does this add up to? It is all too easy when starting the design process to work on our own with the latest software tools. Generally goes something like this: there is a preliminary design review in two weeks, who has time for daily internal reviews not to mention the customer is expecting to see a beautifully shaded and textured virtual model…I just have to get this done. There are a few things inherently wrong with CAD on the front end of the design process.
How do we combat this at Setpoint?
Don’t misunderstand me, CAD is a valuable tool in design; however, it’s not always the best tool.
You read and hear a lot about virtual companies these days. What does it take to actually try and make one work?
At Setpoint, we are in a highly cyclical business. We used to size our business based on the busy times and then try and tough it out during the slow times with out having to lay people off. Every time you have to lay people off, it is very painful – not only for the people you have to let go, but it is difficult for those that remain. A couple of years ago we made a strategic decision to size our company for the lean times and use outsourcing techniques to handle the busy times, we decided to try and become a small base of key people that can wear many hats and outsource some functions that we believed could be more generic with proper management.
I had read many articles about the virtualization of the work force. One book that gives great insight is The Future of Work by Thomas W. Malone.
It is hard to make a virtual company work. Reading about it is one thing, putting it into action profitably has been much more difficult.
We used www.dice.com to help us filter and identify technical people that fit our needs. We then used our best mentoring VP to sort through the resumes and set up discussions to find those that might match with our culture.
One thing we did instead of flying them out to meet with us was, we set up a 20 hour project they had to complete (we paid them for this) to see how they would do. We found out a lot by seeing how they solved that project. Like all people that work for a company – not all will be a fit for you or them, the sooner you find out the better for everyone involved.
We have needed many tools to help us make this concept work. One of the main tools we use many times a day is from www.37signals.com – it is called Basecamp. This is our main communication and file tool, it is a diary of all that is taking place and assignments given. We use concurrent licenses for our engineering software programs to give us flexibility to share licenses. www.twiddla.com helps in our concepting phase. Every engineer has a unique color they use so we can recognize who has done what. www.gotomeeting.com is used to host virtual meetings and share information. You will need a conferencing program so that many can join the daily conversations. Setpoint is considering IP phones so we can send phones to our virtual employees and have them just a local extension away.
As you start out with new people give them clear short work assignments to make sure you and they are a good fit with your culture. The key roles of some of your employees will have to change. They have to over communicate and not be afraid to call up and see how their distant team member is doing. One of worst things is to assume everything is going fine if you don’t hear from a virtual team member.
More than anything it is important to have frequent (at least daily) contact with your virtual people. We have done things to connect with our offsite members so they feel like they are working for a real company that cares for them. In Basecamp we have a picture of our facility. As we send messages back and forth through Basecamp we have our own pictures on the message to reinforce that there is a real person behind all of this action.
Your face to the customer has to remain with your employees. We have found that customers have to connect with employees – not virtual team members. It has to appear seamless to them.
We feel that we are making progress but it is a continual battle. Is it better than carrying too many employees through a downtime in the cyclical nature of this business? For us, the answer is a definite yes.
We are still growing at being a company that has virtual team members and believe we still have many lessons to learn as we go down this path. We’d love to hear from any of you out there that can help Setpoint get there faster.