The following blog is first in a four-part series of blogs highlighting the causes of margin erosion and demonstrating how modern software like Progressus can help you minimize the effects of this common challenge!
In the current economic climate, professional service firms are acutely aware of the threat posed by the erosion of profit margins. Without proper planning and monitoring, project margin erosion can sneak up on you gradually. Everything appears to be in order until, suddenly, nothing adds up. And erosion can accelerate quickly.
Margin erosion is a term used to define loss of margin dollars that can occur once a job has been won. More simply, it is a gradual reduction in gross profits over time. Every business has to worry about margin erosion. It can be caused by anything from human error, system error, bad business decisions or practices such as excessive discounting or markdowns, poor quality control or lack of sufficient inventory.
For professional services firms, issues like excessive overhead costs or capital investments ultimately affect profitability; however, margin erosion on projects is generally the most significant impact on the bottom line, quickly eating into a company’s overall profitability.
There are several factors that can lead to margin erosion, some more controllable and preventable than others. They key is to strategize ways to close the gap and avoid margin erosion.
Here is the first tip:
1. Establish repeatable processes for providing accurate cost estimating
Good estimates are the critical first step in assuring that your projects will be successful. However, even under the best of these circumstances, cost estimating is difficult. It requires both quality data and judgment.
In the highly competitive services industry, precise financial information is required for accurate proposals. Knowing and anticipating the project’s expenses correctly provides a definitive advantage in the business development process and ultimately, the financial success of the project, particularly on lengthy or large jobs where small discrepancies can have a domino effect throughout the project.
Developing a good cost estimate requires:
- an accurate project scope,
- access to detailed documentation and historical data,
- standard processes and work break down structures to ensure that no portions of the estimate are omitted and to make it easier to make comparisons to similar projects,
- a risk and uncertainty analysis that allows a contingency for unknown costs, and
- an independent review to establish confidence in the estimate.
A project’s approved cost estimate is a major component in creating a project budget. Because a reasonable budget is essential to a project’s efficient and timely execution, a competent estimate is the key foundation of a good budget.
If you are using Excel for your estimates, there is a good chance that your project managers are using old rates, inconsistent language, and poor assumptions in their budgets, schedule and project reporting.