BUSINESS MANAGEMENT IN CONSTRUCTION ENTERPRISE manuals/CLOEMC-I-III manuals/M4 EN... · 2019. 8....

CONSTRUCTION MANAGERS’ LIBRARY, Leonardo da Vinci: PL/06/B/F/PP/174014

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BUSINESS MANAGEMENT IN CONSTRUCTION

ENTERPRISE

David Eaton

Roman Kotapski

Wrocław, Salford, 2008


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This manual is part of the Construction Managers’ Library – a set of books related to the wide area of management in construction. The books were created within the Leonardo da Vinci (LdV) project No: PL/06/B/F/PP/174014, entitled: “COMMON LEARNING OUTCOME FOR EUROPEAN MANAGERS IN CONSTRUCTION”. Warsaw University of Technology, Civil Engineering Faculty, Department of Construction Engineering and Management was the Promoter of the Project. The following organisations were Partners in the Project: - Association of Building Surveyors and Construction Experts (BE) - Universidad Politécnica de Valencia (ES) - Chartered Institute of Building Ireland (IE) - Polish Association of Building Managers (PL) - Polish British Construction Partnership Sp. z o.o. (PL) - University of Salford (UK) - Chartered Institute of Building (UK) The objective of this project was to create seven manuals conveying all the information necessary to develop civil engineering skills in the field of construction management. The scope of knowledge presented in the manuals is meant to be the basis for assessing the managerial qualifications of civil engineers by the Association of European Building Surveyors and Construction Experts for the purposes of the European engineering professional card - EngCard. The following manuals have been developed (in the brackets you will find an estimate of didactic hours necessary for mastering the contents of a given manual): M1: PROJECT MANAGEMENT IN CONSTRUCTION (100) M2: HUMAN RESOURCES MANAGEMENT IN CONSTRUCTION (100) M3: PARTNERING IN CONSTRUCTION (100) M4: BUSINESS MANAGEMENT IN CONSTRUCTION ENTERPRISE (100) M5: REAL ESTATE MANAGEMENT (100) M6: ECONOMY AND FINANCIAL MANAGEMENT IN CONSTRUCTION (240) M7: CONSTRUCTION MANAGEMENT (100) The manuals created for the purposes of the library are available in three languages: Polish, Spanish and English. The manuals may be used as didactic materials for students of postgraduate courses and regular studies in all three languages. Graduates from the courses will receive a certificate, which is recognized by all organizations – members of the AEEBC, association of construction managers from over a dozen European countries. Polish representative in the AEEBC is the Polish Association of Building Managers, in Warsaw. More information about the LdV project see: www.leonardo.il.pw.edu.pl More information about the Polish Association of Building Managers: www.psmb.pl


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TABLE OF CONTENTS TOM I: BUSINESS MANAGEMENT IN CONSTRUCTION ENTERPRISE ................................................................................................... 8

Introduction ................................................................................................. 8

CHAPTER 1 CONSTRUCTION ORGANIZATIONS ......................................................... 9

TYPES OF CONSTRUCTION ORGANIZATIONS ................................... 10 Legal Entities ............................................................................................ 10 Sole trader ................................................................................................. 10 Partnerships ............................................................................................... 11 Companies ................................................................................................. 12 Unlimited Companies ............................................................................... 12 Limited Company ..................................................................................... 12 Private Limited Company ......................................................................... 13 Public Limited Company .......................................................................... 13 Holding Companies and Conglomerates ................................................... 14

ORGANIZATION DESIGN ......................................................................... 14 CLASSICAL ORGANIZATION THEORY ................................................ 16

Decentralization ........................................................................................ 19 Tall and Flat structures .............................................................................. 20

MODERN ORGANIZATION THEORY ..................................................... 21 Information processing view ..................................................................... 22 Project designs .......................................................................................... 23 Matrix designs ........................................................................................... 25 Horizontal designs ..................................................................................... 26 Virtual organization .................................................................................. 27 Business clusters - Keiretsu ...................................................................... 28

CHAPTER 2 RISK MANAGEMENT .................................................................................. 30

RISK ............................................................................................................. 31 Introduction - what is risk? ....................................................................... 31

TAXONOMY OF RISKS ............................................................................. 33 When To Start the RMP Process ............................................................... 37

RISK IDENTIFICATION -The Detailed Steps ........................................... 38 Risk Metrics and Milestones ..................................................................... 44


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Create and Agree a Risk Management Plan .............................................. 44 Allocate Resources & Implement Plan ..................................................... 45 Control ...................................................................................................... 45 Monitor Progress ....................................................................................... 45 Cybernetic Feedback ................................................................................. 46 Report Progress ......................................................................................... 47 Creating a legacy archive .......................................................................... 47 Conclusion and Summary ......................................................................... 47

CHAPTER 3 VALUE MANAGEMENT.............................................................................. 49

Introduction ............................................................................................... 50 Definition of Terms ................................................................................... 52 The Job Plan .............................................................................................. 53 Phase 1: Orientation .................................................................................. 54 Phase 2: Information ................................................................................. 55 Phase 3: Creativity .................................................................................... 55 Phase 4: Evaluation ................................................................................... 55 Phase 5: Development ............................................................................... 55 Phase 6: Presentation ................................................................................ 56 Phase 7: Feedback ..................................................................................... 56 The Timing Of The Application Of VM ................................................... 56 The 40 hour Value Management Study .................................................... 59 Value management versus Cost management ........................................... 61

CHAPTER 4 COST ................................................................................................................ 63

INTRODUCTION TO NEWER TECHNIQUES ......................................... 64 GENETIC ALGORITHMS IN CONSTRUCTION: AN INTRODUCTION ........................................................................................ 64

How do genetic algorithms work? ............................................................ 65 Example construction GA ......................................................................... 66 When should genetic algorithms be used? ................................................ 68

AN INTRODUCTION TO FUZZY LOGIC ................................................ 70 AN INTRODUCTION TO CHAOS THEORY ............................................ 72 AN INTRODUCTION TO COMPLEXITY THEORY ................................ 74 THE ORIGINS AND INTERACTIONS OF BIOMIMICRY CONCEPTS IN INNOVATION AND CHANGE........................................ 75


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CHAPTER 5 DECISION MAKING IN CONSTRUCTION .............................................. 77

QUANTITATIVE DECISION MAKING: INTRODUCTION .................... 78 Decision making: exemplar....................................................................... 79 What is a decision? ................................................................................... 81 Why are decisions made? .......................................................................... 83 Decisions and conflict ............................................................................... 84 The process of decision-making................................................................ 84 Classification of Decision TACTICS ........................................................ 85 Decision models ........................................................................................ 85 The assumption of rationality.................................................................... 86 Main approaches to decision making ........................................................ 88 Basic structure of a decision model .......................................................... 89 Types of variables ..................................................................................... 90 Pay-off matrix formulation of a decision problem .................................... 91 Decisions classified by degree of certainty ............................................... 91 Certainty, risk and uncertainty models ...................................................... 92 Aspects of decisions and decision making ................................................ 92 Behaviour and decision making ................................................................ 93

CHAPTER 6 PERFORMANCE, PRODUCTIVITY AND BENCHMARKING ........ ..... 95

PERFORMANCE MEASUREMENT AND PRODUCTIVITY EVALUATION ............................................................................................. 96

Productivity Evaluation ............................................................................. 97 BENCHMARKING – VALUE CREATION METRICS ............................ 97

Introduction: Benchmarking - helping yourself to be better .................... 97 Benchmarking: a Definition ...................................................................... 99 Pre-Requisites of Benchmarking............................................................. 100 Benchmarking Processes ......................................................................... 100 Benchmarking Methodology ................................................................... 103 The Uses of Benchmarking: Performance Measurement ........................ 103 Responses to the Benchmarking Process ................................................ 107 Benefits of Benchmarking....................................................................... 107 Implications of Benchmarking ................................................................ 108 Conclusions ............................................................................................. 110


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CHAPTER 7 MARKETING ............................................................................................... 112

Introduction ............................................................................................. 112 Responsibilities of marketing personnel ................................................. 113 Marketing instruments ............................................................................ 114 Keys to success – business strategies ...................................................... 117

MARKETING APPLIED TO CONSTRUCTION INDUSTRY ................ 119 Products in construction .......................................................................... 120 Price in construction ................................................................................ 120 Promotion in construction ....................................................................... 121 Placement in construction ....................................................................... 122 People in construction ............................................................................. 123 Process in construction ............................................................................ 123 Physical evidence in construction ........................................................... 124 Marketing as a management function ..................................................... 124 Image ....................................................................................................... 125 Globalisation ........................................................................................... 126

TOM II: BUDGETING. COSTS OF OPERATION OF A CONSTRUCTION-ASSEMBLY COMPANY ........................................... 129

Introduction ............................................................................................. 129

CHAPTER 8 BUDGETING IN ENTERPRISE MANAGEMENT ................ ................. 131

THE NATURE AND OBJECTIVES OF BUDGETING .......................... 131 THE BUSINESS MODEL OF CONSTRUCTION AND ASSEMBLY ENTERPRISES ........................................................................................... 138 ASSEMBLY AND CONSTRUCTION COMPANY BUDGET STRUCTURE ............................................................................................. 143 THE ENTERPRISE REVENUES AND COSTS BUDGET ..................... 147 THE BUDGET OF REVENUES AND EXPENSES OF AN ENTERPRISE ............................................................................................. 156

CHAPTER 9 CONSTRUCTION BUDGETING ............................................................... 164

CONSTRUCTION COSTS ........................................................................ 164 THE CONSTRUCTION BUDGET ............................................................ 171


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COST CONTROL FOR A CONSTRUCTION CONTRACT ................... 182 ORGANIZATIONAL ASPECTS OF CONSTRUCTION BUDGETING . 191

CHAPTER 10 BUDGET OF THE CONTRACTOR’S PLANT AND TEMPORARY FACILITIES.................................................................................................. 200

COST OF OPERATION OF THE DEPOT ................................................ 200 THE BUDGET OF THE EQUIPMENT AND TRANSPORT DEPOT ..... 203 MONITORING OF ACTIVITY OF THE EQUIPMENT AND TRANSPORT DEPOT ............................................................................... 212

CHAPTER 11 CONTROL OF ACTIVITY OF THE ENTERPRISE.............. ................. 219

THE NATURE AND SYSTEM OF CONTROL OF ACTIVITY OF AN ENTERPRISE ............................................................................................. 219 PROFIT AND LOSS ACCOUNT OF AN ENTERPRISE ........................ 224 RECORDING OF THE ENTERPRISE REVENUES AND COSTS ......... 231 REPORT ON ACTIVITY OF THE ENTERPRISE ................................... 235

BIBLIOGRAPHY ......................................................................................... 242


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TOM I: BUSINESS MANAGEMENT IN CONSTRUCTION ENTERPRISE

INTRODUCTION

This manual is part of a prescribed set of learning manuals. Although the material is largely self contained this manual should be read in the context of the entire suite. Major linkage points to other manuals are indicated in the text. This module begins by examining the links between the different types of construction organisations and the business structures that they can adopt. It then considers the links between the critical factors of: risk; value; and cost and how these factors affect decision making.Internal performance is demonstrated by evaluating productivity and benchmarking. The module concludes by showing the links to increasing workload availability through marketing.


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CHAPTER 1

CONSTRUCTION ORGANIZATIONS

LEARNING OUTCOMES

After studying this chapter within the context of your workplace, you should be able to:

1. Describe the business context of Construction Organisations approaches including the key influence on business practices;

2. Recognise the impact of Construction Organisations on the business

performance within the industry; 3. Describe and apply appropriate Construction Organisations structures

within the context of business performance; 4. Appreciate the strategic importance of Construction Organisations both

internationally and within the national industry market place. These learning objectives furnish the reader with an appreciation that if the potential benefits of Construction Organisations are to be effectively and efficiently channelled into companies’ business practices, companies need to be:

a) Guided and motivated by ethically driven Construction Organisation

practice; b) Creative in the appropriate application of Construction Organisation

structures; c) Aware of the strategic importance of Construction Organisations;

Stimulated and supported by the synergistic integration of other Construction organisations impacting upon them.


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TYPES OF CONSTRUCTION ORGANIZATIONS

Construction Organisations are a varied and complex array of combinations of people, skills, knowledge and expertise. Even the aims and objectives of the organisations vary. However, they all have a feature in common – they are all a form of legal entity. That is they have an economic identity, and they all have a legally acknowledged structural form.

LEGAL ENTITIES

The entity view of organisations is that the organisation is distinct from any individual or group of individuals associated with it. This concept applies to all enterprises regardless of size, ownership, or legal status. The main difference between the different types of entities is two fold:

The legal liability of the owners for the management of the organisation; The legal liability for the debts of the organisation.

The managers of each entity then have varying degrees of responsibility to produce reports on the operations and financial health of the organisation to satisfy particular stakeholders. This entity concept also applies to groups of companies.

SOLE TRADER

A sole trader is a legal entity consisting of one liable individual. The individual ‘owns’ the business. In effect this individual holds all of the equity and all of the liability for the business. Since this individual owns the entire business, the only financial reporting that is required is to satisfy Government requirements for taxation purposes. Other parties are not entitled to obtain reports about the financial health of the business.


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There are two forms of sole trader:

• Sole Proprietor; • Sole Practitioner.

A proprietor is usually a trader selling physical products to customers. In the construction industry this may be, for example, an electrician, plumber or plasterer. A practitioner is usually a professionally qualified person selling services to clients. In the construction industry this may be, for example, an Architect or Design Engineer. Since the sole trader holds all of the equity in the business, there is no practical distinction between the business and the owner. The owner is responsible for all debts incurred by the business, regardless of how much has been invested in the business. This means that the owner has unlimited liability for the debts of the business, and if the owner cannot repay outstanding debts, then all of the personal assets of that individual may be used to repay the debts. In the event that personal assets do not cover the debt then the owner may be declared personally bankrupt. For accounting purposes only, there is a distinction between the business finance and other personal financial activities of the owner. The business is considered as a separate accounting unit from the owner.

PARTNERSHIPS

Partnerships are the same as sole traders’ businesses except that the equity is owned by two or more individuals who are jointly and separately liable for all of the debts of the business. Partners can be classified into three groups:

• General Partners – unlimited liability for the debts; • Limited partners – liability for debts limited to the amount of investment; • Nominal Partners – liability limited to a stated cash sum.

Partners can distribute any profits from the business in any way that they wish.


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A partnership is normally extinguished upon the death of a partner, or by notice of termination of the partnership agreement by one of the partners. Partnerships can have a standing agreement which avoids this necessity for reorganising. For accounting purposes only, there is a distinction between the business finance and other personal financial activities of the owners. The business is considered as a separate accounting unit from the owners.

COMPANIES

Companies tend to be businesses owned by many individuals who are often not active in the management of the organisation. Companies are legal entities, created in accordance with national laws. Ownership is established by holding shares – and the owners are known as shareholders. There are many forms of company, but, they can be roughly grouped as follows:

• Unlimited Companies; • Limited Companies.

UNLIMITED COMPANIES

Very similar to a sole trader or partnership, but with many owners, most of whom have no management function within the business. This structure is an archaic form, and has largely been replaced by limited companies, because of the benefits conferred on the owners by the ‘limited’ status.

L IMITED COMPANY

Archaic forms, such as incorporated, chartered, or joint stock companies still exist, however they are a specialised form only suitable for particular circumstances. An example of incorporated company is the Royal Institute of British Architects. An example of a chartered company is the Royal Institution of Chartered Surveyors. A more generic and the typical form of limited company is the Company Limited by Shares.


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Two typical versions exist:

• Private Limited Company – XYZ Co. Ltd – shares not generally traded; • Public Limited Company – ABC PLC. – shares generally traded via

stock exchanges. Limited companies have an entirely separate legal identity from shareholders. The debt liability of limited companies is restricted to the sum of the capital at face value of the share stock. Generally the liability of an individual shareholder is limited to the investment used to purchase shares. Companies continue indefinitely, and are not generally affected by the death of individual shareholders. This limited liability, plus the ability to raise large amounts of money from having many investors, has made this the predominant organisational structure world wide

PRIVATE L IMITED COMPANY

Private limited companies are generally smaller than PLC’s. The shares are generally restricted to purchase by individuals fulfilling particular conditions. Frequently the shareholding is restricted to members of the same family group, or shareholding is by agreement of the existing shareholders. This means that the control of the company is more closely monitored, and unknown ‘hostile’ takeover is unlikely. The requirements for financial reporting are restricted to reporting for taxation purposes. All other financial details can remain confidential to the shareholders. The general public does not have access to any financial records of these companies.

PUBLIC L IMITED COMPANY

PLC’s are generally larger than Ltd Co’s. The shares are openly traded on stock exchanges around the world. Shareholding is unrestricted and any individual can obtain shares if they are prepared to pay existing shareholders a sum at which they are prepared to sell. Normally the current selling price is well


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publicised, but is highly variable depending upon current events occurring within the company or within its markets. A PLC can offer additional share issues and other securities and cash instruments to raise further capital. The ability to do this is constrained and regulated by much stricter regulation and accounting requirements than those required of Ltd. Co. The requirements for financial reporting are more onerous. Financial records are available for public scrutiny. In most cases annual accounts and annual reports will be sent to any person requesting a copy – although in some instances a small charge can be made.

HOLDING COMPANIES AND CONGLOMERATES

A holding company is a parent company that has subsidiary companies trading in related markets, either related by products and services or by geographical location. Holding companies have a legal identity separate from the subsidiaries, but are generally liable for debts of subsidiary companies. A conglomerate is a parent company that has subsidiary companies trading in unrelated markets. Conglomerates have a legal identity separate from the subsidiaries, but are generally liable for debts of subsidiary companies. The main advantage of holding companies and conglomerates is that taxes, for example, VAT, are not charged on supplies between group members.

ORGANIZATION DESIGN

A company can be described in many ways. It depends on the field of view, of what the observer wants to examine. To set the scope the view of the company as a system will be used. In general, every basic system has three main parts: input; transformation process; and output. Fig 1.1 shows that basic system.


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Fig. 1.1 Basic System A Company could be seen as an Open System. The main thing to recognize a company as an open system is to determine its boundaries. Boundaries are delimiting inside from outside in the specified field of view. One could suggest that there are many fields of view so the boundaries are not easy to establish. That is true. The boundary is not the only possible one. For some research there can be very wide boundary; e.g. if the research question is: ‘How will the global world economic changes impact on the company?’; or there could be very narrow boundary; e.g. if the research is investigating communication issues between sub-contractors and the company. To be able to discuss organizational structure, which is an internal issue of each company, the boundary will be set as everything that has its origin inside the company as a result of some internal process and goes outside of the company is internal. Everything that has its origin outside and goes as an input to some internal process in the company is going through the boundary and is an external input. The same definition also applies to the outputs. (see Fig. 1.2)

Fig. 1.2 Boundaries surrounding the company It is obvious that if the box in the middle of Fig. 1.2 includes the whole company it can be a very sophisticated and complex structure. The internal structure of a company is called the Organization Design. The internal structure of the company affects its efficiency, effectiveness and ability to respond to new opportunities, which can affect the level of organizational

The Company

Internal

Inputs Outputs

Internal

External External

Transformation process

Input Output

Boundary


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profit. This chapter discusses several organizational designs, their historical development and the advantages and disadvantages of some of the most popular designs.

CLASSICAL ORGANIZATION THEORY

To discuss organization designs it is necessary to start from the classical designs and then advance to modern designs as knowledge and experience of the classical structures has advanced. The classical organization is most often associated with bureaucracy. Even nowadays in the modern world with modern and highly developed companies there are still bureaucracies. They can be seen typically in government structures such as the army and in public administration. The design of the bureaucracy is attributed to Max Weber and dates back to the beginning of 20th century. Weber specified what he believed as an ideal company structure. Some characteristics of Weber’s ideal bureaucracy structure can be identified [107], [73]:

• Positions arranged in a hierarchy: According to Weber: ‘The organization of offices follows the principle of hierarchy: that is, each lower office is under the control and supervision of a higher one.’ This design is a classical approach to how systems organize. It has its roots based in nature, where the stronger rules the weaker. Herbert Simon [96] stated similarities of the hierarchy design with nature and the laws of physics, when he stated: ‘Each cell is in turn hierarchically organized into a nucleus, cell wall, and cytoplasm. The same is true of physical phenomena such as molecules, which are composed of electrons, neutrons, and protons.’;

• Specialization: Bureaucracy is based on specialization, power and competence. Each level of the structure has to know its competence, goals and the subjects that it is in charge of. The authority that is giving orders is very important in bureaucracies. Orders come only from this authority and not from anywhere else. Each part of the chain in the bureaucratic model knows precisely its competence in order not to conflict with things under the care of other parts of the organization;

• Impersonal relationship: Weber’s belief was that the ideal bureaucracy must work with impersonal relationships. To produce rational decisions


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it is necessary to leave out any personal emotions like passion, love, hate, etc.;

• Strong rules: The ideal bureaucratic company is a strong one. To achieve stability even when the personnel inside of the company are changing there must be a set of abstract rules for all circumstances. This includes all of the company rules; from specifications of particular internal processes and how to accomplish it, to permits and prohibitions for employees behaviour;

• Promotions: To maintain stability and give employees feeling of safety and security there are specific rules for promotion. Promotions are made according to achievements and seniority. Older employees (in the view of time served within the company) are higher up the ladder of competency and it is almost impossible that an individual could achieve several levels of promotion at the same time;

• Technical qualifications: People are employed based on their qualifications. In the ideal model it is impossible to hire engineering qualified personnel for management functions and vice versa.

There are many more particular characteristic of Weber’s ideal bureaucracy, but those mentioned above are the most important and strongest ones. It has to be mentioned that Weber’s model is understood as an idealised design and no real-life company has adopted it precisely. It is a concept of theory, which was believed by Weber to be the most effective design for companies in early 20th century. However bureaucracies were much criticised by sociologists and philosophers, including Karl Marx, for example. They said that bureaucracies are used primarily to control people and have strict rules, which kills the enthusiasm and initiative of the employees. Bureaucracies have been used for many years in many companies with many modifications to the Weber’s idealised model. This acted as a pragmatic evaluation of the bureaucracy concept and many scholars and management consultants, including the famous Peter Drucker and others, observed it closely and proposed modifications to the Weber’s model. Warren Bennis summarized some of the bureaucracy deficiencies in ten points as follows [5]:

1. Bureaucracy does not adequately allow for personal growth and the development of mature personalities;

2. It develops conformity and groupthink; 3. It does not take into account the informal organization and the emergent

and unanticipated problems; 4. Its systems of control and authority are hopelessly outdated;


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5. It has no juridical process; 6. It does not possess adequate means for resolving differences and

conflicts between ranks and, most particularly, between functional groups;

7. Communication and innovative ideas are thwarted or distorted as a result of hierarchical divisions;

8. The full human resources of the bureaucracy are not being utilized because of mistrust, fear of reprisals, and so forth;

9. The bureaucratic designs cannot assimilate the influx of new technology or scientists entering the organization;

10. The bureaucratic designs modify individual personality in such a way that the person in a bureaucracy becomes the dull, gray, conditioned ‘organization man’.

The classical Weber’s bureaucracy’ in its pure form is not applicable to any real company. One of the most important aspects of why the idealistic model is so rarely accepted in real life is because people all over the world are not the same. Differences between nationalities are huge and what works in one country might not work in the other. During many years of evaluating the bureaucracy models in real companies managers and sociologists developed diagrams of how to capture a company’s organizational structure, today called Organization Epigrams. Historically they wanted, humorously, to show how the organization of the company works. They are not precise not exhaustive, but reflect typical behaviour of the people and the structure in how they are organized in the companies. The most typical use of the organization epigrams is to show differences between organizational structures in different countries. Fig. 1.3 shows some of the organizational epigrams for randomly selected countries. Note how closely the shown structures correspond to national characteristics, habits and behaviour of people in that particular country.


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Fig. 1.3 Examples of international organizational structures Source: [73] During many years of using the more traditional bureaucratic models in companies some modifications to the ideal model have been developed and observed. The most distinctive characteristics are centralization versus decentralization and tall versus flat structures.

DECENTRALIZATION

Centralization and decentralization seems to be self-descriptive, but that merely adds more to the confusion. There are three alternatives of how the structure can be decentralized: geographical; functional; and by decision making:

• Geographical decentralization is the clearest understandable one. The main criterion for it is the geographical location of the company’s operations (houses, subsidiaries, etc.). In today’s global world every international company has some level of geographical decentralization as it has subsidiaries in many different countries. The more the company wants to expand the greater this type of decentralization will be.

• Functional decentralization focuses on how centralized or decentralized are the functional parts of the companies operations. The company can

American

In the USA employees are convinced that everyone can

affect the top person.

It has been said that Irish bosses report to the

employees.

Irish Italian

Almost no lateral communication in the Italian organizations.

British

British workers are used to working with others on the same level, but with no or very low communication

upward.

Chinese

Very strict bureaucracy in Chinese organizations.

Only top-to-bottom communication is allowed.

French

Confusing and unclear connections at all of some

people.


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be split into functional departments (e.g. IT, finance, marketing, human resources, etc.) and then it depends if all parts of the same department are based in the same location and centralized together or not. The company can have one IT division controlling all IT in the whole company and it is based in one place, or every subsidiary can have its own smaller IT department. The centralized model is the first case and decentralized in the second.

• Decentralization by decision making means if the company has centres where decisions are made, grouped together or not. In Weber’s bureaucracy model there is only one chapter where the decision are made – the top subject on the hierarchy model. It appears that the level of this type of decentralization is bound to the level of geographical decentralization. In companies where there are managers of each subsidiary with full responsibilities over it, the top managers in the company headquarters determine only whole company policy and rules, but not specific tasks for the managers.

It could be discussed that at what level of centralization/decentralization is the right one? But there is no correct answer. As has been mentioned already the company structure must be in correspondence with national behaviour and its habits of employees, thus there are differences between nations so the level of decentralization needs to be different too. But traditionally the implication is that decentralization is better than centralization. With the ten deficiencies of bureaucracy mentioned earlier in mind it is obvious that decentralized structures add to people’s autonomy. With more autonomy comes more intellectual development and the possibility of people’s own realization, bringing more satisfaction with it. The truth is that world globalization brings opportunities for companies to spread into other markets and build their subsidiaries in different countries, which means to increase the level of geographical and delegation decentralization. Nowadays, because of all these facts, decentralization is more recognized as a better (and necessary) organizational design than a centralized one.

TALL AND FLAT STRUCTURES

The terms ‘flat’ and ‘tall’ are nothing new and concern the scope of control in the company. ‘In organizational analysis, the terms flat and tall are used to describe the total pattern of spans of control and levels of management. Whereas the classical principle of span of control is concerned with the number of subordinates one superior can effectively manage, the concept of flat and tall


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is more concerned with the vertical structural arrangement for the entire organization [73].’ It could be mentioned that the traditional bureaucratic structure is very tall. In the modern view of organizational theory flat structures are better perceived. In fact both of them have their advantages and disadvantages. Tall structures offer better control for managers of lower levels. Managers have fewer people they care for which makes it possible to maintain stronger relations with his or her subordinates. The flat structure has better (quicker and superior) response to commands coming from the top because the route is much shorter (fewer levels) and there is less possibility for information becoming biased on its way. There is another thing which is counted as plus for flat structures – it enables better individual initiative and self-control.

MODERN ORGANIZATION THEORY

Amongst the criticism of the Weber’s traditional approach to organization theory there have been some arguments that ‘Weber really did not intend for it to be an ideal type of structure. Instead, he was merely using bureaucracy as an example of structural form taken by the political strategy of rational-legal domination’ [108]. Traditional organization theory served as a “spring board” for others and helped to form modern organizational theory. As the market has progressed and evolved during the last century a new phenomenon has become more obvious than ever before – competitiveness. With more companies in the market producing and offering substitute (or exactly) the same products, companies needed to start redesigning their structures to become more effective. Four organizational theories evolved, which are now counted as modern organization theory. Probably the major one is to think about the company as a system made up of interacting parts. This concept is called the Open-System and as such was introduced in the introduction to this chapter. In short it means that the company is an interacting system with its outside environment. Receiving from and sending information to the outside and acting based on this information. The second concept of


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organizational theory says that there is no one ‘perfect’ structure of the organization. It depends on the core business of the company and on the cultural aspects too. It could be seen in Fig. 1.3 that different nationalities have different habits and ways of thinking. The third approach is ‘ecological’. In this approach the company is being compared to nature, where natural selection occurs. Only the sturdiest and toughest subjects can survive and in order to survive the internal structure of the company has to evolve to achieve the success. The fourth and the newest approach is called organizational learning. ‘[...]the learning organization is based largely on system theory but emphasizes the importance of generative over adaptive learning in fast changing environments’ [73].

INFORMATION PROCESSING VIEW

The information processing view focuses on the company as a system, which receives, gathers, processes and produces information. Because there are many other similar systems outside interacting together (other companies and the environment) the organization must deal with some degree of uncertainty. The uncertainty is defined by Jay Galbraith as ‘the difference between the amount of information required to perform the task and the amount of information already possessed by the organization’ [35]. Uncertainty is always present. It is not possible to see the future and without that ability there is always uncertainty in what will happen. Companies need to respond to the change coming from outside and adapt to that change to survive. A great advocation of that can be found in Tushman and Nadler [103] where they state that ‘Given the various sources of uncertainty, a basic function of the organization’s structure is to create the most appropriate configuration of work units (as well as the linkages between these units) to facilitate the effective collection, processing, and distribution of information.’ Tushman and Nadler formulate the following propositions about an information processing theory:

• Different organizational structures have different capacities for effective information processing;

• The tasks of organization sub-units vary in their degree of uncertainty; • If organizations (or sub-units) face different conditions over time, the

more effective units will adapt their structures to meet these changes in information processing requirements;


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• As work-related uncertainty increases, so does the need for an increased amount of information, and thus the need for increased information processing capacity;

• An organization will be more effective when there is a match between the information processing requirements facing the organization and the information processing capacity of the organization’s structure.

Because of the increasing competitiveness of companies in the market their managers started to look for new, better organizational structure to survive. In the last fifteen years of the 20th century some widely recognized organizational structures have developed and been successfully applied to real life. They are:

• Project designs; • Matrix designs; • Network designs; • Horizontal designs; • Virtual organizations.

Each of these organizational designs has its advantages and disadvantages. As has already been mentioned there is no one universal ‘best’ structure that every company should adopt to be successful.

PROJECT DESIGNS

The modern trend in business is to supply services rather than only goods. The specialization of companies means that they are focused on their core business and for support services they need complementary services from appropriate partners. The complete service (one-stop-shop) includes a large number of activities for the supplier. To offer a complete service could be treated as project management. The company needs to manage the whole business cycle from communicating with the customer and specifying what they really need, through making or developing a product, to delivering and maintaining it. Moreover the company can have many simultaneous projects running together producing different types of outputs, which is in contrast with the classical company structure where the company produces only centrally specified types of outputs. In this form of company it is not possible to centrally plan what each unit will do because each project needs something different. To aid this business strategy the project design structure has appeared. Fig. 1.4 shows the typical organizational structure of a company applying a project design organizational strategy.


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Fig. 1.4 Typical project organization structure Note that both projects are using the same units (departments) of the company, but for different purposes. In Fig. 1.4 it is obvious that every project manager answers to one general manager. This is typical, but for specific purposes there is a modification of this typical project structure, which is shown in Fig. 1.5.

Fig. 1.5 Modified project organization structure

It cannot be said which one is better or why. It depends on cultural characteristic as well as on business aspects. In large companies the general manager wouldn’t be able to manage all the projects by himself so the typical structure is obvious in that case. The other thing that is needed if the company wants to adopt a project design structure is the different styles of management. Probably the most obvious

General Manager

Project Manager 2

Quality Control

Engineering R&D

Marketing Analysis

Project Manager 1

General Manager

Project Manager

Quality Control

Engineering R&D

Marketing Analysis

Project 2

Quality Control

Engineering R&D

Marketing Analysis

Project 1 Project Manager


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instance is that change happens every time, everywhere. This requires dynamic activities to successfully manage the whole structure. The managers must become reoriented to the management of human resources rather than strict functional rules based on calculations. Good relations between each part of the project groups are crucial for achieving effectiveness. It is obvious too that project structure is a concept of management and not only a form of structural organization.

MATRIX DESIGNS

A matrix structure is one of the most applied organizational structure in companies nowadays. The reason for it is that the matrix structure combines two structures together and takes pros from each of them. A matrix structure is a combination of functional and project organizational forms. Fig. 1.6 shows a typical, but simplified, matrix structure.

Fig. 1.6 Matrix organizational structure In a matrix organization, each project manager reports directly to the general manager (in large companies there could be more levels). Since each project represents a potential profit centre, the power and authority used by the project manager come directly from the general manager. The project manager has the total responsibility and accountability for the success of the project. The functional departments (such as R&D, etc.) have functional responsibility to

General Manager

Analysis Manager

Quality Control

EngineeringR&D

R&D Manager

QC Manager

EngineeringManager

Marketing Manager

Project Manager 1

Analysis Marketing

Quality Control

EngineeringR&D Project Manager 2

Analysis Marketing

Quality Control

EngineeringR&D Project Manager 3

Analysis Marketing


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maintain technical excellence on the project. Each functional unit is headed by a functional manager whose prime responsibility is to ensure that a unified technical base is maintained and that all available information can be exchanged for each project. The main difference of the matrix structure is that the same unit is used by many projects. It is up to project managers and their agreement who will do what and when. Observation of the companies utilising matrix structures shows that ‘[...] because of the amount of interaction among members in matrix structures, and the high levels of responsibility they possess, matrix organizations usually have greater worker job satisfaction’ [93].

HORIZONTAL DESIGNS

Currently the “customer-driven” approach is recognized as the ’correct way’ for companies to evolve. Horizontal organizations consist of teams which are organized around business processes rather than functional departmentalism. The teams are responsible for the results they generate. They are measured and people are rewarded according to team results, not individual performance. This approach leads to a better focus on the task rather than to individual specializations. The example of the horizontal design is shown in Fig. 1.7.

Fig. 1.7 Horizontal organizational structure In order to be a successful horizontal structure, all employees need to be fully informed and trained. Communication between and inside of the team is crucial. People should be provided with full data, not just some parts, and in conjunction with this information and ability to interpret the data to produce better decisions. The next typical thing for a horizontal structure (for project

General Manager

Costumer Acquisition

Team 2 Team 3 Team 1

Team 5 Team 4

Order fulfilment

Team 2 Team 3 Team 1

Team 5 Team 4


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organization structure too) is the contact between team members and external subjects like suppliers or customers themselves. Team members communicate with customers directly, which produces less bias in information going from customers than if they were going through traditional ways through many layers of the structure before it reaches its destination and makes it possible to react quickly and adequately to customer’s requirements or problems. As stated in Byrne [15] many American international companies like AT&T, Motorola, GE, Xerox and others have adopted the horizontal structure to increase their effectiveness and survive in the market.

VIRTUAL ORGANIZATION

Virtual organizations are the newest approach to organizational design. It has emerged as a response to environmental change, which demands quick, cheap and quality solutions (goods, services, etc.). One definition says: ‘A virtual organization or company is one whose members are geographically apart, usually working by computer e-mail and groupware while appearing to others to be a single, unified organization with a real physical location.’ [109]. Another more target oriented definition says: ‘The virtual organization is a temporary network of companies that come together quickly to exploit fast-changing opportunities.’ [73]. In other words it could be described as a large alliance of companies connected together by modern information technology, with different backgrounds but focusing on the same goal. This collaboration gives the involved companies competitive advantage in the market which they are not able to achieve alone. According to [12] and summarized in [73] the key attributes of virtual organizations are:

• Technology: Informational networks will help far-flung companies and entrepreneurs to link up and work together from start to finish. The partnership will be based on electronic contracts to keep the lawyers away and speed the linkups;

• Opportunism: Partnerships will be less permanent, less formal, and more opportunistic. Companies will band together to meet all specific market opportunities and, more often than not, fall apart once the need evaporates;

• No borders: This new organizational model redefines the traditional boundaries of the company. More cooperation amongst competitors,


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suppliers, and customers makes it harder to determine where one company ends and another begins;

• Trust: These relationships make companies far more reliant on each other and require far more trust than ever before. They share a sense of “co-destiny”, meaning that the fate of each partner is dependent on the other;

• Excellence: Because each partner brings its “core competence” to the effort, it may be possible to create a “best-of-everything” organization. Every function and process could be world-class – something that no single company is likely to achieve alone.

BUSINESS CLUSTERS - KEIRETSU

Even though a business cluster is not an organizational structure in its true sense it still belongs to some part of organizational theory. A business cluster ‘consists of several enterprises that have entered into a formal, continuing association in order to pursue some activities in common and derive maximum benefit from such synergy [105].’ This closely resembles to definition of a virtual organization – see above. There is a tendency for companies of a similar kind in a specific region to do business in close cooperation. These associations then bring their members a number of advantages (e.g. specialization, lower costs per unit, better access to raw materials), production savings and bilaterally useful cooperation with many institutions (e.g. universities, research institutes, consultant companies, etc.) and, very importantly, support of local governments. The business cluster‘s structure is usually composed of:

• Core Businesses: The businesses that are the lead participants in the cluster, often earning most of their income from customers who are beyond the cluster’s boundary;

• Support Businesses: The businesses that are directly and indirectly supporting the businesses at the core of the cluster. These may include suppliers of specialized machinery, components, raw materials; and service firms including finance/venture capital, lawyers, design, marketing and PR. Often these firms are highly specialized, and are physically located close to the core businesses;

• Soft Support Infrastructure : In a high performance cluster, the businesses at the core and the support businesses do not work in isolation. Successful clusters have community wide involvement. Local schools, universities, polytechnics, local trade and professional associations, economic development agencies and others support their


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activities and are key ingredients in a high performance cluster. The quality of this soft infrastructure, and the extent of teamwork within it, is a very important key to the development of any cluster;

• Hard Support Infrastructure : This is the supporting physical infrastructure: roads, ports, waste treatment, communication links, etc. The quality of this infrastructure needs to at least match competitive destinations, be they local or further a field.

The typical business cluster structure is shown in Fig. 1.8.

Fig. 1.8 The structure of a business cluster To sustain competitive pressure from many companies in the market the companies need to systematically gather information about their rivals and based on that information make decisions. Gathering information is usually not a big problem for international corporations, but sometimes it is a compelling problem for small and medium-sized enterprises (SMEs). It is not only about financial or personnel abilities, but SMEs mostly do not know what they want to find or they do not have enough time for detailed analysis. It is therefore logical, that in this kind of situation, companies can group with similar companies to form a cluster and to dispense some tasks across members of the cluster and later on all members of the cluster can profit from information sharing. It also then becomes possible to support a system, which is fully or partially automated for finding, sorting and analyzing information in a particular area, but it is unreachable (financially and even technically) for a single SME.

Core

Support organizations

Soft infrastructure

Hard infrastructure


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CHAPTER 2

RISK MANAGEMENT

LEARNING OUTCOMES


1. Describe the business context of Risk Management approaches including the key influence on business practices;

2. Recognise the impact of Risk Management on the business performance

within the industry; 3. Describe and apply appropriate Risk Management techniques within the

context of business performance; 4. Appreciate the strategic importance of Risk Management both

internationally and within the national industry market place. These learning objectives furnish the reader with an appreciation that if the potential benefits of Risk Management are to be effectively and efficiently channelled into companies’ business practices, companies need to be:

a) Guided and motivated by ethically driven good Risk Management practice;

b) Creative in the appropriate application of Risk Management; c) Aware of the strategic importance of Risk Management; d) Stimulated and supported by the synergistic integration of the Risk

Management impacting upon them.


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RISK

INTRODUCTION - WHAT IS RISK ?

Everything we do has risks associated with it - events that might prevent the achievement of stated objectives if they occur. A project by definition is trying to introduce some form of change - a new production system or way of working, a new building, etc. Change involves uncertainty, which in turn means that projects are more likely to be blown off course by a potential future event. In other words, projects are inherently risky undertakings. To be fully effective, Project Managers need to recognise that risks exist and actively manage them; this is an indication of good project management, not an admission of failure. By looking ahead at the potential events that may impact the project and putting actions in place to address them (where appropriate), project teams can pro-actively manage risks and increase the chances of successfully delivering the project. Risk Management is therefore a key Project Management discipline and one of the 8 components, as illustrated below.


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Fig. 2.1 Place of Risk Management in Project Management according to PRINCE 2 methodology (Reproduced from the PRINCE 2 Manual) A risk can be defined as a potential event, either internal or external to a project that, if it occurs, may cause the project to fail to meet one or more of its objectives. A risk therefore has two aspects:

• The expected likelihood (or probability) of that event occurring; • The expected impact if it does occur.

An Issue (in project management terms) is something that is happening now and is jeopardising (or will soon jeopardise) the delivery of one or more of a project’s objectives or deliverables. It may therefore represent a risk that has materialised (in other words one where the probability has reached 100%). Where issues are outside the authority of the Project Manager, they should be escalated up the project management organisation to the appropriate level that has authority to deal with them. Issue Management is a separate process, which is not the subject of this chapter. Risk Management aims to recognise as early as possible the potential problems (in other words the risks) to a project so that the opportunity for taking more

StartingUp a

Project

Directing a Project

Initiatinga

Project

Closinga

Project

ManagingStage

Boundaries

Planning

ManagingProductDelivery

Controlling a

Stage

Change Control Organization

Planning

Controls

StagesManagementManagement

of Riskof Risk

Quality in a project environment

ConfigurationManagement


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effective (pro-active) action is maximised. Thus a risk may turn into an issue (when the risk occurs); an issue will not turn into a risk, because by definition, it has already occurred.

TAXONOMY OF RISKS

Risks can have a classification system. This system classifies risks in relation to their locus of action. That is the organisational level at which the risk will have the most impact. Project Risks: are those risks within the project boundary that could affect the delivery of the business outcome that the project is set up to deliver. In other words, those that could affect the delivery of the project’s objectives. Business Risks: on the other hand are those risks that affect the operation of the business outcome once it has been delivered by the project. . Environmental Risks: are those risks that are external to the project environment but which nevertheless can affect the project objectives. For example, the Gulf War had a devastating effect upon gas field projects in Kuwait in 1990. External change risks: are those risks that are beyond the immediate project environment but which could have a major impact. Frequently in contractual terms these may include FORCE MAJEURE events. However, external change risks go beyond force majeure, for example because of a shift in Government policy or in its interpretation of a law. The main aims of risk management are to: Identify potential risks;

1. Assess the probability and impact of each risk;

2. Identify alternative actions that prevent the risk from happening (avoidance), or if it does happen ameliorate the impact (reduction), or


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provide a strategy for dealing with the accepted consequences of such a risk occurring (acceptance);

3. Implement and monitor those actions that are cost effective and

necessary to the successful delivery of the project objectives (NB: project objectives not project);

4. Provide feedback from experiential learning to improve the risk

management of future projects and to inform the training and development of project managers.

Risk Management is therefore an integral part of project management - not an additional extra. It should be used to drive, inform and support planning. Effective risk management should:

• Anticipate and influence events before they happen by taking a pro-active approach;

• Provide knowledge and information about predicted events; • Inform and where possible improve the quality of decision making,

recognising the preferred hierarchy of risk avoidance, risk reduction, risk control, and risk acceptance;

• Avoid covert assumptions and false definition of risks; • Make the project management process overt and transparent; • Assist in the delivery of project objectives in terms of benchmarked

quality, time and cost thresholds; • Allow the development of scenario planning in the event of the

identification of a high impact risk; • Provide improved contingency planning; • Provide verifiable records of risk planning and risk control.

To achieve effective and efficient risk management risk planning is required. The commonest form of risk planning is the Risk Management Plan. A risk management plan (RMP) comprises: The risk strategy which records how risks will be owned, evaluated, controlled, reviewed and reported upon; the plan will show:

• Who is accountable for a particular risk (ownership); • What that particular risk is (evaluation);


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• How that particular risk will be managed, controlled, reviewed and reported, in other words the physical actions or management actions that will be taken to avoid, reduce, control or accept the risk.

The key to effective risk management is ownership. Each risk (and associated actions) must be owned so that there is clear responsibility and accountability for that risk and its associated action. It has become an axiom of good risk management that the ownership of a risk should lie with the party ‘best’ able to control the risk probability and its impact. Different risks and actions will need to be owned by different stakeholders. For example:

• The Client should own any risks that affect the business or business case e.g. those that would prevent the benefits of the project from being fully realised.

• The Project Manager should own any risks that might affect the delivery

of the project e.g. those that affect the project schedule. • The Project Contractor should own any risks that might affect the

contractors’ ability to deliver the project objectives. The Project Manager may initially determine ownership, when risks are accepted and entered onto the Risk Log. It may then be ratified / agreed by the Client or Project Contractor. The risk owner is responsible for ensuring that the risk is effectively monitored and managed through appropriate, agreed mitigating actions. The Project Manager has overall responsibility for delivery of the project and therefore also has responsibility for the RMP. This means the control of risks (and any actions associated with them) and the communication of the plan so that all parties understand their role(s). This includes reporting the presence of any risks that, if realised, would:

• Affect the project base-line (e.g. business case or schedule); • Affect the fit of the project within the Business strategy; • Affect dependent projects (or programmes). If the project is a part of a

programme, such programme level risks will be managed by the programme management function.


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The Process - how can Risk Management be implemented? Risk Management is about trying to eliminate the unexpected, by thinking about all the things that might happen to deflect a project from its objectives. The process can be divided in to 2 phases comprising 4 iterative stages, shown schematically below:

Fig. 2.2 Phases and stages of Risk Management Process Each Stage has a number of Steps: these are covered in detail below.

IDENTIFICATION

ASSESSMENT

MITIGATION

CONTROL

RISK ANALYSIS RISK MANAGEMENT


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Fig. 2.3 Phases and stages of Project Management Process

WHEN TO START THE RMP PROCESS

It is important to begin developing the RMP from as early on in the project as possible – during the Inception stage:

• When the feasibility appraisal or any full study is undertaken; • As a part of any financial appraisal, before formal project approval is

sought. However risk management is an ongoing part of project management. This is not just in terms of mitigation and control. It also means that the whole process should be repeated and re-assessed throughout the project. When this is done should be a part of the risk strategy outlined at the beginning of the project and included as one of the project management products. Some key stages which might be suitable as review points are:

• Between Inception and Initiating a Project

Reports

Start

Stage 1 Identification

Stage 2 Assessment

Stage 4 Control

Stage 3 Mitigation

Project Complete

RISK ANALYSIS RISK MANAGEMENT


38

• When Managing Phase Boundaries, as one stage is completed and the next is planned in detail, as part of the management review;

• As a part of project reviews: for example, full project reviews or internal reviews.

RISK IDENTIFICATION -The Detailed Steps

1 Identification: Identification is a key stage of the risk management process providing the foundation upon which the remainder of the process is built.

Key deliverables include:

The risk management strategy (recorded in the RMP); A risk register for the project.

2 Set the Context and Perspective for Analysis: Before identification can

begin, the project must have clear:

Scope; Objectives;

and, Reference Business Strategy.

It is important to outline the risk strategy at this stage. This will depend on the type of project and its complexity (in terms of number of stakeholders, dependencies and products, its length & timescales, the budget, and so on). It should set out:

• The level of risk management required for the project. For example, will any risks be quantified or modelled (for example to test cost sensitivities or different likelihood of occurrence)? Or will qualitative analysis provide enough control?


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• What the levels or types of risk are for this project (See Roles and Responsibilities above.)

• The process and frequency with which risks and actions will be reviewed e.g. will a special meeting of the project management team be needed?

• The process for escalating risks (for example if the project is a part of a larger programme.)

• The likely points within the project when the whole risk identification process will be repeated. For example, at the start of each new stage or phase when detailed plans are being developed.

3 Gather Information On Risks: There are a number of different

techniques for identifying risks. These will be discussed in detail later. The main points to remember are:

Some techniques may suit particular types of project better than others;

Some people may prefer one technique rather than another. Two of the commonest techniques are:

Brainstorming: with key stakeholders for the project, such as the Project Sponsor, Team Leaders, Users and so on, trying to capture as many of the risks associated with the project as possible. It may also be worth involving those who have been involved in other, possibly similar, projects, so that their experience can be incorporated. As with all brainstorming the key thing at this point is to capture everything. Consideration of which risks to accept or to manage, comes later.

Checklists: these can seldom be exhaustive, but can help to ensure that the most common key areas of project risk are considered. They are particularly useful as “prompts” to facilitate brainstorming.

4 Classify Risks According To Causes

Depending upon the size and type of project, it may be helpful to classify the risks. There are a number of ways of doing this, for example grouped according to:

Cause(s): relating to customers, staff impacts, technology and so on; Project objectives or Critical Success Factors (CSF’s);


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Project activities; Products.

5 Assessment

Once risks have been identified they need to be assessed so that decisions can be made about:

Which are the highest priority and therefore what level of management ownership they require. The possible management actions that could be taken.

6 Determine The Likelihood And Consequences. All risks have two elements:

The likelihood that they will happen; The impact on the project if they do happen, for example on costs, schedule and benefits.

Both of these elements need to be assessed so that risks and actions can be prioritised relative to one another.

There are two main methods of doing this: qualitative and quantitative. These methods will be defined later. All risks should be assessed qualitatively first, to give a feel for the relative riskiness of the project and the highest risks.

Qualitative assessment looks at the relative likelihood and impact of any risk. A first step could use the following:

Table 2.1

Qualitative assessment – first step

Likelihood: High Medium Low

It is very likely that this risk will happen

It is quite likely that this risk will happen

It is unlikely that this risk will happen


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Impact: Different risks are likely to impact different aspects of the project; for example – time, cost, quality or benefits.

It is worth considering which type of impact is likely to be most critical to the project at the stage it has reached. The impact can then be focused upon this area - for example costs could be considered as stage costs, development costs or whole project lifecycle costs. Initial examples shown in table 2.2.

Table 2.2

Examples of impacts on project with taking into account their level

Impact Level

On High Medium Low

Cost Cannot be contained in project base-line

Unlikely to be contained in project base-line

Likely to be contained in project base-line.

Schedule (e.g. key milestones)

Project will not be delivered on time

Project unlikely to be delivered on time

Some slippage to milestone Schedule but not overall project schedule

Benefits Business case deliverables are not achievable

Business case deliverables likely to be reduced

No real impact

The impact allocation is then taken to be the highest category for that risk in the three impacted areas.

(NOTE: impact on quality is likely to be reflected in some or all of the above, as, for example benefits include “soft” issues such as customer service). Initial Ranking Of Order Of Importance: This will be a combination of the likelihood and the impact on cost, quality, schedule and benefits. A ranking technique can be used where: high = 3; medium = 2; low = 1.


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For each risk multiply the impact and likelihood together: the risks can then be ordered according to the highest score. In this system the highest risk ratio is 9 (high probability and high impact) and the lowest risk ratio is 1 (low probability and low impact).

Finally in this step, consider the timing of the highest scoring risks: When are they likely to impact the project?

What does this mean for the possible management actions that could be taken?

Depending on the complexity of the project, it may be worth considering an additional dimension for describing the risk - its Urgency based upon how soon it will impact the project.

7 Mitigation

Once the identified risks have been prioritised and their timing has been established, possible management actions should be considered. These management actions are designed to contain the risk, by either making them less likely to happen or by reducing their impact if they do happen.

8 Decide On Any Actions

Risks can be contained by taking actions that either reduce the likelihood of the risk occurring or its impact if it does occur. Using the ordered set of risks, decide whether any action should be taken and if so, what:

Prevent: an action which reduces the likelihood;

Mitigate: an action which reduces the impact to the project should the risk occur; Transfer: transfer the risk to someone who can better manage it, for example to the project contractor (this is normally combined with acceptance) or partner the risk; Contingency: a contingency plan which can be brought in to play should the risk occur e.g. to deliver the business outcome (or part of it) in a different way);


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Accept: no action will be taken - the risk is accepted as it is. For example if the impact is very low (or the potential returns/benefits are very high); Insure: purchase an underwritten policy that provides for financial restitution if the risk occurs; Decline: reject the risk – this may entail declining the entire project or entering into detailed negotiations with the prospective client.

Two additional categories of action are also worth considering:

Lack of Root definition: not enough information to make a decision - carry out further investigation; Avoidance: a different course is taken so that the likelihood of the risk is reduced to zero. In other words the risk is avoided.

Fig. 2.4 Risk Management decision scheme Any management action must be assessed in terms of:

Its cost; The kind of action it is; this will affect when that action should be included within the project plan. For example, an action aimed at

Accept: no action taken - risk accepted

as it is

Avoid: eliminate the cause of the

risk

Sourceof ris k

Risk Direct

consequences Consequenceson business

Start

Poor definition: carry out further

investigation

Prevent: reduce the likelihood

Transfer: transfer the risk to someone else

Reduce: the direct

consequences

Fallback/Contingency: reduce the business

consequences e.g. by delivering the desired

outcome in a different way

Actions aimed at reducing the probability Actions aimed at reducing the impact


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reducing the likelihood of a risk should be included in the project plan. An action affecting the impact will be contingent upon the occurrence of the risk and should therefore only be included in the plan if the risk occurs; Its predicted effectiveness in containing the risk; Its associated consequences - to ensure that the counter-measure does not have any unforeseen consequences. (There is a covert assumption that root definition has been achieved and that the action is not to relieve ‘mere’ symptoms.

These can then be compared to the risk assessment, to decide which actions are appropriate, given the level of risk. Once a risk has been both accepted and an appropriate countermeasure(s) identified, the risk and countermeasure owner(s), should be agreed.

RISK METRICS AND M ILESTONES

For each risk that has an action, consider what measures or milestones will give early warnings that the risk is about to happen. These can then be monitored as a part of the risk management plan.

CREATE AND AGREE A RISK MANAGEMENT PLAN

Create an initial management plan. Again the Risk Register can form the basis for this. The nature of the plan will be dependent upon the type of risk, its timing and the type of counter-measure selected. For example, where a risk has been identified that is likely to occur in the current stage of the project and a preventative counter-measure is available, that counter-measure can be built into the activities within the project or stage plan. The action should still be controlled and managed through the RMP. In contrast, contingency management actions are dependent upon the risk occurring and so will not be immediately built into the project plan. These measures have been “planned”, in that they have been considered and accepted, but are only put into operation within the project / phase plan as and when the


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risk arises and the action is authorised. Such management actions are therefore available as required The RMP (along with the other project plans) should be agreed, ensuring that all stakeholders are aware of any actions that are their responsibility.

ALLOCATE RESOURCES & IMPLEMENT PLAN

Resource allocations should be pre-planned and, where appropriate, allocated to the agreed actions. Immediate actions should be built in with the other project activities, as an integral part of the overall project management plan. Other actions will be dependent upon the risk materialising and will be triggered by the occurrence of a risk metrics and milestones.

CONTROL

The final stage is to: • Monitor risk metrics and milestones, so that contingent actions can be

implemented if required; • Monitor the effectiveness of risk management actions, to ensure that they

are having the predicted effect. (Improper root definition may create unexpected events at other points within the system).

• To feedback lessons about which actions are the most effective.

MONITOR PROGRESS

Ensure progress against the risk management plan. This will involve: • Co-ordinating the risk activities alongside the other project work,

(effective communication between the risk owner and the Project Manager is a necessity);

• Monitoring resource usage against limits and resolving conflicts; • Monitoring risks to ensure that they remain within agreed limits; and • Monitoring risks to ensure that they do not become too large for the

project manager to manage effectively; • Monitoring risks to ensure that they do not threaten the viability of the

project objectives; • Reporting risk as outlined in the risk strategy;


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• Re-evaluating the risks to the project as outlined in the risk strategy; • Invoke the Dispute Resolution Procedure for any risks or issues that fall

outside the authority of the project team. For example, an environmental risk which impacts more than one stakeholder;

• Invoke the Dispute Resolution Procedure for any risks or issues that are not being effectively managed by the risk owner, and as a consequence, other stakeholders may be adversely affected.

Such escalation demonstrates good project management - it should not be viewed as an admission of failure.

CYBERNETIC FEEDBACK

Cybernetic feedback is knowledge and experiential learning about the effectiveness of actions. For example, a preventative action may have been put in place to reduce the likelihood of a risk from high to medium.

• Was this effective? • Did the risk materialise? • If so was this because the action was ineffective or for some other

reason? • In retrospect might a different action have been more effective?

These lessons can be used to:

• Improve ongoing risk planning on the project itself; • Share good practice with other projects; for example through Legacy

Archives, Project Evaluation Reviews or Post Implementation Reviews; • Monitor Risk Metrics and Milestones; • Monitor risk metrics and milestones to assess which risks are happening

or about to happen. This will therefore involve both:

• Checking whether risk metrics or milestones have been reached, and therefore whether any contingent management actions are required, and

• Ensuring that indicators continue to give a clear picture of the status of that risk.


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Where appropriate, Reduction and Contingency actions should be scheduled in to the project plan.

REPORT PROGRESS

Monitor and report on the change of status of any risk. The precise method and frequency of reporting depends on the risk strategy for the project that was developed during inception. The Project Manager is responsible for reporting progress, cost, trends etc. to the project team on the agreed specified dates. Risk owners are responsible for monitoring and reporting on “their” risks to the Project Manager. In addition, they are responsible for reporting to the Project Manager, who is responsible for reporting to the Project team the occurrence of any risks that:

• Affect the project base-line, in terms of time, cost or quality of delivery of project objectives;

• Might affect the congruence of the project with the business strategy; • Affect risk owners ability to manage other risks; • Affect dependent phases or work packages.

CREATING A LEGACY ARCHIVE

The Risk Register should be managed throughout the process protocol phases. Risks will either be:

• Deleted/closed because they have passed, or • If still current, be transferred to the live operation/maintenance as a part

of handover.

CONCLUSION AND SUMMARY

Risk Management is an integral part of project management and should be used to drive, inform and support planning. The key aspects are: Recognition of risk is not an admission of failure. It provides the opportunity to manage the project proactively rather than continually reacting to events.


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The key step in any risk management exercise is Identification. Use a range of techniques to ensure that all aspects of the project are considered. Risk management can be greatly improved by involving key stakeholders in identification exercises. Start early and repeat the whole process (including identification) regularly. For example when Managing Phase Boundaries. Once identified, the impact and likelihood of each risk should be assessed. Initially this can be done in a qualitative way; however, even simple quantitative techniques can help to improve consistency and the comparison/prioritisation of risks. Management actions to address risks can reduce either the likelihood of occurrence (e.g. avoidance) or the impact (e.g. reduction). Some key risks may require both kinds of actions. Risks and actions should be owned at the correct level within the project. This might be the Project team, the Project Manager or Project Contractor. However, the Project Manager remains responsible for the Risk Management Plan (RMP). Risk actions should be monitored to ensure that they are having the desired effect - either reducing the likelihood or the impact of the risk. In addition, risk indicators should be monitored so that contingency plans or contingency actions can be put in place if it seems likely that a risk will occur. Risk Management is not a one-off process - it should be repeated at key points through the project as the focus shifts; for example from design, to development to implementation. Each exercise may require the involvement of different stakeholders to the last exercise. Make sure all risks are either closed or transferred to the live operation as a part of the Creation of a Project Legacy.


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CHAPTER 3

VALUE MANAGEMENT

LEARNING OUTCOMES


1. Describe the business context of Value Management approaches including the key influence on business practices;

2. Recognise the impact of Value Management on the business

performance within the industry; 3. Describe and apply appropriate Value techniques within the context of

business performance; 4. Appreciate the strategic importance of Value Management both

internationally and within the national industry market place. These learning objectives furnish the reader with an appreciation that if the potential benefits of Value Management are to be effectively and efficiently channelled into companies’ business practices, companies need to be:

a) Guided and motivated by ethically driven good Value Management practice;

b) Creative in the appropriate application of Value techniques; c) Aware of the strategic importance of Value Management; d) Stimulated and supported by the synergistic integration of the Value

Management impacting upon them.


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INTRODUCTION

‘Value management is a service which maximizes the functional value of a project by managing its evolution and development from concept to completion, through the comparison and audit of all decisions against a value system determined by the client or customer’ [51]. Or ‘Value management is the name given to a process in which the functional benefits of a project are made explicit and appraised consistent with a value system determined by the client’[52]. To begin to investigate what VM is and why it is important, yet another, but this time more technical definition of VM is used:

‘Value management is the name given to a service in which the sponsor of a project, the client, transmits a clear statement of the value requirements of that project to the project designers’ [51].

From that last definition it can be seen that VM is something between the client and the project builder. In the case of construction the common approach to this interaction between the client (a project sponsor) and the contractor (project builder) is the contract. Both sides agree on the subject of what is to be built and on terms and conditions under which it should be done. Is there really a space for another separate discipline like Value Management? The following example will show the potential benefit of VM. The sponsor wants to build a hotel. The architect and designers create the project, then try to find a suitable contractor, able to build the project in the specified time and under the conditions, as specified in the contract. After finding such a contractor and signing the contract, the client has a very limited influence on how the final ‘product’ will be. The builder then takes the detailed project design as an authoritative source of information of how the project has been designed and should be built. But is that the right approach? Value Management tries to change that approach to the benefit of the client. The same situation, building a hotel, but with the use of VM could look as follows: The sponsor wants to build a hotel. The architect and designers create the project. At the same time, client, designers, cost consultant and other construction professionals, undertake a VM workshop with VM managers to establish a basic set of values for the project. The document called the ‘job plan’


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is begun to be assembled. In that document the client specifies expectations of the project, the reason the project is being built and the costs limitations. Then the whole cycle of VM takes place and during it the VM team comes out with suggestions as to what could be changed and improved and in which ways, but whilst maintaining the cost under the set limit. In this example of the hotel, the architect designed it to use steel as the main structural material. But the client’s image of the whole hotel is more family oriented and traditional rather than modern. Knowing the clients views the VM team have the idea of replacing the steel with cheaper load-bearing brickwork and blockwork, which firstly, will be more in compliance with the client’s wishes and, secondly, will lower (or maintain) the costs. This approach is what Value management is all about – systematically aiding the process of design evolution of a project to achieve the best value for the client whilst preserving specified cost limits. The characteristics which separate value management from an accounting vision of an audit are [51]:

• A positive and pro-active approach through the use of a multi-disciplinary team-oriented creative process to generate alternatives to the existing solution;

• The use of a structured systems method; • The relationship of function with value.

The need for Value Management rose from globalisation and increased competitive pressures between companies in the market. Efficiency and effectiveness became important aspects of companies and even countries. The never-ending competition between countries all around the world for the most successful country led to developing VM as a tool to control and improve effectiveness. The traditional approach – cost management – focused on efficiency, not effectiveness. Norton and McElligott [87] state that ‘Whereas cost management seeks to do a thing right, i.e. efficiency, VM seeks to do the right thing, i.e. effectiveness.’ To build any facility is a huge investment. The board of any organisation should think twice before deciding to build. VM is the right tool to address this issue. There are three stages in a sponsor’s decision about building a project:


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• Business strategy; • What is needed to deliver the strategy; • How to deliver what is needed.

Business strategy is the highest level of viewing a projects feasibility and viability. Building a new facility will translate into significant fixed costs for any organization. These costs have to be accounted for when the company is establishing prices for their products, etc. VM should be applied in the first stage of the business strategy when decisions to address issues of whether the construction of a facility represents the best manner in which to meet the organization’s needs, are made. Only after this careful investigation has been done and the decision shows that building the facility is the right approach can the other two questions ‘what’ and ‘how’ to build be addressed.

DEFINITION OF TERMS

It is important to clarify two basic terms that can be seen across the literature and which bring about some confusion - ‘Value Management’ and ‘Value Engineering’. To see the difference it is necessary to go back in the past to the origins of the whole discipline. Value Engineering is based on the work of Lawrence Miles, who worked during the Second World War for the General Electric Company in the USA. Because of the war, there were shortages of input materials and certain finished products. However, manufacturing industry was running at maximum capacity, and smart ideas where needed to further expand production, within this situation, to get the needed production output. Lawrence Miles was the man responsible for purchasing the raw materials. He came up with the idea that if he was unable to obtain some specific material, then it was necessary to obtain a replacement material which performed the same function. Characteristics of this ‘Value Engineering’ approach began with a team approach to creativity which allowed the generation of many alternatives to the existing solution. Because General Electric Company was a manufacturing


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company the term ‘engineering’ was seen as being more appropriate at that time, than ‘management’! Later in the 20th century, Value Engineering started to spread cross the world. Because of the differences between the mentality and the behaviour of American companies and European companies, value engineering with its methodology as developed in the USA wasn’t able to adapt without some modification. Consequently, the European Community in its SPRINT (Strategic Programme for Innovation and Technology) adopted the term ‘Value Management’ as an official term. It describes the same philosophical concept but in terms that are acceptable to European management styles. The term Value Management is also applied as a broad, high order description which encompasses all value techniques, whether applied at the strategic or tactical level. The following list summarize and describe commonly used terms [87]:

• Value Management (VM) is the title given to the full range of value techniques available. It is a higher order title and is not linked to a particular project stage at which value techniques may be applied;

• Value Planning (VP) is the title given to value techniques applied during the ‘planning’ phases of a project. Thus, VP studies are those conducted during the Briefing or Sketch Plan stages;

• Value Engineering (VE) is the title given to value techniques applied during the design or ‘engineering’ phases of a project. Thus, VE studies are those conducted during the early part of the Working Drawings stage;

• Value Analysis (VA) is the title given to value techniques applied retrospectively to completed projects to ‘analyse’ or audit the project’s performance.

THE JOB PLAN

Traditionally VM counts the job plan as a central document. The job plan can be characterized as a logical, sequential, approach to the study of value. The original job plan was manufacturing oriented, but the name and main principles have been applied in other sectors too. In the traditional VM approach the job plan implies a sequential process that should be strictly adhered to. But according to a study by Kelly and Male [52] practice has demonstrated that operating sequentially can sometimes hinder flexibility and innovation and limit


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team dynamics and flexibility. So it is up to the decision of the VM team if they want to strictly adhere to the job plan or if they want to slightly alter things in their own way and then return to the original plan. A summarized structure of the traditional job plan is as follows [52]:

• Phase 1: Orientation. Asking: what is to be accomplished? What does the client need and/or want? What are the desirable characteristics?

• Phase 2: Information. Secure all costs, quantities, drawings, specifications, manufacturing methods, samples and prototypes. Understand the manufacturing process. Determine the amount of effort that should reasonably be expended on the study;

• Phase 3: Speculation. Generate every possible solution to the identified problem using brainstorming sessions. Record all suggestions;

• Phase 4: Analysis. Estimate the monetary value of each idea and rank in order of highest gain and highest likely acceptability. Investigate thoroughly the best ideas;

• Phase 5: Programme Planning. Establish the manufacturing programme by identifying operations, design and production personnel, suppliers, etc;

• Phase 6: Programme Execution. Pursue the programme, evaluating and appraising further suggestions from suppliers, etc;

• Phase 7: Status Summary and Conclusion. If in a position to take executive decisions, act on new ideas; if not, make recommendations to those who are to make the decisions.

PHASE 1: ORIENTATION

This phase is about the first orientation meeting where value managers meet with decisions makers from the investor and managers from the designers and prospective contractor. It is a meeting chaired by the Value Management Facilitator for the project. Mainly three questions are addressed: What is to be accomplished? What does the client need and/or want? What are the desirable characteristics? It is primarily to begin communication between the involved people and to set up the scope of the study.


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PHASE 2: INFORMATION

This phase is about obtaining the right information together. Information to be obtained in this phase is: Clients needs: which are the requirements the client has for the project; Clients wants: which are requirements that would be nice to have but do not need to be satisfied; Project constraints: what are the factors that are limiting design such as regulations, location of the site, etc.; Budgetary limits: which is expressed as a total sum that the client can spent on the project; Time: which is the time within the project must be completed and the period for which the client will have an interest in the building.

PHASE 3: CREATIVITY

In this phase the value team is trying to come up with new ideas and solutions. The most used technique to create ideas is brainstorming. Then, a few cost dominant functions will be selected for study.

PHASE 4: EVALUATION

This phase acts as a filter for ideas. In phase 3 there are lots of ideas. Some of them are selected as the most promising for further investigation. That investigation is done in this phase. The number of ideas is reduced to a manageable size for further study.

PHASE 5: DEVELOPMENT

This is where the detailed evaluation of the selected ideas from the preceding phase takes place. Every selected idea is evaluated separately. Life cycle costs and classical costing methods are used to determine the economic attributes of each idea. Then at the end of the phase the team will again consider the worked up ideas. Those that do not comply with the basic value requirements which were defined at the beginning of the project will be dismissed.


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PHASE 6: PRESENTATION

The selected and detailed worked up ideas are presented by the value engineers’ team to executives and decision makers. The decision makers must then decide which ones to implement.

PHASE 7: FEEDBACK

Receiving feedback is always important. Value engineers’ team should receive information about the ideas that have been put into practice. With that information they can see how efficient the value team was.

THE TIMING OF THE APPLICATION OF VM

Value Management is a methodology of how to obtain higher value for a project. Because of that it could be implemented at many stages of the project. However it does matter at which point the changes will be adopted. Fig 3.1 shows the dependency between costs and phase in which the changes are implemented.

Fig. 3.1 Cost of implementation Source: [51]

Maximum cost reduction potential occurs early in the design phase of the project. In that phase to change something means to change it only on the paper

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within documentation, later as the project is being built the same change will cost much more than the paper change. Kelly, Male et al. [52] conducted a benchmarking study where they investigated whole project life-cycles and the most suitable points for value management intervention. They concluded that there are five points when VM techniques are useful and can have the most positive result on the project. The studies conducted at value opportunity points are:

• Strategic briefing study (1); • Project briefing study (2); • Concept design workshop (3); • Detail design workshop (4); • Operations workshop (5).

Fig. 3.2 Value opportunities points during project life-cycle Source: [52]

Strategic briefing study (1) This is the first phase of VM works. It is conducted at the very beginning of the project and its primary aim is to summarise and clarify the client’s expectations. The decision ‘to build’ has been made by the client for some validated reason. The client wants something, such as expanding its manufacturing capacity, expanding to a new market, investment in property, etc. In this phase all of the possibilities of how to achieve predicted outcomes should be summarized and considered. Only after careful consideration that the decision ‘to build’ is the right one can the process advance to the next step. The outputs of this phase would include:

• The mission statement for the project; • Organisational structures;

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• Overall scope of the project; • Level of risks; • A global capital expenditure budget and cash-flow constraints; • An implementation plan.

Project briefing study (2) If the result of the preceding phase is positive, in terms of the build solution, then the more technical phase begins. ‘The project briefing study focuses on delivering a “technical project”; that is, the construction industry’s response to client requirements expressed in the strategic brief’ [52]. The outputs of this phase would include:

• The aim of the design; • The functions and the activities of the client; • The size and configuration of the facilities; • Environmental policy; • A cost centred budget for all aspects of the project; • Servicing options and specification implications; • Key performance indicators for each stage.

Concept design workshop (3) In this phase the VM team develop a list of the options and ideas of how to improve the value of the project. For each of the options there is a cost plan, risk plan, etc. The ideas are presented to the client and the rest of the decision team. Only the best of them are selected for the next phase of detailed consideration and design. The outputs of this phase would include:

• The project execution plan; • The procurement strategy and it options; • Key milestones; • Key performance indicators; • A detailed cost plan; • A schedule of activities.

Detail design workshop (4) Once the strategic concept is agreed the detailed technical plan needs to be developed. The final sketch design will define in great detail every component


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of the construction work. It should identify further risks and propose solutions to them if they arise. One of the main task of this phase is to set up key milestones and benchmarking methodologies to measure progress and efficiency. The outputs of this phase would include:

• Updates of the project execution plan; • Key milestones; • Performance measures; • Location of site, information on planning approvals and other detailed

permissions as agreed; • Dimensions of spaces and elements provided; • The cost plan; • Proposal for maintenance.

Operations workshop (5) The focus of this phase is establishing the supply chain, detailed specification of execution and risk management plans. On completion of the operations study site operations would commence. The outputs of this phase would include:

• Project execution plan; • Key milestones and targets; • Key performance indicators; • Supply chain diagram; • Risk management plan.

THE 40 HOUR VALUE MANAGEMENT STUDY

There are a number of approaches to VM, however the 40 hour study is the most widely used one. It was and is still widely used in the USA and now it has spread to the rest of the world. Within a working week the whole job plan is reviewed by a design team under chairmanship of a value management facilitator. This practice showed that this approach is quick and effective. The procedure for the study can be summarized as follows [51], [52]:

• The client should inform the members of the design team at the time of their fee bid that the project will be the subject of a value management exercise. This is important both from a human relations aspect and also


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from the point of view of establishing how the design team are to cover the cost of any re-design work arising out of the exercise. Some clients require the members to cover this cost within their fee bid. Others state at the time of the fee bid that the design team members will be reimbursed for any necessary re-design work on an hourly basis;

• The client appoints the value management team. The value management facilitator establishes the date for the study. Normally the facilitator will submit a fee bid which covers the cost of the complete value management exercise;

• The value manager will appoint a value management team, normally six to eight professionals in a mix that reflects the characteristics of the project under review;

• The study is normally held near the site of the proposed project, either in a hotel or in a room provided by the client within the client’s office;

• The date of the study is a key date for the design team and the value management team. The design team must be complete to sketch-design stage one week before the date of the study. This includes the architectural design and also the structural, mechanical and electrical engineering designs.

During the week of the study the team will strictly follow the stages of the job plan.

1. Monday – Information

The team have sketch drawings, initial cost estimates and other information. Together with the architect and the client they will discuss which areas of the project are within the scope of the exercise. The team concentrate their efforts on identifying the functions of the various parts of the building. In the study emphasis is given to those functions which are not important but attract a high cost. Attention will be also be paid to those functions which are primary and important but attract a low cost.

2. Tuesday morning – Creativity

In this phase a brainstorming session takes place. The team is trying to come up with new ideas about identified problems in the previous phase.


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3. Tuesday afternoon – Judgement

At this stage the team decides which of the ideas generated are worthy of further development. There is a need to reduce the number of ideas which came out from brainstorming.

4. Wednesday and Thursday – Development

This phase is about working on the selected ideas in detail. The team can split into smaller groups to better accommodate investigating problems.

5. Friday – Recommendation

In this phase the team will gather together again to discuss the worked solutions. Those solutions which cost more than the original, reduce quality or are not technically feasible are rejected. The accepted solutions are presented to the architect and the client.

6. The following week – action and feedback

At the beginning of the next week the final report from the VM team is sent to the client. Everyone from the client’s decision team will get a copy. Then it is requested from each of the members to provide feedback; accepting the proposed solutions or rejecting them. All those which have been unanimously accepted are required to be incorporated into the design. Discussion takes place about majority, and minority responses and of the rejected ones to justify the rejection.

VALUE MANAGEMENT VERSUS COST MANAGEMENT

The terms Value Management (VM) and Cost Management (CM) can be easily but erroneously interchanged. But in the true meanings they are different. However, the total economic evaluation of the project involves both of them. VM occurs much earlier in a project whilst CM occurs in the later stages. Fig. 3.3 shows the most appropriate use of VM and CM within the project life cycle.


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Fig. 3.3 Value management versus Cost management Source: based on [51] Value Management is defined ‘as a service that utilizes structured functional analysis and other problem solving tools and techniques in order to determine explicitly a client’s needs and wants related to both cost and worth’ [51]. As opposed to CM, VM is wider in terms of a client’s expected outcomes. It is not so tightly bound to the specific project. VM analysis should take in to account the whole business expectations of a client and clearly show possible alternatives and their advantages together with disadvantages. ‘Value Management services involve considerably more emphasis on problem solving, in-depth functional analysis, the relationship between function and cost, and a broader appreciation of the linkages between a client’s corporate strategy and the strategic management of the project’ (Ibid.). Cost management is defined here ‘as a service that synthesizes traditional quantity surveying skills with structured cost reduction or substitution procedures using a multi-disciplinary team’ (Ibid.). CM is more bounded to the specific project. CM techniques begin after pre-briefing and briefing stage of the project so the decision ‘to build’ and what to build have been made already. There still remains a space for optimising the project to reach lower costs. CM, despite VM, does not make any significant changes to the project design.

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CHAPTER 4

COST

LEARNING OUTCOMES


1. Describe the business context of New Costing Techniques including the key influence on business practices;

2. Recognise the potential impact of New Costing Techniques on the

business performance within the industry; 3. Describe and apply appropriate New Costing Techniques within the

context of business performance; 4. Appreciate the potential strategic importance of New Costing

Techniques both internationally and within the national industry market place.

These learning objectives furnish the reader with an appreciation that if the potential benefits of these New Costing Techniques are to be effectively and efficiently channelled into companies’ business practices, companies need to be:

a) Guided and motivated by ethically driven good Costing practice; b) Creative in the appropriate application of New Costing Techniques; c) Aware of the strategic importance of Costing Techniques; d) Stimulated and supported by the synergistic integration of the new

techniques impacting upon them.


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INTRODUCTION TO NEWER TECHNIQUES

These new techniques do not have the historical pedigree of the more traditional techniques. Many of these traditional techniques have been used for many hundreds of years. The mathematics upon which they are based has been in existence for two to three thousand years.

These newer techniques have a basis in history, yet the techniques themselves have a history of fewer than fifty years. Despite this relative short history these techniques are currently developing at an unprecedented rate. They have also been shown to have a significant potential to change the way costing is conducted, especially within the construction and property industries.

GENETIC ALGORITHMS IN CONSTRUCTION: AN INTRODUCTION

The goal of creating artificial intelligence, mimicking human learning and providing computerised professional advice has been a dominant direction in construction research. Construction expert systems have been developed, however these have been based upon algorithms, predetermined mathematical formulae developed to optimise a solution to a particular question. Work is now expanding into the fields of neural networks, machine learning and evolutionary computation. It is hoped that developments in these fields could lead to the organic creation of mathematical formulae to solve problems. Genetic algorithms, (GA's) were invented by John Holland in the 1960's. In contrast to developing algorithms to solve specific problems, GA's were developed to study the phenomenon of adaptation. Adaptation in computing terms requires that a program continues to perform well in a changing environment. In the construction industry an estimating programme, for example, would be required to provide accurate estimates


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during both boom and slump market conditions using common data. This suggests an analogy to biological evolution. It is therefore a method for designing innovative solutions to complex problems. Mitchell in 'An introduction to genetic algorithms' states, "that GA's have been used to model the processes of innovation, the development of bidding strategies, and the emergence of economic markets."

HOW DO GENETIC ALGORITHMS WORK ?

The GA methodology is to develop a population of (a number of possible) 'first generation' simple chromosomes (algorithms) and to test each chromosome for it 'fitness' in providing a solution. The better chromosomes are then selected and altered by natural selection and re-tested to see if they have improved in accuracy. This 'generation' is altered by genetics-inspired alterations such as crossover, mutation, and inversion to create a 'second Generation'. The better chromosomes of the second and subsequent Generations are selected and tested and altered until a point is reached when the GA fails to improve over a significant number of generations. At this point the GA has developed complicated ‘rules' to evaluating the solution to the problem. Selection is biased, thus those chromosomes in the population that are 'fittest' are selected more often to reproduce. Crossover occurs when two randomly selected chromosomes swap a bit ( a part of the algorithm). A random locus within the algorithm is chosen and the 'bits' are exchanged. Eg. Two chromosomes abc and def are chosen. A random locus is chosen between a and b. The swap occurs and the subsequent generation of chromosomes are aef and dbc. Mutation occurs when a chromosome randomly swaps some of the bits within itself. Eg. A chromosome abc swaps a bit and the subsequent generation chromosome becomes ebc. Mutation is usually controlled within the GA by making the probability of a swap at any position within the chromosome very small. (Typically p=0.001).


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Inversion occurs when a chromosome has a bit sliced from its length and the order of that bit is then reversed before replacement in its original position. Eg. A chromosome abcdefg has a slice cde cut and reinserted as edc. The next generation chromosome becomes abedcfg. Inversion is usually controlled within the GA by making the probability of a slice being selected very small. (Typically p=0.001). The traditional theory of GA's assumes that, at a basic level, GA's work by discovering, emphasising and recombining 'good' 'building blocks' of solutions in a highly parallel manner. Good solutions consist of collections of good bits. A bit can then be described by 'instances' and 'defining length'. An instance is a bit that fits a particular template, thus chromosome abcdefg has instances of abc and efg and the bits have a defining length of 3. Thus by applying inversion and mutation to instances and specifying the defining length of the bit, fitter solutions can be developed more rapidly. These concepts are developed in the "schema theorem" and "Building block hypothesis" of Holland. They can act in the same manner as truncation, filtering and pruning of traditional solution methods.

EXAMPLE CONSTRUCTION GA

Let the letters a-i represent the variables: market conditions, current workload, political stability, environmental constraints, labour supply, materials supply, currency fluctuations, inflation, and project risks in a GA for contract bid evaluation. Each letter (bit) would contain data identifying the variable condition and numerical weighting of significance. The variables are linked to independent numerical indices. (Sources of these indices are beyond the scope of this paper, but would include for instance tender price indices, wage rate data, etc.) Simple algorithms such as abcdefghi are created as the first generation. The population size of these first generation algorithms is pre-selected. A small


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population of say 50 of the approximately 363,000 rank combinations are created, the algorithms are designed to categorise the significant factors of a construction bid in weighted rank order. (Every rank combination would also have an infinite number of individual weights.) Thus the bits a, b, etc. represent the tentative ranking and weighting of the variables in order of significance to the creation of the bid. The GA is tested to see how 'fit' the results are. The closer the solution is to reality the better the 'fit' of the GA. First generation algorithms are unlikely to fit well! These first generation strings then undergo reproduction to create second generation algorithms. For example, the GA can be programmed to select the 'fittest' 15 and duplicate them in the next generation. The next 10 'fittest' are reproduced in the next generation. The remaining 10 second generation algorithms can be selected at random from those not already selected for reproduction. This random element is important, in that it tends to prevent 'in-breeding' in the trial population. These then form the tentative next generation of algorithms. The 50 selected then undergo reproduction subject to the predetermined rules of inversion, crossover and mutation. For example, the bit-string abcdefghi, (of the tentative second generation bit-strings) a random locus between d and e is chosen as the point for crossover. Thus subsequent generations of the bit string become abedifghe. If the 'fitness' of this string is greater than the previous string then the GA is predicting that the particular weighted rank variable "bit i" (project risks) is more significant in predicting bid costs than "bit e" (labour supply). In subsequent generations the improved 'fitness' of abcdifghe, means that it is more probable that it will be selected for reproduction than abedefghi. Eventually after a large number of generations the GA will produce weighted rank bit-strings that more successfully predicts contract bid prices than any other combinations. If a single bit-string emerges then this will be the algorithm to predict the contract bid price. This is however, very unlikely, and what will emerge are a number of genetic algorithms that equally effectively predict the bid price. What should be appreciated in this approach is the phenomenal number of combinations and permutations of weighting and ranking that can be examined.


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WHEN SHOULD GENETIC ALGORITHMS BE USED ?

There is no rigorous answer! Many researchers share the belief that GA's are useful if:

• the possible permutations of variables large; • the variables are not completely discrete (fuzzy boundaries); • the distribution is not unimodal; • the form of the distribution is not readily defined; • the distribution has abnormal kurtosis; • the degree of 'fitness' function is imprecise; • the task requires a 'satisficing' solution rather than a global optimisation.

'Fitness' as used here refers to the requirements of taking error-prone measurements from 'real-life' with no possible method of determining the accuracy/reliability of such real-life measurements. A GA works by accumulating 'fitness' statistics over many repetitions (generations) and therefore perform robustly in such circumstances. 'Satisficing' refers to meeting an acceptable threshold of performance, ie. If quickly finding a sufficiently good solution is more appropriate than finding the maximising solution. GA's may find a nominally effective solution rather than a global maximum solution. For example, setting a bid profitability GA to satisfice at 6% profitability may quickly (say 100 generations) find solutions that meet this threshold whereas a longer evaluation over many more generations may yield a maximum solution of 8% profitability. There is an obvious trade-off in this instance between speed and accuracy. A GA's performance will depend on methodological details such as:

• method of encryption; • the operands; • the number of generations in the trial; • the parameter definitions; • the mutation and inversion probabilities; • satisficing criteria.

Encryption may be by binary strings (bit strings, 'bits'.) of zeros and ones, many character encoding or by real-valued (fuzzy) codes each of which may be regularly or tree encrypted. There are many reasons for selecting each of the encryption methods; however a critical appraisal is beyond the scope of this


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paper. Tree encryption allows the development of irregular lengths of strings and allows for development of the GA domain as the GA performs its reiteration over a number of generations. The definition of the operands (both independent and dependent variables) requires careful consideration. Much work has been done in the definition of operands for bidding models, (eg. see Skitmore, Akintoye et al.) in construction. The distinction between dependence and independence is critical in stochastic and deterministic models; its significance in GA's is less important but still requires consideration. The selection of operators, such as crossover may require the consideration of one point or two-point or multiple-point crossovers. Mutation may be seen as the mechanism that disturbs fixed strings, thereby creating new variations and avoiding stagnation of the GA. It is important to recognise that it is the recombination of both crossed-over and mutated strings that creates vigour within the GA at subsequent generations. Therefore it is the balance between crossover and mutation probabilities that is as important as the actual probabilities of either. Variations created by crossover and / or mutation also differ in relative usefulness through the life of the GA. The set values of the parameters for operators can only really be determined by experiment! The population size, the number of generations under test, the probability of crossover and the probability of mutation typically interact non-linearly! There are no conclusive results as to what is best; most GA trials seem to intuitively adopt what has previously been reported to work well within a similar problem domain. An obvious affector of the success rate of any trial GA is the satisficing criteria specified. A satisficing criteria set at say 95% of the maximum is less stringent than a 97.5% criterion. In a GA (assuming a variable operand distribution that is normal) the probability of a successful solution at the 95% level is approximately 10 times more likely than a 97.5% criteria at each generation. Multiply that success factor by the number of generations in the GA cycle and the significance of the expressed satisfying criteria is overwhelming. Genetic algorithms are useful for examining the endogenous interactions of business systems. They are ideally suited to 'gedanken experiments' or 'idea-testing models'. They can therefore test:

• the plausibility of proposals without the necessity for real-life trial and error;


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• to produce predictions of real-life trends; • what-if' scenarios; • the significance of changes in individual operands; • predictions that would not be possible in the real world; • phenomena.

GA's are promising tools for the solution of technically complex construction problems. The difficulties associated with modelling of construction complexity can be handled by careful selection and manipulation of the technique. Risk and uncertainty can be realistically predicted and therefore practically managed. With development, the GA may be capable of predicting supra-system changes from iterations of the organisational GA. A GA to give advance warning of political, economic, technical and professional developments. A competitive advantage identifier and an environmental scanner combined!

AN INTRODUCTION TO FUZZY LOGIC

Fuzzy logic is not a new science, its roots stretch back 2500 years. Aristotle asserted that there were various degrees of true and false. It is only in the last 25 years that this concept has been labeled fuzzy logic, after the work carried out by Lotfi Zadeh. The theoretical basis of fuzzy logic is that mathematics can be used to link language and human intelligence [112]. Fuzzy theory has evolved to represent data or activities that cannot be clearly determined within boundaries. It is the opposite of binary data which is always a Yes/No or 1 and 0 outcome. An extreme fuzzy logic set known as a crisp set only has 2 possibilities, but this is another example of a special set and is not representative of typical fuzzy sets. The expression which defines fuzzy theory is TV ||0-1||. When simplified into terms, the meaning is the truth-value lies between zero and one, the two extremes. (Abe 1995) As fuzzy logic uses approximate reasoning, the outcomes that are generated are neither exact nor inexact and when dealing with complex data fuzzy


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theory can be used to simplify the results. The process also makes very complex results easier to prove the truth or certainty due to grouping of the data, this is called the rules of inference. (McNeill 1994) The first practical application of fuzzy logic came about in the 1970's when a British engineer Ebrahim Mamdani discovered it by accident. He was trying to develop an automated control system for a steam engine, which was currently being operated by a skilled operative. The machine had to adjust the throttle to maintain the steam engines speed and boiler pressure but by using a mathematical formula (intelligent algorithm) the results were poor (Sanchez 1997). When he tried an artificial intelligence method called 'rule based expert system' (a type of fuzzy logic), which combines human expertise with a series of logic rules, the results were beyond expectations. From this time, fuzzy systems have becoming increasingly a part of our lives as they have many uses. The idea has developed rapidly in Japan as many of the leading companies such as Nissan and Matsusisha have incorporated fuzzy logic into their products (Klir 1995). For example, Matsusisha have developed a fuzzy logic washing machine. At the beginning of the washing cycle the machine carries out a pre-wash and assesses the dirtiness of the water and applies a certain measure of detergent to the cycle. The concept is that it maximizes the efficiency of the cycle and does not bleach the clothes with too much detergent. Examples of other uses of fuzzy logic in today's environment are in traffic light systems, video and television tuning automation and anti-lock brakes on motor vehicles. The advantages of employing fuzzy logic to situations (in particular construction) with multiple complex solutions are that linguistic, not numerical, variables are used, making it similar to the way humans think (McNeill 1994). Also rapid prototypes or budget costs can be created, as the information produced is not detailed. Other advantages are that fuzzy logic is cheaper to develop than other intelligent systems, simplifies knowledge acquisition and representation and can accommodate rules on complexity. The drawbacks of a fuzzy logic system are that it is very hard to develop a model from the outcome, as it is so broad and imprecise. Also compared to other control systems fuzzy logic relies on a detailed input and requires fine-tuning before it can become operational. As construction projects are usually one off designs there is little room for trail and error. Probably the biggest drawback is that humans are culturally biased towards an avoidance of uncertainty (Hofstede, 1980) which fuzzy logic can generate, where as, mathematically precise or crisp systems produce linear control models which minimize risk and are culturally more acceptable.


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AN INTRODUCTION TO CHAOS THEORY

Chaos theory is very hard to define. It is still a young and rapidly developing field. Chaos theory was originally considered to be disorder or confusion within data. This often arose in scientific investigations when there seemed to be no logical connection between the inputs and outputs of a study. Repetitions of an experiment produced different results. The researchers could find no ‘logical’ explanation for the apparent differences. (Imho 2000). The most significant factors which causes chaos are change and time. Williams 1997 (p9), defines chaos theory as:

"Chaos is sustained and disorderly looking long term evolution that satisfies certain special mathematical criteria and that occur in a deterministic non-linear system."

This quotation is based on the qualification that, chaos only happens in deterministic, non-linear, dynamical systems. Deterministic means that the results follow set rules and are not just random numbers (Schuster 1989). Non-linear signifies that the output is not directly proportional to the input and a dynamical system is a process, which evolves over time, moves or changes. The first experimenter in chaos was the meteorologist Edward Lorenz in 1960. In 1961, whilst experimenting with weather prediction, using twelve complex formulae, (Frank 1998, Gleik 1987, Imho 2000, Shulka 1998) Lorenz required to run a particular sequence again and started the computer process in the middle to save time by inputting the previous figure. After one hour the process evolved differently (Dev 1998), when Lorenz analysed the reasoning for the differences in results it was found that the number inputted was 0.506 which had been rounded down on the print out to save paper from 0.506127. The results are shown below in the chart.


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Fig. 4.1 Lorenz’s experiment: the diffrence between the start of these curvers is only 0,00127 Ian Stewart, Does God Play Dice? The Mathematics of Chaos. The diagram shows that chaos had arisen from a very small change in the input value.

"Tiny differences in input can give rise to large discrepancies in output, a feature acquiring a technical name known as sensitive dependence on initial conditions or the ‘butterfly effect’"

Eaton [30] The biggest unresolved matter in the field of chaos theory to date is that it is extremely difficult to identify any uses in real life situations (Roberti 2000). Chaos is used in mathematics and scientific laboratories where controlled environments exist, but there seems to be very little work on real life situations. Therefore three alternative perspectives have developed in the debate over the applicability of chaos theory in a real life situation. There are:

• Scientists who believe it is a mathematical curiosity; • A middle group who feel it may be real but to date it is no more than a

scientific illusion (Berryman & Millstein 1989); • Scientists on the other extreme who believe that chaos theory is the 3rd

scientific revolution of the 20th century after relativity and quantum mechanics. This stems from reports that chaos was discovered in chemical reactions and weather prediction etc. (Williams 1997).

The practical implications of the chaos theory in long-term predictions under chaotic conditions are worthless, as the chaotic behaviour can stem from the simplest of causes (Butterfly effect). (Gleik 1987, Dev 1998) Chaos theory has been used in biology over recent years to help understand new evolutionary process like genetic algorithms and to give a better understanding of the brain.


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This research can be traced back to the work of Charles Darwin that challenges Newton’s understanding of the nature of time. (Thinkquest 2000) General applications of chaos theory have already affected our lives. It has had a great impact on all sciences (Tsonis 1992). Some toys and computer games have been based around chaos theory such as SimLife, SimCity etc. Chaos theory has ‘led’ to the development of the complexity theory.

AN INTRODUCTION TO COMPLEXITY THEORY MM Waldrop in his book, Complexity: the emerging science at the edge of order and chaos [106] noted:

“…that corporations and industries evolve for better survival in a changing environment. And the marketplace responds to changing tastes and lifestyles, immigration, technological developments, shifts in the price of raw materials, and a host of other factors. Finally, every one of these complex, self-organising, adaptive systems possesses a kind of dynamism that makes them qualitatively different …… Complex systems are more spontaneous, more disorderly, ..[yet].. at the same time, however, their peculiar dynamism is also a far cry from the weirdly unpredictable gyrations known as chaos. These complex systems have somehow acquired the ability to bring order and chaos into a special kind of balance.”

Complexity theory arises between order and chaos.

“Complex systems tend to locate themselves at a place we call the edge of chaos. We imagine the edge as a place where there is enough innovation to keep a living system vibrant and enough stability to keep it from falling into anarchy. Only at the edge of chaos can a complex system flourish.”

(Malcolm, 1995)


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Research has shown that complexity is very similar to chaos theory (Decker, 2000; Flood, 1988) but requires a structured environment to exist. Therefore the majority of research (Ambos-spies, 1993) has followed on from the basis of the chaos theory and is still an emergent theory with many unknowns. Due to this, no definitive definition is accepted and the statement above tries to place it in context. Research on complex systems in biology (Phelan, 1995) has focused on the use of cellular automata. These models control single cells via a set of rules or by the state of its immediate neighbours. The Game of Life, a simple computer program popular among computer programmers in the early 1980’s, is a well-known form of cellular automata. (Wolfram, 1986; Hubler, 1986). Complexity is well suited to specific physical or chemical applications (Lloyd, 1995; AppliedFutures, 1998) as these types of examples look very chaotic but are based solely around a well-structured environment. As an example of the potential application of chaos-based theoretical models a study of the development and change of sources of competitive advantage is presented below. It is important to note that chaos theory points towards a well-structured environment (ie, carefully and comprehensively detailed, yet dynamic in nature.

THE ORIGINS AND INTERACTIONS OF BIOMIM ICRY CONCEPTS IN INNOVATION AND CHANGE

Biomimicry is the application of recognised biological concepts outside the discipline of biological science. By demonstrating one analogical application the prompt is provided to ‘find’ other biological concepts that could usefully be applied at some future point. The significance of the term biomimicry is that it is more than an analogy. Many of the biological concepts are firmly supported by analysis and tools. As an example, studies of endangered animal species have produced a formula for the background level of extinction:


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S = cAz Where:

S = number of species becoming extinct; A = geographical area of dispersion of the species; c = constant for specific taxonomic group; z = relationship function for isolation specific area curve.

Examining the components of the formula it would appear that the same formula could be applied to the extinction (bankruptcy, etc.) of firms within the property and construction industry. At the present time no information is available regarding c or Z but it may be possible to evaluate these, or by examination of past records to estimate approximate values for preliminary analysis. The evaluation of the background level of extinction of construction and property firms will have a major impact on the quantification of insolvency risks associated with risk management techniques currently being developed within construction. A further application from biomimicry comes from the biological mnemonic SLOSS, (Single Large Or Several Small). In biological terms this mnemonic is used in the examination of sustainable colonies of a particular threatened species. Is it better to have a number of isolated colonies of a threatened species or a much larger colony containing all the animals? A comparison could be drawn with the development of PFI and current initiatives of ‘bundling’ small projects into a larger project, or the other initiative of ‘unbundling’ to create smaller projects, which companies other than the existing experienced PFI operators can compete for. Thus increasing the competitive pool for future projects. However the most patent example of biomimicry is the use of Darwin’s ‘Survival of the Fittest’ concept as an analogy for organisational survival.


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CHAPTER 5

DECISION MAKING IN CONSTRUCTION

LEARNING OUTCOMES


1. Describe the business context of Decision Making approaches including the key influences on business practices;

2. Recognise the impact of Decision Making on the business performance

within the industry; 3. Describe and apply appropriate Decision Making techniques within the

context of business performance; 4. Appreciate the strategic importance of Decision Making both

internationally and within the national industry market place. These learning objectives furnish the reader with an appreciation that if the potential benefits of Decision Making are to be effectively and efficiently channelled into companies’ business practices, companies need to be:

a) Guided and motivated by ethically driven Decision Making practice; b) Creative in the appropriate application of Decision Making; c) Aware of the strategic importance of Decision Making; d) Stimulated and supported by the synergistic integration of the Decision

Making impacting upon them.


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QUANTITATIVE DECISION MAKING: INTRODUCTION

In your professional career you will be involved in making countless decisions, some minor but many of major significance. Typically the decision determines how to proceed. Usually the decision reflects a path that minimises risk and maximises benefit. Unfortunately the process of evaluating the risks and benefits is poorly done within the property and construction professions. Frequently the decisions are intuitive and qualitative rather than quantitative, frequently the decisions are WRONG! Decisions related to time, cost and quality are specifically necessary within projects. However the identification of specific risks may not be undertaken unless specified by the client. There are risk analysis techniques appropriate for construction and property decisions. These are presented ion Chapter 2 of this manual. Risk ranking and assessment is a specific skill, it is largely subjective but if done well it can highlight issues requiring further attention. It could even identify uncertainties! Risks and Uncertainties form a major part of this module. The COBRA paper 'Interpretive and Modelling Problems of Risk and Uncertainty in Bidding Techniques', David Eaton presented at Cobra 1995, Research Conference of the RICS, Edinburgh, provides the theoretical background and practical definitions that underpins this module. Most attention is directed at commercial and financial matters, (Including this module!) however health and safety issues now require risk assessment under the CDM regulations. The tools and techniques of this module can equally be applied to health and safety issues. Finally, issues not specifically addressed by this module are the aspects of negotiation and legal issues of claims, (covered in Procurement and Administration of Contracts, you should also note the implications of a 'Calderbank' offer).


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Remember: the theories and practices presented in this module are only a sample of the vast numbers related to decision-making. You must use the directed reading time to read around the subject. Some papers will be provided but you are expected to use appropriate literature search techniques to identify wider reading. You might even have to borrow books from the library!!!!!!! CASE STUDY

DECISION MAKING : EXEMPLAR

Pete, an ex-army commando is working as a pot-holing guide in Scotland. He has taken a party of 8 architects (all novice pot-holers) down a cave system. The members of the party are:

Margaret a 39-year-old housewife, with 3 children; Roger a 63-year-old widower, with a bad leg, who has 4 grandchildren; Pierre a French garlic grower who is single and aged 43; Alison a 22-year-old American student. Her father is the multi millionaire chairman of Droflas cars and employs many people in the UK and abroad; Joanne is 29 and works on a campsite in Scotland with her husband. She has been having an affair with Pete the group leader for the last 6 months. Chris is 52 and single. He has been doing scientific research and has developed a design for a temporary shelter that can be built from oil drums; car tyres and black plastic bin bags and would solve the future homes shortages that will affect the planet. Unfortunately he does not have a written copy of the plans; they are all in his head and cannot be quickly explained to anyone else; Mike is a 48-year-old vicar. He enjoys crosswords, ABBA records and is currently attending evening classes in soft furnishings. He is well known for his charity work and has helped a number of under privileged children in the UK and abroad.


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Stacey "Buster" Brown is the UK's ladies wrestling champion. She has won many fights during her career and is lined up for a showdown with Stone-Cold Steve Stone next month which is due to be televised on Channel 5. She has 3 daughters aged 6, 4 and 3 and her husband Malcolm works in a cake shop and he specialises in making fairy cakes. Stacey is well known for becoming violent when confronted with a problem.

You are the leader of a rescue party heading to the potholes. Pete managed to get a message to you on his radio just before the batteries went flat. He informed you that the entrance to the pothole had collapsed and that they were trapped, to add to his worries, the pothole is filling with water and he estimated that they would all drown within 3 hours if they were not rescued. Together with your fellow rescuers you have determined a rescue route and calculated that you can rescue one person at a time, however, it will take 30 minutes to rescue each person and you will not be at the site for another 20 minutes. You must decide before you get to the potholes the order in which you are going to rescue the potholers. Identify the rescue order you would adopt and provide an explanation of the reasons that support your decision.

Reasoned Resolution To The Decision Making Exemplar There is no single ‘correct’ solution to the exemplar. Your decision presumably assumes you will rescue as many people as possible within the timescale. But why? Another reasoned response could be to leave them, since the cave-in has weakened the entire cave system and anyone entering the system is placed in extreme danger. A more idiosyncratic solution, which has been suggested by previous students, is to leave them all. Why bother to rescue a group of architecture students? They are no use to anyone!!!!


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The critical issues to recognise are: • Supra-system: Eg. External constraints affecting the decision; • System issues: Eg. Rescue party skills mix and equipment availability; • Formal sub-system issues: Eg. Rules and regulations associated with

cave rescue; • Informal sub-system issues: Eg. The perceptions and reactions of the

rescue personnel at the scene; • Technical sub-system issues: Eg. Availability of rescue equipment,

breathing apparatus etc.; • Personal sub-system issues: Eg. Potential relationships between the

rescue party and those trapped. Would having Joanne’s husband as a rescue party member make a difference?

• System and sub-system congruence: Eg. The potential clashes between system objectives.

There are a number of assumptions implicit to your particular problem solution. The solution assumes a cultural, ethical and moral perspective that may not be obvious to others. The solution assumes a particular philosophical theory, for example a cognitive utilitarian approach. The significance of these implicit reservations is that they are idiosyncratic and they are unique to you! Therefore in justifying a particular plan it is necessary to make these covert assumptions overt, allowing a thorough consideration of the plan before implementation, and also setting out the considerations for review and evaluation after the event. Transparency in decision-making is vital under all circumstances. Elements of this chapter will identify implicit assumptions associated with particular decision-making techniques.

WHAT IS A DECISION ?

A decision is a choice from amongst alternatives. If there are no alternatives then there is no choice! Therefore there is no decision! The section title- Quantitative Decision Making, needs some explanation, since it contains some assumptions.


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Quantitative decision-making assumes that the criteria upon which a decision will be justified are based solely upon data. The data will be analysed in some way to generate facts, and these facts will inform the decision making process. It suggests that the decision making process is mathematical and scientific. It therefore excludes any personal judgement, intuition, hunch or bias! Rational decision-making assumes that the evaluation of the consequences of a decision will be judged against some logical criteria. The rationale underpinning a decision may be completely idiosyncratic it may also be covert. Effective decision-making needs the rationale to be made explicit. This will expose any assumptions, constraints, reservations or limitations implicit in the decision. For example, a young boy is invited to play a game with a group of teenagers. The small boy is given the choice between a shiny €1 coin and a crumpled €5 note. Whichever he chooses he can keep. What does he do? He picks the shiny €1 coin, to the great amusement of the teenagers. Why does he pick the €1 coin? If you assumed that he picked the €1 coin because it was shiny, you could be right. The clues where in the brief: shiny €1 coin; crumpled €5 note. However, the young boy, whose name was Albert Einstein, picked the €1 coin because he calculated the long-run average profit of both alternatives. If he picked the €5 note the teenagers would not find the choice amusing, hence if he were lucky he might get to keep the €5 note, if he were unlucky he would simply have the €5 note taken off him by the teenagers, they have the strength to break the rules and possibly some of his bones! If however he picked the €1 coin, he would reinforce the teenagers’ assumption that he was a ‘silly’ child; he would amuse the teenagers and would be likely to keep the coin. If he kept selecting the €1 coin the game could be repeated. The long-run average profit would be better than a short-run high profit strategy with high risks to his personal safety!!! Not such a ‘silly’ decision after all! You just didn’t understand Albert Einstein’s decision-making criteria.


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For a decision to be made the decision-maker requires a set of ‘rules’. These rules may be explicit or implicit. These ‘rules’ will define the following decision making criteria:

1. A set of goals or objectives; 2. A system of priorities; 3. Numeration of alternative actions; 4. The outcomes associated with each alternative; 5. A system of choice criteria.

Decisions are sequential in nature. They are always constrained by previous history.

WHY ARE DECISIONS MADE ?

The essence of decision-making in ‘construction management’ (taken in its broadest sense) is to make decisions that commit resources to:

• Planning; • Organising; • Staffing; • Direction; • Control; • Leadership; • Communication, etc.

There-by ensuring effectively and efficiently managed projects and the creation and/or retention of further opportunity.

Effective decision-making = ∫∫∫∫ effectiveness, efficiency, opportunity. Decisions are made for a number of reasons:

• Economic - because resources are scarce;

• Human Motivation – wants and needs: o Biological; o Physical; o Financial; o Social;


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o Ego; o Self-actualisation, (cf. Maslow’s hierarchy of needs).

• Satisfy Organisational Aspirations:

o Via achievement of objectives and time-oriented goals.

DECISIONS AND CONFLICT

Typically decisions are required when the ‘rules’ are inconsistent or when multiple-goals are specified and these multiple goals cause system / sub-system incongruence.

• Examples of Multiple Goals: • Individual – E.g., money and leisure; • Organisational –E.g., sales, production and finance; • Higher Management decisions creating constraints, E.g.:

o Conflict resolution; o Pursue ‘unclear’ overall objectives – E.g., profit maximisation,

sales maximisation and turnover maximisation.

THE PROCESS OF DECISION-MAKING

Decision making is usually in three phases: two of these phases are the direct responsibility of the decision maker. The third and final phase may be delegated to someone else. Phase 1:

• Formulate goals and objectives; • Enumerate supra-system constraints; • Identify alternative strategies; • Estimate relevant pay-offs.

Phase 2:

• Select strategy.


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Phase 3: • Implement strategy.

CLASSIFICATION OF DECISION TACTICS

There are many classification systems for decisions. Typical examples are: Functional:

• Strategic – relating to supra-system environment; • Tactical – relating to system environment; • Operational – relating to repetitive day-to-day problems; • Administrative – relating to acquisition and structuring of resources.

Programme:

• Programmed – repetitive and well-structured problems, can be processed routinely;

• Non-Programmed – non-routine, novel, policy type problems. Effect:

• Individual; • Managerial.

Sphere of Interest – (multiple dimensions) A useful acronym is SLEEPT:

• Social; • Legal; • Economic; • Environmental; • Political; • Technical.

State:

• Static – one decision for the entire planning horizon; • Dynamic – series of interrelated decisions.

DECISION MODELS

There are three widely recognised categories of decision models:


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Descriptive models: • How people actually make decisions; • Discover factors leading to success.

Prescriptive Models:

• How people ought to make decisions; • Prescribe preferred courses of action; • Decision criterion is part of model, E.g., maximise profits; • Assume rationality.

Normative Models:

• How people must make a decision; • Rule based; • Often legally enforceable; • Assume rationality.

THE ASSUMPTION OF RATIONALITY

It is a mistake to assume that all decision making is based on rational thought. Frequently decisions are based upon irrational, illogical and nonsensical criteria. However, in the construction industry it is an implicit assumption that decision making will be rational. You must always recognise that this is an assumption and in evaluating decisions a final consideration can be given to irrational decisions of others. This is frequently prefaced by the question What if…? Rationality requires:

• Ability to state objectives clearly and rank in some order of preference according to a set of decision criteria;

• Employment of proper means to optimise the achievement of these objectives;

• Decision Maker to choose according to agreed upon criterion or criteria; • Absence of personal bias.

Types of decision-makers:

• Economic Man – fictitious, completely ‘rational’ being, endowed with perfect knowledge, perfect foresight, perfect certainty and perfect luck, infinite wisdom, optimises with unerring accuracy;

• Administrative Man – real, partially ‘rational’ being, with limited knowledge and ability, aims at ‘satisficing’ with ‘bounded rationality’.


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It is implicit within the rest of this section that the decision making is made by Economic Man. The later section on qualitative decision making allows this ‘perfect’ yet theoretical approach to be modified for ‘real world’ applications.

Symbiotic relationship between quantitative and qualitative decision making The quantitative approach to decision making requires that decision problems be:

• Defined, analysed and solved; • In a conscious, rational, logical, systematic, and scientific manner; • Based on data, facts, information, and logic; • Not mere whim or guess.

Uses objectively measured decision criteria, the range of which can include:

• Calculating simple break-even point • Constructing a balance sheet or income statement; • Developing behavioural model of job satisfaction; • Linear programming; • Queuing models; • Simulation models; • Genetic algorithms; • Fuzzy-logic models.

There is a symbiotic (mutually supportive) relationship among intuition, judgement, science quantitative attitudes, qualitative techniques, practices, methods and models.


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INTELLIGENCE, INFORMATION & DATA

DECISION PROCESS

TURBULENT &DIFFERENTIATEDENVIRONMENT

PLACID &UNIFORMENVIRONMENT

COMPLEX &ILL-STRUCTUREDPROBLEM

SIMPLE &WELL STRUCTUREDPROBLEMS

SCIENCE &QUANTITATIVEMODELS

INTUITION JUDGEMENT

Fig. 5.1 Decision making process

MAIN APPROACHES TO DECISION MAKING

There are 4 main approaches to decision making:

• Inductive: based upon: o Observation; o Problem definition; o Hypothesis formulation; o Testing hypothesis; o Implementation; o Control.

• Deductive: using a general modal.

• Payoff matrix Formulation: optimal strategy identified by the use of a

decision criterion.


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• Marginal Analysis: to develop general model or solve specific problems.

These approaches can be used: • Separately; • Sequentially; • Combined.

Knowing which approach to use is one of the most important ‘skills’ of successful management. The choice of approach is made upon the basis of:

• Reliability; • Validity; • Economic consideration.

BASIC STRUCTURE OF A DECISION MODEL

The figure below shows a model structure.

SCIENTIFICATTITUDE

SYSTEMSORIENTATION

LIST OFASSUMPTIONS

ENVIRONMENT &RELEVANT FACTORS

PROBLEM RECOGNITION

PROBLEM DEFINITION

FORMULATE OBJECTIVES

DEVELOP DECISIONMODEL

SOLVE THE MODEL

SOLVE THE SPECIFICPROBLEM

IMPLEMENT & CONTROL

DE

CIS

ION

MO

DE

L

Fig. 5.2 Decision making model


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TYPES OF VARIABLES

Decision making is based upon the evaluation of changing factors. Each factor that can affect the outcome of a decision is defined as a variable. There are various types of variables:

Dependent Variable:

• Value depends on other variable inputs to the system; • Also called:

o Output variable; o Endogenous variable, internally generated by the system; o Criterion variable, used as a yardstick for making a decision.

Independent Variable:

• Often subject to an ‘independent’ choice by the manager; • Also called:

o Input variable; o Exogenous variable, externally generated ( eg., demand, interest

rate etc.); o Predictor variable, as values ‘predict’ the value of the dependent

variable. Both types of variables may be either:

• Controllable, value chosen by manager, also called a decision variable or solution variable, a specific combination of controllable variables is called a strategy;

• Non-controllable, dictated by the environment, can be a fixed input, (eg., constant value or single most likely estimate) or a variable input (eg., a probability distribution), a specific combination of non-controllable variables is called a state of nature.

The relationship between the criterion variable and decision variable is called the objective function.


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PAY-OFF MATRIX FORMULATION OF A DECISION PROBLEM

The number of strategies available to a decision maker may be: • Infinite: solved by, for example, the Simplex Method (outside the scope

of this module); • Finite: solved by use of a payoff matrix.

A pay-off matrix is the monetary reward or utility that is a consequence of a specific strategy in conjunction with a given state of nature. A pay-off matrix or pay-off table is a tabular arrangement of pay-offs. A pay-off associated with any strategy is conditional on the occurrence of a specified state of nature, hence ‘conditional pay-off matrix’.

DECISIONS CLASSIFIED BY DEGREE OF CERTAINTY

DECISIONMAKINGUNDER UNCERTAINTY

DECISION MAKINGUNDER

RISK

DECISION MAKINGUNDERCERTAINTY

COMPLETEUNCERTAINTY

COMPLETECERTAINTY

DEGREE OF CERTAINTY

PERMEABLE BOUNDARY

Fig. 5.3 Degree of certainty


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CERTAINTY , RISK AND UNCERTAINTY MODELS

Table 5.1 Pay-off matrix

Decision Making Under

Certainty Decision Making

Under Risk Decision Making Under Certainty

State of Nature

State of Nature State of Nature

N N1 N2 N3 N1 N2 N3 Utility or

Payoff Utility or Payoff Utility or Payoff

Strategy S1 u1 u11 u12 u13 u11 u12 u13 S2 u2 u21 u22 u23 u21 u22 u23 • One state of Nature • Single column matrix • Deterministic

outcomes • Optimal strategy is the

one with the highest utility

• More than one state of Nature

• Multiple column matrix

• Probabilistic outcomes (Ie., probabilities are attached to various states of nature)

• Optimal strategy is identified by the use of the expected value criterion.

• More than one state of Nature

• Multiple column matrix

• Uncertain outcomes, (Ie., probabilities are not attached to various states of nature)

• Optimal strategy is identified by using a number of different criteria.

ASPECTS OF DECISIONS AND DECISION MAKING

• Real world decisions are essentially sequential in nature, CF., decision trees;

• Real world decisions have multiple and conflicting criteria; • Decision types include:

o Strategic, relating to the outside environment; o Administrative, relating to the acquisition and structuring of

resources; o Tactical, relating to the implementation of a strategy; o Operational, concerning repetitive daily problems;


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o Programmed (repetitive) or Non-Programmed (non-repetitive); o Individual or Managerial; o Those concerning different spheres of interest; o Static (single) or Dynamic (sequential).

Models may be:

• Descriptive; • Prescriptive; • Normative.

Optimal Strategies:

• Are artificial (rational) • Yield maximum payoffs or minimum losses (deterministic); • Yield maximum expected utility or expected monetary values or

minimum opportunity loss (non-deterministic).

BEHAVIOUR AND DECISION MAKING

Having achieved an acceptable decision making ‘culture’ within the organisation and having designed an appropriate decision making strategy it is now important to develop the appropriate decision implementation process. This process is fraught with difficulties. The decision may have inherent content flaws; there may be implicit constraints that will affect the implementation. These content dependent issues need to be addressed. However even with perfect decision content there are numerous context issues that must be addressed to improve the probability of successful implementation. At this point it is necessary for the DM to carefully review the potential tactics and determine the most appropriate tactic for the particular circumstances of the specific decision process. It is impossible to define a hierarchy of tactics, each of the possible tactics have advantages and disadvantages. The DM will have to evaluate the content and context to determine which tactic is likely to be the best approach. There is no certainty about this process, it may be largely an intuitive process, but early deliberation can only improve the probability of success. Part of the evaluation process will involve an assessment of the relative power of each stakeholder group, both in relation to the DM and relative to each other. A further part of the evaluation will be the determination of the decision time scale. Quick implementation will inevitably make certain tactics much more


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difficult. Slow implementation may improve the potential benefit of certain tactics. A further part of the evaluation is the psychological factors associated with any change. Decision implementation tends to be more acceptable, and hence less resisted when:

• It is understood; • It does not threaten an individual; • Those affected feel engaged in the creation of the decision; • Those affected feel engaged in the implementation; • There is a previous history of successful decision making; • It has genuine benefits to an individual’s workload; • The outcome of a decision is reasonably certain; • The implementation process has been mutually planned; • The implementation timescale has been mutually planned; • There is significant evidence of senior management support for the

decision. Decision tactics is as much about changing individual mindsets as about the implementation of the perceived decision content.


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CHAPTER 6

PERFORMANCE, PRODUCTIVITY AND BENCHMARKING

LEARNING OUTCOMES


1. Describe the business context of Performance, Productivity and Benchmarking approaches including the key influence on business practices;

2. Recognise the impact of Performance, Productivity and Benchmarking

on the business performance within the industry; 3. Describe and apply appropriate Performance, Productivity and

Benchmarking techniques within the context of business performance; 4. Appreciate the strategic importance of Performance, Productivity and

Benchmarking both internationally and within the national industry market place.

These learning objectives furnish the reader with an appreciation that if the potential benefits of Performance, Productivity and Benchmarking are to be effectively and efficiently channelled into companies’ business practices, companies need to be:

a) Guided and motivated by ethically driven Performance, Productivity and Benchmarking practice;

b) Creative in the appropriate application of Performance, Productivity and Benchmarking;

c) Aware of the strategic importance of Performance, Productivity and Benchmarking;


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d) Stimulated and supported by the synergistic integration of the Performance, Productivity and Benchmarking impacting upon them.

PERFORMANCE MEASUREMENT AND PRODUCTIVITY EVALUATION

Performance Measurement relies on an explicit understanding of how the organisation and each of the processes that it conducts are inter-related. This manual describes the organisation and some of the generic management processes that they perform. Measuring productivity depends upon having a clear focus on the level at which you are trying to measure productivity. At the organisational level, financial performance measures, such as gross turnover and profit, or performance ratios, such as liquid asset ratio, give a measure of performance. They must however, be examined in context. For example, the profit level of a newly established company is unlikely to be at the same level as a well established company. However, the profit level for the new company may well be ‘good’ if it was compared to other newly established businesses. At the process output level, for example, plastering a newly built wall depends upon the combination of labour, materials, plant, etc., and the specific features of the location of the wall. How high it is above ground level, what shape is the wall, etc., all affect the productivity. At all levels, productivity measurement is a complex combination of generic features, applying in all circumstances, and specific features that only apply in a particular instance. It is therefore VITAL to recognise that performance measures provide information that must be analysed and interpreted. Analysis and interpretation are the primary functions of the Construction Enterprise Manager. Manual 6 Financial Management provides the tools and techniques required to analyse performance.


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PRODUCTIVITY EVALUATION

Productivity evaluation carries exactly the same caveat as performance measurement. Manuals 7 Construction Management and 3 Human Resources Management provide the basic tools and techniques required to evaluate productivity. The previous ‘warning’ is worth repeating - It is therefore VITAL to recognise that productivity evaluation measures provide information that must be analysed and interpreted. Analysis and interpretation are the primary functions of the Construction Enterprise Manager.

BENCHM ARKING – VALUE CREATION METRICS

INTRODUCTION : BENCHMARKING - HELPING YOURSELF TO BE BETTER

The principal purpose of benchmarking an organisation is to allow the company to fulfil itself, to grow and to develop to be the best that it can be. Benchmarking is the application of the skill of comparison. Comparing ones own performance of a particular strategy, operation, task or operation with someone else’s. In the construction industry the comparator should be someone who’s past performance has been ‘good’. The term benchmarking has been adopted when the comparator is regarded as the ‘best’ available. This label, BENCHMARKING, should come with an industrial hazard warning. Benchmarking has no new techniques, no toolkits, pro-forma or software. It is quite simply a view of:

“…how well the future business compares with its competitors, not only in its likely market share, but in things like the rate of introduction of new products and services, and by counting the development of intellectual assets as an investment.”

C. Handy [40]


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Thus benchmarking is concerned with the comparison of the ‘detail’ of the organisation. How its systems, structure, strategy and behaviours are manifested within the organisation, how they are promoted by the distinctive capabilities of the organisation in delivering services to clients and how they monitor and respond to external environmental influences. It is also concerned with the ‘dynamic’ environment. How the organisation can utilise its systems, structure, strategy and behaviours to respond to changes in the competitive market place and hence change over time. Benchmarking compares a snap shot of performance at a particular instant in time. This snap shot indicates the current performance and the inherent potential for future performance.

At each [snapshot] there is found a material result: a sum of productive forces, an historically created relation of individuals to nature and to one another, which is handed down to each [snapshot] from its predecessor; a mass of productive forces, capital funds and [factor] conditions, which on the one hand, is indeed modified by the new [snapshot], but also on the other prescribes for it its conditions of life and gives it a definite development, a special character.

Karl Marx, The German Ideology, (ed) CJ Arthur. London, 1974

Benchmarking does not change practises or procedures. Other measures are necessary to implement changes. It does however create the momentum to ‘kick start’ the change.

“One mistake we did make was the idea of having three objectives equal in importance……. To affect a culture change, …., you have to zero in [on one issue only]”.

D T Kearns & D A Nadler, [49] Since then, many organisations have used benchmarking comparisons to stimulate responses to changes in quality improvement initiatives (e.g. British Airports Authority: Bacon in Armathwaite Initiative 1997), cost reduction strategies (e.g. Rover Motor Group: Graves & Madigan in Armathwaite Initiative 1997), budget allocation systems (e.g. BAe), new business-venture evaluation (e.g. British Telecom), ethical and cultural behavioural changes (e.g. The Body Shop), environmental and sustainability system alterations (e.g. Degussa AG and Skanska AB).


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BENCHMARKING : A DEFINITION

Benchmarking can provide an objective analysis of business activity health. It aims to adopt a systematic measurement process of the improvement to an organisation’s performance in the utilisation of inputs, transformation system and outputs (in the form of its product or service) and to compare these measurements against the following:

• The organisations’ own vision of performance; • The organisations’ main rivals level of performance; • The ‘best available’ comparators from other industries.

The measurement of performance will result in quantitative and qualitative data that indicates the gap in performance. Management must then initiate change to alter performance. Such alterations as previously indicated may be changes in structure, strategy, systems or behaviour. The benchmark objectives can therefore vary from:

• Internal ‘detail’ comparisons; • Competitors’ internal ‘detail’ comparisons; • Competitors’ distinctive capabilities comparisons; • Competitors’ external ‘detail’ comparisons; • Industry-wide external ‘detail’ comparisons; • Out-of-Industry external ‘detail’ comparisons; • Internal ‘dynamic’ environment comparisons; • Competitors ‘dynamic’ environment comparisons; • Industry-wide ‘dynamic’ environment comparisons; • Out-of-Industry ‘dynamic’ environment comparisons.

Careful consideration is required to determine the appropriate objective and therefore the appropriate methodological approach to benchmarking to achieve prescribed objectives. The objective of construction benchmarking is the appropriate application of a tool (benchmarking techniques) to satisfy a management vision of construction business process improvement. Thus aiming to implement continuous improvement (Kaizen) of all business activity to add value and to counter the natural regression of sources of competitive advantage.


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PRE-REQUISITES OF BENCHMARKING

The benchmarking activity should be stakeholder driven. Commitment to such fundamental review of processes and practices requires acceptance by the stakeholders. Reservations, restrictions and ‘sacred cows’ should be avoided. Nothing should be excluded from analysis, since this may lead to fragmentation and false assumptions and ultimately to a failure to achieve an accurate measure of the issue. Peter Senge noted in his book, The Fifth Discipline, “that people do not resist change, they resist being changed.” Thus without the participation of all, the benchmarking procedure may not yield accurate data, and therefore the benchmarking targets may be fundamentally flawed. The procedure must be forward-looking and focused on internal visions. Benchmarking allows the organisation to move from where it is to where it wishes to be. It can also be used to identify what may be necessary to move the organisation forward.

However, it cannot tell the organisation where it should want to be! It should not be used to identify how an organisation arrived at where it is now, and it should not be used to identify those ‘responsible’ for where the organisation is now. Therefore the pre-requisites for benchmarking are that the aims and objectives of the benchmarking procedure should be made explicit to the stakeholders and the entire procedure should be transparent. This involves a significant degree of trust and mutual respect between the stakeholders. It is also recognised that in many benchmarking exercises these pre-requisites do not exist. Caution is recommended in the interpretation of any results of a benchmarking exercise that fails to satisfy the criteria of necessary pre-requisites.

BENCHMARKING PROCESSES

The strategic objective for the benchmarking process should be pre-determined. The impetus for a benchmarking activity will typically have been derived from an exogenous source. There are four alternative strategic objectives to consider:

• Paradigm shifts;


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• Incremental change; • SWOT identification; • CSF identification.

For example, a gradual loss of competitive advantage within a market may require an incremental benchmark procedure. Alternatively, the elimination of a market, due to a change in government policy, may require a paradigm shift benchmark procedure. The SWOT (strengths, weaknesses, opportunities and threats) identification could be required as a part of a strategic review of current performance. The CSF (critical success factor) identification could be a part of the tactical implementation of a particular strategy. Whatever the exogenous prompt for change is; the correct process must be selected to enable the strategic objective to be achieved. When the strategic objective has been defined then the type of benchmarking process can be selected. The alternative benchmarking types are:

• Internal; • Competitive; • Parallel; • Best Practice.

Table 6.1 Benchmarking methodologies

APPROPRIATE BENCHMARKING METHODOLOGIES

PA

RA

DIG

M

INC

RE

ME

NT

AL

SW

OT

CS

F

INTERNAL +/- * */+ * COMPETITIVE */+ * * * PARALLEL + + X X BEST PRACTICE * * */+ *

Key: * typical; + possible; - unusual; x impractical When considering the use of a particular benchmarking process it is important to recognise the constraints inherent in the procedures.


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Typical constraints would concern the anonymity of respondents when the process involved questionnaire, survey, case study or action research. Internal benchmarking assumes a level of cross-functional knowledge and experience that may not exist. When using a parallel or best practice procedure the selection of the comparator will depend upon the eclectic criteria of selection, how exhaustive should the search be for a ‘best’ comparator, how exhaustive should the available data be for the use of the selected comparator? Table 6.2

Benchmarking techniques

APPROPRIATE BENCHMARKING TECHNIQUES

QU

ES

TIO

NN

AIR

E

INT

ER

VIE

WS

CA

SE

ST

UD

IES

AC

TIO

N

RE

RS

EA

RC

H

INTERNAL * * */+ -

COMPETITIVE + X X -

PARALLEL */+ - - X

BEST PRACTICE + + X X

Key: * typical; + possible; - unusual; x impractical Responses to benchmarking processes can include quantitative and qualitative data. The treatment of such data requires the use of different techniques. The selection of the appropriate technique is considered to be a significant constraint. A major trend in current research has been toward reductionism. Newtonian scientists break things apart and look at them one at a time. This is a fundamental presumption in physics, the way you understand the world is that you keep isolating its ingredients until you understand the stuff that you think is truly fundamental. Then you presume that the other things you don’t understand are mere details! Benchmarking tries to capture both the dynamic and detail complexity of real world problems. A different philosophical approach, a matter of looking at the whole is needed. This holistic view is a necessary precursor to the effective use of benchmarking. Unfortunately the Newtonian reductionist approach appears in many benchmarking exercises.


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This section cannot possibly deal with all of the reservations and constraints associated with the use of benchmarking. The reader is referred to research methodology texts for full details of the reservations and constraints associated with such research methods.

BENCHMARKING METHODOLOGY

Whatever process is selected the methodology follows a consistent pattern, namely:

• Identification of the core issues under scrutiny; • Internal data collection; • External data collection; • Analysis of data; • Production of conclusions; • Implementation of responses to the conclusions; • Feedback Loop.

This methodology requires a specific skills mix. Careful selection of the person to conduct the benchmarking exercise is necessary. The process will involve the analysis and interpretation of quantitative and qualitative measurement. The resultant conclusions can only be as good as the skills of the investigator.

THE USES OF BENCHMARKING : PERFORMANCE MEASUREMENT

The benchmarking process can have two uses: to generate quantitative measures of performance and as a method of highlighting qualitative data relating to performance. Alternately, the quantitative measures can be utilised to create metrics and milestones for comparing against exemplars of ‘best practice’. The qualitative data is more usually used in support of the development of strategies for some form of quality improvement within the organisation. For example: operational improvements associated with the introduction of life cycle costing or facilities management procedures.


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The qualitative data from competitor organisations can be used to promote cost reduction or budgetary control improvements, similar to a process of cost planning. Qualitative data can also be used in the evaluation of new ventures or as a confirmation of proposed action in response to a competitive crisis. Thus the effective use of quantitative and qualitative data can typically inform corporate visions and corporate plans. It can be used to substantiate and justify proposed strategies. It can also be used to confirm the tactical necessity for the implementation of revised procedures and controls. However, a more efficient use of benchmarking is when benchmarking is used to facilitate organisational learning and organisational change. This form of use is a complex issue and the reader is referred to other sources for details. For example, Larraine Segil’s Intelligent Business Alliances. It takes the organisational response beyond what is typically reactionary response and into generative learning; this includes the implementation of both single and double loop learning; whereby the organisation can identify the structural explanations of the underlying causes of behaviour. Altering the underlying structures can therefore produce different patterns of behaviour. The potential application of qualitative benchmarking procedures exists in the evaluation of new and innovative developments within the construction industry. For example recent developments in the creation and development of ‘Relational Contracting’ and ‘Partnering Agreements’ have created new contractual and ‘quasi-contractual’ relationships, the performance of which would require evaluation. Similarly human resource changes involving team working and empowerment initiatives will require an evaluation mechanism. Benchmarking techniques can be utilised in this evaluation. For example in external processes: Client Management: benchmarking the effectiveness of management systems by measuring, for example, the rate of client attrition, rate of new client introductions, proportion of turnover associated with new clients; Consultant Management; benchmarking the efficiency of management systems and data manipulation by measuring, for example, ratio of CAD/CAM projects to traditional design, proportion of contract work outsourced, ratio of


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introduction of new consultants, average age of appointments to consultants approved list; Contractor Management: benchmarking the efficiency of management systems and data manipulation by measuring, for example, proportion of EDI tendering, ratio of introduction of new contractors, average age of appointments to contractors approved list, ratio of recommendation to tender list, ratio of successful to unsuccessful bids; Site Process Alteration: benchmarking the effectiveness of management systems by measuring, for example, drawing revisions issued, method statement alterations, issue of variation orders, issue of verbal instructions, requests for clarification of details, receipt of notices for prolongation and disruption; Briefing and Design: benchmarking the effectiveness of management systems by measuring, for example, client feedback, statutory authority compliances, environmental impact assessments, BREEAM (Building Research Establishment Environmental Assessment Method) assessments, design reviews, proportion of projects using 3D modelling, use of virtual reality walkthroughs; Planning, Monitoring and Control : benchmarking the effectiveness and efficiency of management systems and data manipulation by measuring, for example, resource levelling, progress report status, exceptions reports, safety policy amendments, alteration to QA plans and reports; Facilities Management: benchmarking the effectiveness and efficiency of management systems and data manipulation by measuring, for example, property acquisition ratios, changes of use, building usage, occupancy rates, lease management, space utilisation, budgetary control failures, risk management failures, life cycle cost alterations; Cost Estimating and Bidding: benchmarking the effectiveness of management systems and data manipulation for budgeting, risk assessment, value management, cost modelling, site surveying, measurement, pricing and project planning; Cost and Variation Management: benchmarking the effectiveness of management systems and data manipulation for measurement, pricing, cost planning, cost checking, life cycle costing, value management;


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Contract Management: benchmarking the effectiveness of contract management and data manipulation by measuring, for example, extensions of time for prolongation or disruption, payments, debtors, financial claims for loss and expense; Tendering, Enquiries, Quotes and Orders: benchmarking the effectiveness of management systems and data manipulation for preparing, evaluating and completing, enquiries, quotes and orders. For internal organisational processes, benchmarking could be used for evaluation and amendment of: Strategy: benchmarking the effectiveness, efficiency and opportunity for, alteration of business and operational aims and objectives, quantification of particular business and operational contributions, extent of intra-organisational information transfer, extent of inter-organisational information transfer, ratio of use of IT to traditional communication etc. new opportunities and business ventures; Policy: benchmarking the effectiveness, efficiency and opportunity of the current strategy, mission statement and vision; Procedures: benchmarking the effectiveness, efficiency and opportunity for, process improvement, application of new philosophy tools and techniques, staff development and training; Communication: benchmarking the effectiveness, efficiency and opportunity for innovation, introduction of EDI, intranet, e-mail, e-commerce, web data etc.; Project Specific Requirements: benchmarking the effectiveness, efficiency and opportunity for creating niche and focused services utilising generic concepts and initiatives, spin-off services, spin-off facilities; Selection of Suppliers: benchmarking the effectiveness, efficiency and opportunity for process improvements, partnering agreements;, value chain improvements, keiretsu agreements, etc.; Legal and Health and Safety Requirements: benchmarking the effectiveness, efficiency and opportunity for performance improvements, covering safety policy, COSHH/CDM regulations, insurance, building regulations, British standards and Codes of Practice.


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RESPONSES TO THE BENCHMARKING PROCESS

The typical response to a benchmarking exercise is the alteration of structure or strategy or systems or behaviour. Benchmarking cannot achieve such changes. The process merely indicates what changes may be necessary. A more holistic and comprehensive alteration is when all four elements change simultaneously. Xerox is an exemplar of ‘best’ practice organisational change. Typical examples of responses to benchmarking are indicated below.

• Structural Change: • Lean Organisations; • Empowered Organisations;

• Strategic Change:

o Product Differentiation: Specialisation and additional services; o Process Differentiation: PFI procurement; o Market Differentiation: Specialisation and Niche focus;

• Systemic Change:

o Backward Value Chain Integration: Design and Construct; o Forward Value Chain Integration: Facilities Management;

• Behavioural Change:

o VFM, Value For Money Initiatives; o Value Added Initiatives; o Process Re-engineering.

BENEFITS OF BENCHMARKING

The changes implemented as a result of the benchmarking process yield benefits associated with organisational effectiveness, efficiency and opportunity:

• Competitive Advantage via: o Integration; o Flexibility; o Speed: improved cycle times; o Quality: reduction in defects; o Cost reductions; o Customer Focus: delivering client expectations;


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o Improved Image and Reputation. • Profitability via:

o Increased opportunity; o Cost reductions; o Reduced wastage; o Reduced re-work.

• New Markets via:

o Differentiation; o Focus; o Niche.

• New Products and Services via:

o Segmentation; o Specialisation.

IMPLICATIONS OF BENCHMARKING

Many conclusions can be drawn from the results of a benchmarking exercise. The organisation must recognise the necessity of adopting a holistic approach to organisational change indicated by the benchmarking exercise. The appropriate level of investment must accompany such change. This investment may not necessarily be financial investment, but inevitably there is a need for significant investment in people. Benchmarking is a tool for continuous improvement therefore embarking on a benchmarking exercise indicates the necessity for continuous benchmarking activity. This has inevitable implications for staff and other resources. For the successful continuity of benchmarking the process must be made transparent. The results of benchmarking activity should be made available to those affected, therefore reinforcing the necessity for the proposed actions. Benchmarking of ‘hard’ targets is becoming commonplace. Construction organisations are benchmarking the activities indicated in this report. ‘Egan’ metrics have been published:

• 10% annual savings in construction costs; • 10% annual savings in construction duration; • 20% annual reduction in project defects.


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Future developments of benchmarking applications will move to the measurement of ‘softer’ behavioural activities, and assessment of future business potential, for example:

• Education and Training Needs: evaluating the growing expectations of customers and staff, accounting for business growth through personal development and accounting for the potential loss if customers and / or staff become dissatisfied;

• Professional Scope and Values: achieving business development by promoting entrepreneurial initiative and by the adherence to professional standards;

• Professional Ethics: assessing the impact of inappropriate professional behaviour and the likely reaction of professional bodies;

• Professional Standards: evaluating the impact of failure to deliver services of an appropriate professional standard, to reduce the impact of potential claims for professional negligence;

• Leadership Effectiveness: evaluating the effect of releasing the organisations potential through effective management;

• Customer Focus: to exceed client expectations and to minimise the impact of failure to meet client expectations causing potential damage to future business prospects or damage to image and reputation;

• Integration of Processes: to support improvements in the whole construction life cycle through design, construction and facilities management, with the aims of enhancing value for the industry’s clients and improving profitability for the industry;

• Integration of Teams; to support the development of effective multi-disciplinary teams and to accrue the benefits from achieving a degree of permanency from such project teams;

• Commitment to People: for example by achieving recognition of employee development through schemes such as IIP (Investors in People) and CharterMark.

Some work is underway in achieving a balance in process improvement. A ‘balanced scorecard’ approach using a ‘radar chart’ representation is a possibility. Figure 3 indicates a fictitious ‘radar chart’ indicating performance as compared to the M4I (Movement for Innovation) key performance indicators.


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Fig. 6.1 Radar chart

CONCLUSIONS

The Egan report cited a construction industry representatives’ view after a visit to Nissan UK. as follows:

“We see that construction has two choices: ignore all this in the belief that construction is so unique that there are no lessons to be learned; or seek improvement through re-engineering construction, learning as much as possible from those who have done it elsewhere.”

Rethinking Construction – ‘The Egan Report’ 1998. Chapter 3, Art. 29. That is the essence of benchmarking, learning as much as possible from those who have done it better elsewhere. Benchmarking alone will not improve anything within an organisation it does however generate data that can be utilised in formulating, strategy, policy and tactics. Holistic alteration of structure, strategy, systems and behaviour is undoubtedly necessary to improve performance within the construction industry.

100

80

60

40

20

Client satisfaction - Product

Client satisfaction - Service

Defects

Predictability - Cost

Predictability - Time

Profitability

Productivity

Safety

Construction cost

Construction time

Current averages

Key Performance Indicators


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Benchmarking is a tool that can be utilised by management to foster such improvement. It will however require significant changes in the trust and respect shown to stakeholders within the construction industry. The message is clear, the construction industry can learn from benchmarking. The construction industry can benefit from others experiences; it can use these experiences to innovate. The industry will have a greater awareness of targets and how ‘best’ practice organisations achieve their goals. Sufficient knowledge should exist to make a difference in practice generally. The industry really could develop to be the best that it can be.


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CHAPTER 7

MARKETING

INTRODUCTION

Let’s start with something from everyday life. Do you have a digital camera, or a new perfume, car or computer? What type did you buy, and why? There are two possible answers to this question. First, somebody told you to do so and recommended you that specific thing. Second, you saw, heard or read about it somewhere. The second choice is more common for a wide range of people. As you are walking across the street you see many boards with advertisements. They are everywhere. Almost every company is trying to sell something and it’s using some kind of advertising, and why? Because if we do not know that there is something, we cannot want it. To let us know that a product is here and it is the best for us. To convince people to buy it is the main task of marketing. A pure form of this marketing has the aim of fulfilling customer’s needs. It’s about giving a client what they really want, rather than what it is thought or assumed they want. Such an approach may mean helping the customer find out what he really needs. For every company it’s profit. To accomplish this task the company needs to know some basic information:

• What to make (what customers will want to buy); • To what quality (quality as opposed to low price); • Who are the target customers and what do they really want (perfect

design but low on function); • Who will sell the products and how will the product be sold (company

by itself, other retailers, on-line); • What are the right attributes of the product (price, design, weight); • When to make it (Will the customers buy that type of good at this time?).

Everything mentioned above has to be gathered together, summarized, compared to the competitors and the market, evaluated and then a decision of what, when and how to do it will come out. The production of data to answer these questions is marketing. It could be called “customer driven production”.


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It’s a discipline for which every company needs to be successful in today’s economic environment.

RESPONSIBILITIES OF MARKETING PERSONNEL

1. Searching the market for the opportunities

If you want to be successful you have to actively look for the opportunities the market offers. There is a necessity to stay in touch with the new technologies and predict what the market would need in the future and be prepared for that situation. This includes searching for answers to questions like: “What trend in selling of our product could we expect in the future? Will there be a boom in some new technology that people will desperately want?” And many other questions like those.

2. Managing products

Marketing is responsible for managing which products to sell, when will be the right time, for what price, and in what markets could they be sold.

3. Managing the distribution chain

There are many types of products. Every type of product needs different ways of how it could be sold. There are products for end-use customers who need to be sold by a wide network of retailers and on the other hand there are products that could be sold by the producing company itself.

4. Advertising and propagation of products and services

Marketing is responsible for communication with customers. It has to inform them about a products existence and its advantages. This is often achieved by advertising. But it’s important to bear in mind that advertisements are for a targeted group of customers only, not for everyone. The main task of advertising is to convince potential customers and raise an interest in them that will be transformed into buying in the future.

5. Pricing and contract conditions


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You could have an interesting product but if it’s overpriced the customers will not buy it. Correct pricing is essential. The price has to be established so that the distributor and end customers are motivated to buy. But the company still has to achieve the expected profit levels. But price is not everything. There is the need to set up a contract that both sides can profit from. You have to specify methods of payment, warranty, contractual default clauses and many others.

6. Planning

Planning is an essential task within the company. Based on such plans a company budget is constructed. You have to predict annual sales, the advertising budget for these sales; the expectation of these sales and plans about entry of new products. If you have carefully observed the market you should have initial information to begin making a good plan.

These generic activities will be returned to later, when they are applied to construction and property activities. It should be noted that we have deliberately not specific people or roles. Each organization should argue for marketing activities to be performed by the most appropriate person or people. Some activities necessarily fall to a specific person, others activities can be distributed. It’s necessary to plan the distribution of marketing activities in that way when each activity is performed by somebody.

MARKETING INSTRUMENTS

Marketing is not only promotion of products, but it contains a wide range of actions as identified above. E. Jerome McCarthy [75] divided marketing into four sets of activities. Progressively it has become standardised as the 4 P’s. The 4 P’s are:

• Product

This contains Product management and Product marketing. It is product oriented and shows how the product relates to the end user’s needs and wants. Historically, the thinking was that a good product would sell itself. But this is no longer accepted as true. The main question today is does the company create what its potential customers want? Does the


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product define the characteristics or service that meets the needs of the customers?

• Price

This entails everything connected with setting a price of a product. This has to be taken very seriously. Too high a price leads to lower sales and lower profit, but may cover costs better. Too low a price leads to higher sales, but because the difference between manufacturers cost and price is small you have to sell a large amount of products to cover all costs. And there are the extended influences of competitors too. So it’s necessary to set a price as a balance of all these influences.

• Promotion

Promotion is the process of how to let potential customers know about the product and its advantages for them. This includes: advertising; sales promotion; publicity; and personal selling.

• Place

Sometimes called Distribution or Placing. This refers to how the product will be made available to the customers, by the company’s own sales network, or retailing, or via on-line shops, etc.

Fig. 7.1 The Marketing Mix

Targeted customers Planned positioning

PRICE

Price list Discounts

Billing conditions

PLACE

Discount for distributors Availability

PRODUCT

Category Quality Design Brand

PROMOTION

Advertising Direct sales

Public relations


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These 4 P’s are called the Marketing Mix. How they are connected with customers is shown in Figure 7.1. This approach should be defined and included in the marketing plan. As a counter to this adds "Perhaps the most significant criticism of the 4 P’s approach, which you should be aware of, is that it unconsciously emphasizes the inside–out view (looking from the company outwards), whereas the essence of marketing should be the outside–in approach" [81]. Even so, having made this important caveat, the 4 P’s offers a memorable and workable guide to the major categories of marketing activity, as well as a framework within which these can be used. It had been thought that these 4 P’s covered all that the marketing plan needs, but lately it has been shown that this is not enough. With more and more companies coming to the market the customer becomes more important than ever before. But the 4 P’s doesn’t include anything about the customer. So another three P’s [7] was established known as the extended marketing mix. The new 3 P’s are:

• People (Stakeholders)

This doesn’t just mean customers, but includes any people who come into contact with a product during the entire sales process. Any of them could have an impact on the satisfaction of the customer. Can you remember any time when you went to the shop and you had decided to buy a new item, but the sales assistant was so annoying that you changed your mind and went to another store to buy it? This is what this P is about.

• Process

Not only goods are being sold, but services too. This P includes processes involved in providing a service. Process is best described by example - booking a flight on the Internet. The process begins with you visiting an airline's website. You enter details of your flights and book them. Your ticket/booking reference arrives by e-mail or post. You catch your flight on time, and arrive refreshed at your destination. This is all part of the marketing process.


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• Physical evidence

If you are going to buy something in a supermarket you see it before you buy it. You can check if it has the expected quality and features you require. This is not possible with services. If you are buying a service you have to perceive some amount of risk and “give it a try”. This could, of course, have an impact on the customer decision to buy the service or not. To reduce the feeling of risk, thus improving the chance for success, it is often vital to offer potential customers the chance to see what a service would be like. This is done by providing physical evidence, such as case studies, testimonials, or pilot implementations.

Even with these 4 P’s + 3 P’s there are marketing experts [9], [34], who want to add other elements like packaging. They say that packaging is very important, because the package is the first thing of the product that the customer has contact with. This could have an impact on the customer’s satisfaction with the product. Even not so good products could be sold successfully if it has perfect packaging and vice versa. This last P could be in doubt, because packaging could be seen as a subfield of promotion.

KEYS TO SUCCESS – BUSINESS STRATEGIES

A good marketing strategy has to be in accordance with the company’s business strategy. A business strategy says what the company wants to do, what it wants to achieve and when. A Marketing plan, as one component of the whole company’s business plan, says how to aid the company’s efforts in achieving its goals. A competitive advantage is an advantage over competitors gained by offering consumers greater value, either by means of lower prices or by providing greater benefits and service that justifies higher prices. There are number of business strategies to achieve a competitive advantage, but whatever model is adopted the output is one or a combination of the follows strategies:

• Product differentiation: Products are differentiated from competitors by giving it some characteristics that they do not share. Differentiated products may cause increased interest for potential customers. If you see something new and unusual that other products don’t have you may be attracted by it and you may want to know more about it. The


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assumption is that this increased interest will generate increased purchase;

• Market segmentation: Market segmentation means the separation of customers into groups according to the products they are likely to buy. It’s very important for marketing to achieve accurate segmentation. If the marketing plan separates customers into groups with particular needs, it could then devise the most effective approach for each group. A detailed analysis should be done in order to get to know what type of clients we being dealt with. Take a food as an example. There are many different types of people with different needs. It’s based on many aspects like living standard, geographical location, national habits and others. Other forms of segmentation could be by age. Young people generally have less concern for their health and will buy burgers, chips, sweet drinks and other less healthy foods. Old people eat differently. This aspect of merchandising goes beyond merely having the biggest shelf for what we sold most of last week. Study of the buying habits of the segmented customers’ means that special promotions and new products can be introduced selectively in particular locations. Market segmentation data is particularly useful and is hence commercially very significant;

• Product specialization: The third approach of how to distinguish the company from its competitors is to specialize. If the company finds a niche in the market, where no one is operating, it has a better chance to build up a business there. If there is no substitute for their products (which in the terms of marketing include services too) the company has a great position to determine the product’s properties, price included, and it’s not immediately threatened by other competitors. The company has time and a space to do things in its own way, because there is no comparison to others, so no one could say their product is better or worse than someone else’s. We will take an example from construction practise. The company digging wells, for instance. Digging wells is a special kind of ground work, needed by the construction industry. If there is no one else who could dig wells the customers who need to dig a well have to go to this company. The company will quote a price and the customer will probably accept it. Why? Because there are no others to whom they could go for better conditions. And this is the principle of specialization – to do things that others don’t.


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MARKETING APPLIED TO CONSTRUCTION INDUSTRY

The theory of marketing, as briefly explained in the previous chapters, is a skeleton that should show that some basic steps need to be done to successfully sell products or services. But it says nothing particular about how to apply this theory to practise. We are talking here about the construction and property industries. Applied marketing to the construction industry is called Construction Marketing and likewise Property Marketing. They are different. In construction the buyer is generally not seeking a product, but this is usually creating an idiosyncratic solution to a particular problem. The buyer has already filtered the potential solution and selected a particular product as being the most appropriate solution. We will not debate the quality of this decision making approach (See Manual – Decision making). However there is very little that differentiate then. Like every other application of theory to practise we have some specific approaches. 7.1 below shows some of the main differences between the typical markets for consumer goods, property and construction: Table 7.1

Differences between customer goods, construction and property Construction Housing/Property Consumer goods

Few buyers More buyers Many buyers Not easily disposable Can be disposable Easily disposable

Capital, Finance Capital, Finance or Cash Cash High consequence High consequence Low consequence

Large purchase Large purchase Small purchase Difficult or impossible to

replace Difficult to replace Easily replaceable

Specialist purchase Needs special assistance Non specialist purchase Long useful life Long useful life Short useful life

High investment required Major investment required

Low investment required

Long term benefit Long term benefit Short term benefit


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To better understand construction and property marketing the particular parts of the Marketing Mix will be shown applied to construction practise.

PRODUCTS IN CONSTRUCTION

“A product is anything that can be offered to a market for attention, attraction, acquisition, use or consumption.” [69]. In the construction industry, products are:

• Physical: houses, facilities, infrastructure, etc.; • Services: consultancy, design, expertise, etc.; • Essential: gas, water, electricity, telecommunications, etc.; • Ideas: urban regeneration, regional development, etc.; • Desirable: environmentally secure, adaptable, etc.

For construction there is one typical point – product conflict. We have at least three views of the product. The first is from the architect. He wants the building to be different, to distinguish it from others, to enhance his own reputation and perhaps to satisfy the judges. The second view is from the engineers/builders. They want to construct a usable building and satisfy the client. This always means reconciling design and appearance with materials usage, facility requirements, durability, longevity and potential flexibility. They also have an eye on producing something that is a monument to their innovation. The third view is from the clients. They always have requirements which are not necessarily in conjunction with the previous two views, starting with a low price and ending with high usability. Construction activity has to manage these competing views and achieve convergence between them.

PRICE IN CONSTRUCTION

Pricing in the construction industry is similar to most other applications. The key to effective pricing is understanding that there is no perfect price for any activity other than that which will sustain the long term security of profitable activity. Because the market is changing the price is a matter of constant review. The absolutely wrong approach to pricing is to pluck the price from the air or establish it as the result of a perception. A full analysis of the company’s position, capability, capacity and the market’s willingness to sustain particular charge levels is needed to successfully set the price. Since construction prices


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are usually bid in advance of production, this can be an advantage, however bidding in advance means production difficulties have to be absorbed within the bid price. Therefore production management becomes a vital component of construction activities.

PROMOTION IN CONSTRUCTION

Promoting the construction company is necessary. We will identify a few of the main reasons why it is important. Promotion:

• Supports the activities of the company and presents them to the best possible advantage in the eyes of existing and potential customers;

• Presents the company’s distinctive features and expertise in s language that is understood by the clients;

• Assists in the process of meeting customer’s expectations.

Because of the nature of the construction industry and the disciplines that operate within it, and because of the uniqueness rather than the mass production of the products generated by the consumer goods market, it is necessary to distinguish between construction promotion and consumer goods promotion. Note that consumer goods promotion depends primarily on the quality and volume of advertising. Effective construction promotion depends on high quality direct sales and targeted marketing activities. Promotion activities available to the construction industry have been divided into three categories by Richard Pettinger [89]:

• Primary promotion: o Direct sales; o Targeted direct marketing; o Public relations.

• Secondary promotion: o General advertising; o Logo design; o Attendance at trade fairs; o Sponsorship.

• Tertiary promotion: o Making the most of positive media coverage; o Positive public relations activities.


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Primary promotion is the most important section. Direct sales are targeted at clients, potential clients and others capable of using the distinctive expertise on offer. It is based on open, face to face contact with the client. An essential part of direct sales is:

• To identify the right potential client companies and the right people within them to contact;

• To identify those presentational factors that enhance a company’s reputation and those that do not;

• To identify the strengths and weaknesses existing within the company’s full range of marketing activities.

The effectiveness of direct sales is based on how successfully the company manages communication with clients. Clients have their own needs and expectations (it could be how much he wants to be informed about situations - frequency of calls, etc.) and it’s up to the company to fulfil the client’s needs in the best way available. Targeted direct marketing is about knowing precisely when and with what material to contact the client. Promotional material, brochures and past and current achievements can be arranged and presented at the right time to the right people. Public relations activities exist to support the direct marketing efforts and to provide a distinctive and positive position that can be supported by other forms of promotion. It is essential that the public relations function has a capacity for dealing positively with the press, TV and other media. This in turn means developing links, contacts and networks so that good stories about the company receive wide and favourable coverage but also that the bad don’t spread too wide!

PLACEMENT IN CONSTRUCTION

Placement, or distribution, in construction is very straightforward. Construction means building something. The customers in this sector could buy either property or services. Both of these activities are customer driven. The location of construction or property is determined in the contract and is unchangeable. It doesn’t matter if the company hires subcontractors or does all the work themselves, because the service for the customer looks the same. The


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construction company doesn’t have many distribution possibilities. In fact it has only one – to build the subject of contract at the place mentioned in contract. With this the distribution is set. No other choices are given.

PEOPLE IN CONSTRUCTION

In the case of selling consumer goods, there are retailers. But for clients in the construction industry, the process of obtaining the building or service is more complicated. In the case of construction it’s called tendering. First the client has to let potential contractors know that he wants something to be built. This can be done by word of mouth but often he will advertise his plan in a journal. The second step is the contractor sees the request and makes an expression of interest. There will be interest from other contractors. After the time mentioned in the tender conditions has expired the client will look at the offers and according to the conditions he will choose the one that suits his needs best. Then the client begins to cooperate and negotiate with the chosen contractor about specific conditions of the project. After a period of time the contract with all the necessary requisites will be made and signed. The people, in terms of marketing, are those people that the customer may encounter during the process of contracting. They are all company representatives. They all communicate with the customer and represent the company. Differently from goods being retailed, construction companies have more control over the people who are in contact with clients. The company could pay more attention when is hiring for that position and invest resources in their education.

PROCESS IN CONSTRUCTION

A genuine process has inputs, transformation and outputs. In marketing the process means how the interaction with clients is achieved. In construction the process begins with discussions about needs, through procurement methods and contract conditions, through construction of a structure to payment. To manage the process marketing in construction means: to inform the client about progress of construction; to inform him about problems that may occur and be prepared to promptly advise a solution; to be prepared for the client’s questions while the construction is running and to meet the client’s wishes in a mutually acceptable way.


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PHYSICAL EVIDENCE IN CONSTRUCTION

Being able to look at what we are buying before we actually buy is not essential. However it gives us a feeling that we know what we are buying and therefore lowers the risk we encounter with every purchase. In the case of construction there are many difficulties to provide the client with physical evidence of what is being purchased. Firstly almost every project in construction is unique. Only projects like housing units could be seen and inspected before signing a contract. But other large projects are unique and the client has to sign the contract without seeing the result first. The construction industry fights this disadvantage in two ways – references and modelling. References and testimonials mean that the construction company has successfully completed many other projects and the result of these could be seen. Moreover we could ask the owner of the referenced property about the company. By modelling, the company is trying to create an image of how it will look after it’s finished. In the case of construction, special computer modelling tools like Autodesk Architectural Desktop or Nemetschek Allplan are used. They provide 3D rendered models that could be presented to the client. Physical scale models are also constructed to provide an impression of the proposed project. Construction companies need a good reputation and good references. A good reputation may get you the opportunity to bid and a good reference could be the thing that makes the difference between winning or losing the contract.

MARKETING AS A MANAGEMENT FUNCTION

Imagine a company operating in the construction industry. It has just had a successful year and the company account report profit levels rose by millions. Every person in the company knows what to do and everything is working well. Will this company last if it doesn’t have a marketing plan and does nothing to promote their services? Definitely not. Eventually a set of circumstances will occur that means that the company has no contracted work and no realistic prospect of obtaining work quickly – especially significant in construction where contract times are extensive. With no work there is no income and the business managers are then forced to comply with financial and accounting law which may force a declaration of insolvency and/or bankruptcy. Every company needs a good marketing plan. Even the most well known companies with years of history could become insolvent if they do nothing to


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improve themselves. The marketing plan is directly connected with the corporate strategy plan. The purpose of the strategy is to: identify the products and services that the company intend to offer; the different types of customers and what it shall offer them; the means by which to approach the customers and the arguments it shall use. The company must assemble information, analyse and make judgements with great care. But it must not let the preparation of the strategy become an end in itself. The real things that matter are conclusions. It is necessary to make sure that the strategy is a servant rather than a tyrant under which the company has to serve until it reaches the time ordained for its review. If market conditions change, the company must bring forward their review. It must be remembered that the strategy is a plan for efficient, systematic efforts to get the company the business it wants. The marketing plan is an integral part of such strategy formulation.

IMAGE

One of the most important parts of the company marketing strategy is building an image, reputation and brand. Brands are prevalent in every aspects of human life: production and consumption, food and clothing, personality and lifestyle; and from pop culture to politics [32]. Brands are representative of the whole company. They are lifestyle of individuals as so of whole groups. Originally the brand represented added value to the product. As life and market evolves the impact of the brands and branding is far beyond that that. The sales of the products depend on the name and reputation of the producer. Even with good product, but without good image in the eyes of the customers, the sales will be lower than it could be. It’s like a face of the company. Everyone is more likely to communicate with someone who has good charisma (which includes both physical and psychical attributes) than with someone who is not so seemly. This applies to the company too. According to study of long-term stock price movements and company reputations changes, 8-15% of the company’s stock price can be accounted for by corporate reputation [37]. Corporate reputation can be defined in terms of a number of attributes that form a buyer’s perception as to whether a company is well known, good or bad, reliable, trustworthy, reputable and believable [72]. It’s important to be aware, that the company’s reputation is based on the information the customers have. There are two problems with that: not everyone has the same information; there could be misinformation too, which affect the customer felling about the company. The company marketing office has to take care responsibly what they do and how they communicate with people, from whom could be potential


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customers in the future. In the first case there is necessary to do market segmentation analysis to discover what type of the customers the company is dealing with and importantly what type of the customers the company want to do business with. Then analyze the requirements, wishes and behaviour of them. Even if it’s needn’t to look like the behaviour is the important too. For example is very important what the customers find as ‘good’ and ‘bad’. It could be environmental friendliness, sponsorship of benefit events, or something entirely different. Because of the nature of the construction the environmental friendliness is very important for construction companies.

GLOBALISATION

Business is now very advanced and there is significant competition in almost every market in Europe. The well known and long established companies are encountering much younger, modern and enthusiastic ones. Where only a few companies operated there are now many. Information technologies have advanced business practices to a higher level, where speed, quality and price matter the most. If a contemporary company wants to sustain these competing forces it needs to evolve with the market and with its customers too. There is no one “true” way what to be successful. Every company is different and each needs a different approach to the challenges of change. However, the external environment is changing dramatically. No longer is competition restricted to geographically constrained competition. Global communication and rapid and effective mass transport means that industry has been opened to world-wide competition. This is noticeable within construction activity in Europe. Many of the larger contracting organisations are multi-national. Even those remaining as single nationality organisations are regularly executing projects in other countries. This expansion of the competitive arena needs to be accompanied by a global marketing strategy. Basic marketing – as described in this manual - includes many activities necessary to meet this global challenge. Probably the most common response from people to the question “What is global marketing?” would be - advertisement. That’s partially true of course, but global marketing is far more than advertising.


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The first requirement is that global marketing should define what the global customer needs and wants. With so many global competitors there is necessity for the organisation to firstly discover what the customers want and need and then start to produce it. However, this idea is not new. For comparison, look back about sixty years ago, around 1950, to when companies cared little for what the customers needed. They started to produce some items without even identifying who wanted to buy it. The expectation was that a global competitor could produce an item that had been identified as being needed in the home nation and export that item unchanged to other countries. This has subsequently been shown to be a badly perceived strategy. In particular, in construction, many companies sought new markets, in Africa and South America for example, and suffered dramatic and very expensive failures. This approach is not viable nowadays. Global marketing is here to tell an organisation what to produce and for whom and where it is required. A requirement of this global approach is that marketing should define a strategy as to how to communicate with global customers. If a company wants to produce an item for a specific type of customer, there is a necessity to know how to communicate with them. The organisation must know how to let potential customers know there is something for them and how to raise their awareness and interest in it. This includes many tasks from the design of advertising, maintaining of company’s brand, to creating an appropriate corporate identity. The company marketing plan should define the sales strategy for each particular product the company offering in each particular geographical region. Marketing, and other research, done by the marketing department of the company, should be the starting point for the whole company business strategy. If it’s clear what to produce and for whom, and where it is required, there is then a clear task for the management – how to do it effectively and efficiently. The company needs to define its global business strategy to achieve its new goals. This may involve self-improvement and changes inside the company currently called business process reengineering. Many processes and standards will need to be changed according to the newer goals. After those changes have


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been done there will come other opportunities to do business and the whole cycle will be repeated. But this is correct only if companies have self-awareness and are constantly improving themselves to survive in today and future global markets.


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TOM II: BUDGETING. COSTS OF OPERATION OF A CONSTRUCTION-ASSEMBLY

COMPANY

INTRODUCTION

Tom II is dedicated to budgeting in construction and assembly companies. The budgeting system is a component of the IT management system, and it was presented in the book from this perspective. In the first place, we discussed the nature and objectives of budgeting. In particular, we present the components of the budgeting system, since it cannot be limited only to numerical tables. In each chapter, we pay particular attention to one of the components of the budgeting system, including:

• the budget structure, • flow of information and data necessary for budgeting, • planning and control of resources, • preparation of budgeting instructions, • organization of the budget control system, • preparation of a report on activity of a company, • organizational aspects of the functioning of the budgeting system in a

company. Tom II consists of 5 chapters. In the first one, we discuss the nature and structure of the budgeting system, as well as a budget of a construction and assembly company. The budget of receipts and expenses and revenues and costs of an enterprise as a whole has been presented here. In the further part of Tom II, we present the significant areas of enterprise operation, pertaining to:

• construction • infrastructure to support performance of construction works, using the

example of the equipment and transport resources,


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• organizational units, which are designated to assist enterprise management.

The above areas of operation were discussed in the following format: costs of operation, budget and control of costs and resources. Thus, we present the detailed identification and mechanisms and reasons for costs in these areas of the enterprise operation. Next we present the rules and examples of budgets. Each chapter ends with the budget control. This section discusses the organization and use of the adequate tools for monitoring of the used resources of the enterprise. The last chapter is dedicated to devising of an enterprise operation control system. It discusses the nature of control of operation of an enterprise, implementation of the profit and loss account and the corporate chart of accounts within the scope included in the budgeting system. Budgeting is used increasingly often for effective enterprise management. The objective of the present book is to assist the Reader in construction of a budgeting system in a construction and assembly company. Therefore, the book contains numerous examples, which may be adapted to creation of an individual budgeting system. The content of the book was based on my cooperation with employees of construction and assembly companies and the needs of participants of trainings in this regard.


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CHAPTER 8

BUDGETING IN ENTERPRISE MANAGEMENT

LEARNING OUTCOMES

This chapter informs you about:

1. What is budget and how it can be used in management of construction and engineering enterprise.

2. Elements of budgeting system for a construction and engineering

enterprise. 3. What are the advantages of budgeting system. 4. What responsibility points can be identified with respect to costs in a

construction and engineering enterprise. 5. How to prepare a budget for a construction and engineering enterprise.

THE NATURE AND OBJECTIVES OF BUDGETING

A budgeting system is a component of the informational management of a company. It allows for organization of the information and data set of the enterprise, ensuring its proper management. Implementation of the budgeting system allows for organization of the scope of duties of employees, who are responsible for individual areas of the company functioning. In particular, this


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enforces real responsibility of the managers of various organizational units established for the purpose of company management. It is due to the fact that the budget includes the tasks to be performed in a given period and the resources necessary for their performance. The advantages of a properly implemented budgeting systems will be visible when certain conditions are met. The budgeting process is a set of functions performed in accordance with the appropriate rules and methods of the process, which lead to preparation of the budget and its use in company management. It includes:

• devising of the budget, its preparation and approval, • the budget performance, • budget control.

A budget is a plan of action expressed in quantitative form (natural units) and in value form (monetary units) for a given scope of activity in a given time period. Budgeting is used increasingly often in company management, which can also be viewed as a certain manner of organization of work at an enterprise. The procedures of preparation of information, processing and circulation of documents and decision-making are specified. This is most often associated with decentralization of many decisions thanks to the established scopes of competences of managers and employees, who are responsible for individual fields of activity of the enterprise, subjected to budgeting. The basic objectives, which can be achieved thanks to implementation of the budgeting system, include:

• enabling implementation of the approved strategy of activity of the company,

• assistance in work planning and organization, • planning of engagement and use of material, human, financial and

intangible resources, • ensuring coordination of activities of various organizational units of the

enterprise, • getting familiar with the level of revenues at the planning stage, • getting familiar with the level of expenses at the planning stage and not

at the stage of payment, • motivating of the managerial staff and employees to act rationally and

effectively, • control of the level of planned and born costs of products and activity of

the enterprise,


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• lowering of the level of risk and uncertainty in operation of the enterprise,

• rational management of the enterprise resources, • monitoring of activity of the enterprise, • assistance in assessment of work of employees.

Budgets are only tools facilitating management of an enterprise. Like in the case of any other tool, it is necessary to learn to use the budgets. A properly implemented budgeting system provides the following advantages for the enterprise managers1:

• it facilitates the management of the enterprise, • it allows for planned and not spontaneous business operation, • it changes the mentality of employees, • it allows for a reliable assessment of activity of various units of the

enterprises, • it allows us to get familiar with the causes and mechanisms of creation of

costs in the enterprise, • it separates the management and enterprise maintenance costs from the

cost of completion of construction orders and production costs, • it creates awareness of the costs born by the enterprises among

employees of various levels of the organization, • it allows for a better cooperation between various organizational units of

the enterprise, • it provides information for the needs of company management, as well as

individual organizational units, undertakings implemented etc. • it allows for successful implementation of strategic plans, • it allows for achievement of the defined objectives, • it allows for conscious management of processes in the enterprise, • it allows for conscious and skillful management of the enterprise costs.

The budgeting system is one of the types of informational systems, and like any system of this kind, it requires procedures that allow for its proper functioning. If there are no well prepared procedures of functioning of the informational system – the budgeting system – its objectives will not be achieved and the associated advantages cannot be enjoyed. An informational system is an integrated team of people, means and methods of gathering, coding, decoding, storing, processing, finding and communicating,

1 More information on the advantages of budgeting in a construction enterprises can be found e.g. in: [45], [59], [100].


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as well as updating and use of data necessary for the managerial staff to make decisions and to manage [91]. Therefore, for the sake of the proper functioning of the budgeting system at the enterprise, like in the case of any informational system, appropriate procedures must be devised [113] for:

• gathering of information, • processing of information, • transfer of information to the appropriate organizational units, • presentation of information (original and processed).

The budgeting system must reflect the processes taking place in the enterprise, its organizational structure, it must enable reporting and monitoring of individual areas of its activity. Therefore, it must encompass:

• the operational budget of the enterprise, • partial budgets (of revenues and costs), • the budget of revenues and expenses, • instructions for budget preparation, • budget control, • the corporate chart of accounts in terms of budgeting, • the IT system managing the budgeting process, • management of the budgeting system in the enterprise.

The budgeting system of the enterprise must include the above elements. Otherwise, the conditions of proper functioning of the budgeting system will not be met by the enterprise. This is a starting point for preparation of individual components of the budgeting system. It will allow for organization of works associated with preparation, and then with implementation and functioning of the budgeting system in the enterprise. The company budget is only a part of the budgeting system. Equally important is designing of other components of the system, such as:

• the budgeting book, • the rules of functioning of budget control, its components and reporting, • individual budget forms, • an appropriate set of analytical and control accounts in the accounting

system of the enterprise2, • a profit and loss account of the enterprise and individual types and fields

of its activity,

2 The financial and accounting system is a basic source of information on the property and financial situation of the company.


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• an IT system, which in practice is to manage the enterprise budgeting system,

• a method of management of the budgeting system in the enterprise.

The functioning of the budgeting system must be described in such a way as to make sure that each user of this system may use it efficiently. Therefore, the so-called budgeting book must be created. A budgeting book is a set of documents pertaining to the functioning of the budgeting system. It includes, among other things, the instructions for devising of individual budgets, the budget forms, resolutions concerning the functioning of the budgeting system of the enterprise, budget drafts, rules of preparation of reports on budget performance, a list of employees responsible for preparation of budgets etc. The content and number of instructions for budget preparation will depend on the devised model of the budgeting system for the enterprise and the real implemented partial budgets and the main budget structure. However, it is necessary to keep in mind the devising of the budget preparation instructions as their lack in the future may make it difficult to prepare budgets and hinder the proper functioning of the budgeting system in the enterprise. Therefore, the budgeting book is sort of a guideline for the budgeting system of the company. Budget control is comparison of the financial and non-financial data contained in the budgets with the results achieved, verification of assumptions and selection of means and assessment of implementation of the processes taking place in the enterprise. Therefore, the process requires the following tools: appropriately devised partial budgets, the corporate chart of accounts, the profit and loss account3 and a report on budget performance. The listed components must be correlated. Otherwise, it will not be possible e.g. to compare the planned and real costs, if the cost calculation formats are different in the budgets and in the corporate chart of accounts. It is very important to prepare the budget using the appropriately devised budgeting forms. It forces the manager to act in accordance with a planned algorithm of proceeding. It allows us to limit the expenses of the enterprise for various purposes at the stage of planning of its activity. At this stage, it is already possible to verify the budgets – not only after receiving the data from

3 The profit and loss account does not have to take into account the legal regulations in force, if it is prepared solely for the internal needs of activity of the company.


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the accounting department. At such time, it is too late for an appropriate response or it is more difficult. An important component of the budgeting system is the corporate chart of accounts within the scope subject to budgeting. The information and data from the general ledger of revenues and costs must, on one hand, allow for preparation of reports resulting from the legal provisions, and on the other – for management of the company, including the making of the appropriate decisions. In particular, from the point of view of the proper functioning of the budgeting system, preparation of plan-performance breakdowns and reports; a component of these is the profit and loss account. Also information and data from the financial and accounting system will be necessary to prepare a report on activity of the enterprise. A division of a construction-assembly enterprise into areas of responsibility and separation of processes and cost centers will be helpful in creation of a corporate chart of accounts, but also in preparation of the enterprise budget structure. The exemplary general ledger solutions for various fields of activity of a construction-assembly enterprise have been presented in works [61], [62]. A report on budget performance must take into account: the profit and loss account, assessment of individual areas of activity of the enterprise, in particular the results obtained for individual construction projects, the degree of use of main resources of the enterprise, in particular the transport and equipment units etc. The report structure and its content must be planned at the stage of devising of the budgeting system. The budgeting system of a construction and assembly enterprise must be managed by a dedicated IT system, which takes into account the specific features of such activity. A budgeting management system must enable:

• defining of partial budgets, • aggregation of partial budgets in accordance with the provided criteria, • approval of individual budgets automatically by the superior, so that

after the preparation date no changes can be entered in it without the superior’s approval,

• defining of access to separate budgeting areas, • employee access to the network budgeting system, • automatic registration of budget printouts, • cooperation with the financial and accounting system, • cooperation with a spreadsheet,


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• automatic presentation of the level of advancement of budget performance,

• a multi-stage and a multi-block profit and loss account, • defining of business models.

These are the basic requirements pertaining to the programme managing the budgeting system. If the software installed does not meet the specified conditions, we may expect that the managers will not be able to use fully the advantages of a well prepared and implemented budgeting system. The budget of a construction and assembly enterprise will not just “happen”. It needs proper management. Therefore, it is necessary to specify in advance the department or persons responsible for management of the entire budgeting system of the enterprise, that is, who will:

• supervise the budgeting system of the enterprise, • monitor the deadlines associated with budgeting, • prepare the enterprise budget and the partial budgets for various areas of

activity of the enterprise, • prepare the budget performance report, • verify the accurateness of budgets prepared and delivered to the decision

makers.

The consequences of introduction of a budgeting system include the change in the scope of responsibility of managers, introduction of organizational changes in the enterprise, as well as a change in the mentality and customs of the employees. Therefore, advantages of the budgeting system can be enjoyed if:

• the scopes of competences of managers and departments are organized for the sake of the functioning of the budgeting system,

• centers and areas of responsibility for revenues, expenses and cost centers are defined,

• a unified IT system is devised for the purpose of functioning of the budgeting system in order to allow for aggregation of partial budgets

• the corporate chart of accounts is adjusted with regard to ledger of revenues and costs of operation of the enterprise for the needs of the functioning of the budgeting system,

• tasks to be performed, specified in the budget, are effectively enforced, • instructions for preparation of individual budgets are devised, • the resolutions passed with regard to the functioning of the enterprise

budgeting system are respected,


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• the management board of the enterprise is genuinely interested in the budgets of individual areas of activity,

• the demands arising as a result of functioning of the budget control system are satisfied.

Lack of familiarity with the functioning of budgeting in the enterprise leads to invalid devising and – as a result – invalid functioning of the budgeting system. The individual components must be identified and they must constitute an entity in form of the entire system. Otherwise, budgeting will not bring the expected results. Unfortunately, in practice, this is not always kept in mind. As a result of such activities, the budgeting system is not functioning properly in the construction and assembly companies.

THE BUSINESS MODEL OF CONSTRUCTION AND

ASSEMBLY ENTERPRISES

Every construction and assembly company operates in a specific way, usually specializing in a selected construction process. Some enterprises construct facilities such as apartment buildings, waste treatment plants, or public buildings. Others specialize in management of parts of the building processes, for instance, rendering specialist equipment and transport services, producing steel structures, producing concrete and delivering it to construction sites etc. Usually, such works require specialist qualifications of employees and the adequate infrastructure to allow for implementation of orders of this type. The business models of construction and assembly companies may vary. This is translated to:

• the ability to complete construction orders and services supporting their completion,

• the resources owned allowing for implementation of these tasks, • division of the enterprise into fields of activity, • organization of the enterprise, • and its organizational structure.


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The above components influence the number of major processes specified, and thus the shape of the budget of a specific construction and assembly company. This will translate to the responsibility and cost centers. A starting point for creation of an enterprise budget is selection of the areas of responsibility, processes and cost centers4. This allows us to determine:

• the areas of operation, • processes taking place in the enterprise, • resources at the disposal of the enterprise, • organizational units in the organizational structure and their real tasks, • the mechanisms and causes of costs in the enterprise.

Determination in an enterprise of the responsibility areas, processes and cost centers will depend largely upon the business model, which determines the activity of every company, but also upon its budget structure. Therefore, depending on the needs of the users, it will be more or less developed. An important issue is identification and selection of processes, which influence greatly its further functioning. In particular, the main processes are to be identified in the following key areas of activity of the enterprise:

• implementation of construction works, • maintenance of resources of the enterprise, • management and maintenance of the construction enterprise.

Identification of processes starts with the basic activity, which is completion of a construction order, or a construction project. Construction may be defined as performance of a construction facility or facilities in a specific place, as well as reconstruction, development, extension and rebuilding of a construction facility. Efficient organization of construction works and rational use of resources on the construction site is decisive for the financial result of the entire enterprise. In contracting companies, the following construction processes can be identified:

• preparation of the cost estimate bid for the investor, • preparation of documentation associated with the planned completion of

the construction order, 4 Division of an assembly and construction enterprise into responsibility and cost centers has been described in the article [67]


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• organization of the construction site, • organization of the construction works, • providing of the necessary resources for implementation of the

construction works, • construction management, • coordination of construction performance, • control of construction performance, • construction settlement.

A construction and assembly company usually has to participate in a tender for rendering of construction services. Therefore, it should prepare the proper documentation on the activity of the company, which is defined in the Terms of Reference (ToR) and present a bid cost estimate or simply propose a price, for which it is able to complete the order. Prior to commencement of construction works, it is necessary to prepare the construction site. Then it is possible to initiate the actual construction works. The construction works require the proper organization. This is associated with preparation of a schedule of completion, delivery of materials, construction equipment, steel structures, tools etc. and specialist teams in the appropriate order. This requires coordination of works of various departments (such as procurement, equipment and transport depot, organization and legal department). In each agreement for completion of a construction order, the conditions of settlements with the investor are specified. Thus the company services must prepare the adequate documents, record the bookkeeping evidence associated with the revenues and expenses with regard to a given undertaking. It is also in the interest of the management board to control the progress of construction works. This, on one hand, is dealt with by the controlling department in terms of finances, and by the department of the production director on the other hand when it comes to specialist services. Rendering of construction services requires the appropriate building equipment (such as diggers, bulldozers, cranes, transport for relocation of equipment from one construction site to another or transport of construction materials). The equipment and transport depot performs the following main processes:

• maintenance and operation of construction equipment,


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• maintenance and operation of transport units, • maintenance and operation of the depot buildings, • maintenance of human resources, • maintenance of cleanliness and order in the depot area, • maintenance of security in the depot, • services on behalf of the depot and contractors, • depot management.

The transport and equipment units require proper operation, specialist management, appropriate maintenance, which is associated both with their security at the construction site and within the depot area. Also in the area of the equipment and transport depot, safety, cleanliness and respecting of the occupational health and safety provisions is required. Another important process that requires identification is management and operation of the depot. This pertains to management of the transport and equipment units. Most often, the dispatcher takes care of that; the dispatcher’s task are the general logistic processes with regard to the resources in order to use them in the best possible manner. This fact is associated with the problem of planning of routes and the appropriate use of the owned potential. It is also necessary to plan relocation of construction equipment to the sites, settle the time of work of drivers, operators, individual units and settle the materials and fuels. During the planning of use of individual units it is necessary to take into account their shutdown for the purpose of renovation and maintenance. Therefore, it is necessary to ensure management of the depot, which will take over some of the activities of the dispatcher and the depot manager. Usually, the depot manager or director is responsible for its efficient operation, depending on the organizational structure and size of a given company. Therefore, it is good to identify the costs of depot administration and management in the budget. Every construction and assembly enterprise requires accounting, human resources management, control of activity and other support processes, discussed earlier. These processes are implemented through identification, in the organizational structure of the company, of specialist organizational units or ordering of a given process (such as outsourcing of accounting services). The main processes at a construction and assembly company, mentioned above, must be translated to its budget preparation. Perhaps other processes could be identified as well. This depends, however, on the applied business model and


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the detailed object of activity of the company. In the further part, it is necessary to assign processes to the appropriate areas of activity of the enterprise and identify the key cost centers. An exemplary division into areas of responsibility, processes and cost centers in a construction and assembly company is presented in table 8.1. Table 8.1

Areas of responsibility, processes and cost centers in a construction and assembly enterprise

AREA OF RESPONSIBILITY AT THE

COMPANY COST CENTERS/ PROCESSES

CONSTRUCTION construction facilities construction section plant and facilities human resources

EQUIPMENT AND TRANSPORT DEPOT

equipment units, e.g. loaders transport units administration and social buildings garages human resources depot operation depot management

WORKSHOP production order machines and equipment building human resources workshop management

PROCUREMENT procurement department warehouses

GENERAL INFRASTRUCTURE administration building parking

ENTERPRISE OPERATION financial and accounting department bid and cost estimate team administration department management board office

ENTERPRISE MANAGEMENT board of supervisors management board of the company department directors

Source: own study on the basis of [67]


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It is obvious that not in every construction and assembly company the fields of responsibility, processes and cost centers are exactly as specified in table 8.1. As it has been mentioned, this will largely depend upon the approved business model, which determines the activity of the company. It should also be remembered that many cost centers may account for individual processes and their implementation in the enterprise. On the other hand, the structure of the enterprise budget depends on the information demands of the management board and the possibilities of its functioning in the enterprise (among other things, on the staffing capacity, specialist software owned, need for control of operation etc.). Therefore, identification of processes, responsibility areas and cost centers is very important as a starting point for preparation of the budget of a construction and assembly company. However, regardless of the subject of activity and the legal and organizational structure of assembly and construction enterprises, it is always necessary to take into account the entire construction process. It requires engagement of materials, assets, human resources and finances. In particular, it is also important to emphasize the intangible assets, such as the business model of the enterprise, its organization, the ability to organize construction works, to manage the construction enterprise, the individual processes and the proper use of the external resources. In the present economic situation, taking into account the functioning of companies on the competitive market, the intangible assets of the company are also of great importance for its development. In the further part of the book, we will focus on budgets of construction and assembly companies, which deal with construction contracts of varying scopes.

ASSEMBLY AND CONSTRUCTION COMPANY BUDGET STRUCTURE

In the structure of the company budget, we can identify the main budget of the company, partial budgets and the budget of revenues and expenses.


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The main budget is a numerical general ledger of operation of the enterprise. Its form may vary. It depends mainly on:

• the business model applied • the company management needs • sector of operation of the company • the types of activity of the company, • the time horizon, • factors influencing the budget preparation.

The main budget contains a set of detailed operating budgets and pro-forma financial reports pertaining to one year or shorter periods (one month, one quarter). On the other hand, the operating budget is most often presented in a quantitative manner and/or according to its numerical value, that is, expressed both as natural units (such as pieces, hours, meters etc.) and monetary units. The operating budgets include the construction budget, the equipment and transport depot budget, the direct material cost budget etc. An important component of the budget of every company is the financial budget. The financial budget is expressed only in monetary units and it is prepared on the basis of data from operating budgets. The financial budget reflects the financial means to be used or achieved in the future period. One of the basic conditions for operation of a construction company is maintaining its financial liquidity. The financial budget includes a budget of revenues and expenses. It is prepared on the basis of operating budgets. Thus it is very important to make sure that these budgets allow for a better management of the company finances. The budget of a construction and assembly company must take into account many components. An exemplary diagram of an operating budget of a construction and assembly enterprise with a developed organizational structure has been presented in fig. 8.1.


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Fig 8.1 Construction and assembly enterprise Source: own study In the budget diagram presented in fig. 8.1, we can identify the partial budget of individual fields of activity of a construction and assembly enterprise. The partial budgets take into account the fields of activity of the company, selected processes or cost centers. This diagram also takes into account the need to maintain the infrastructure, in the case of which the maintenance and functioning cost are not low. On the basis of the diagram in fig. 8.1, the following partial budgets can be identified:

• the sales budget, • the budget of costs of construction orders, • the budget of costs of transport and equipment depot, • the budget of workshop costs, • the budget of company management costs, • the budget of company maintenance costs, • the budget of infrastructure maintenance, • the general costs budget.

Construction production Equipment services Workshop services

Renovation services Transport services Renovation services

Equipment services Construction 5

Maintaince of transport units Maintaince of machines & equipment

Transport services Construction 4 Maintaince of equipment units Building maintaince Workshop services Construction 3

Building maintaince HR maintaince

Other services Construction 2

Maintaince of human resources Workshop maintaince and administration

Sale of materials Construction 1 Dept maintaince & administration THE SALES BUDGEST CONSTRUCTION ORDER

COST BUDGETEQUIPMENT & TRANSPORT DEPOT

COST BUDGETWORKSHOP COST

BUDGET

INFRASTRUCTURE MAINTANCE COST

BUDGET Direct materials Construction management (prod) division Supervisory Board Building maintaince Warehouse maintaince Production prep. division Management Board Computer network Procurement division Accounting division Directors Area & parking maintaince

Controlling division

Organization & Low Dept

Administration & HSS Dept Marketing Dept

CONSTRUCTION & ASSEMBLY ENTERPRISE BUDGET

BUDŻET KOSZTÓW OGÓLNYCH

Construction 6

ENTERPRISE MANAGEMENT COST BUDGET

ENTERPRISE OPERATION

COST BUDGET PROCURMENT COST BUDGET


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Each of the partial budgets has the appropriate groups of revenues and costs within its internal structure. The sales budget encompasses revenues from services implemented by the company, as well as from sale of products. The services pertain to completion of construction orders, services of the equipment and transport depot and services of the workshop, as well as sale of materials recovered from the construction site. The basic area of operation of contracting companies is performance of construction works. Thus the most significant cost budget in a construction enterprise is a budget of costs of construction orders. Therefore, for each construction project, a budget of its costs is prepared separately. Depending on the organizational structure and size of the company and the model of its operation, it has the appropriate facilities for implementation of construction projects. These include in particular the equipment, transport, construction plants or workshops, which render services associated with maintenance at the appropriate level of infrastructure or which complete orders e.g. for construction of steel structures. Within the framework of the budget of costs of a transport and equipment depot, we can identify the costs of rendering services, maintenance of transport units, equipment units, human resources, buildings, management and administration. Each of these cost groups has its individual calculation format. Moreover, for each of these cost groups we identify different cost causes and mechanisms. Another group of partial budgets pertains to the costs of management and operation of the enterprise. These include the costs of individual organizational units, such as the accounting department, the controlling department, production preparation etc. or company management. Depending on the organizational and legal form of the company, we can identify the costs of management and the supervisory board. In the case of a large company, we can also identify the costs of operating directors, who are responsible for various areas of activity of the company. This scope should be taken into account in the organizational regulations and competences of individual employees. The last group of partial budgets pertains to the costs of procurement, maintenance of infrastructure and other costs born by the company. Within the framework of this group, we can differentiate the costs of maintenance of


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warehouses, administration buildings and adjacent areas, as well as the parking lots or maintenance of the computer network and functioning of the procurement department. Other costs pertain, for instance, to the audit of the financial report, unsettled VAT, the corporate social benefit fund etc. Of course, the above qualification and content of the operating budget of the enterprise, and the partial budgets therein, can be completely different. The informational content of individual partial budgets will vary, because they pertain to various fields of activity of the enterprise. However, it is difficult to devise and then prepare a budget without the sales plans, technical and technological designs, knowledge of the standards or the production process or the appropriately prepared information base. The partial budgets are greatly influenced by the applied model of cost accounting of the enterprise. Presentation of data and information contained in the budget should be prepared accordingly, because one of the main budgeting tasks is support in decision-making. Thus every construction and assembly company must have a budgeting system for its individual needs. The system must be incorporated into the information system of the company management. Otherwise, the managers will not be able to take the full advantage of the system benefits.

THE ENTERPRISE REVENUES AND COSTS BUDGET

Sale of services rendered by a construction and assembly company and sale of products manufactured by it serves as a basis for a sales budget. The sales budget is the basic budget, on the basis of which a budget of inflow of money from investors or ordering parties or recipients of products manufactured is prepared. It should be remembered that implementation of construction works by a company requires substantial material and HR expenditures, which are only later expressed as financial expenditures. If the company fails to obtain these means in the appropriate time from its clients, it must incur loans, which is


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associated with interest. This reduces the profitability of the construction order and thus the entire enterprise. The enterprise budget must take into account the receipts, expenses, revenues and costs. These terms are of economic importance, as well as of practical significance in management of corporate finances. Revenues are amounts receivable by the enterprise due to sale of its products, services, goods, fixed assets such as machines etc. Issue of a bookkeeping document, such as an invoice, does not automatically result in receipt of these amounts by the enterprise. The receipts of the enterprise due to sale will be effected when the agreed amount is transferred to the bank account or the cash office of the enterprise. It is also necessary to differentiate between expenses and costs. Expenses are all disbursements of financial means from the cash office or the bank account of the enterprise due to payment for specific materials, services or payment of remuneration to employees or payment of dividend to shareholders, payment of income tax to the revenue office etc. Not all of the expense items mentioned earlier are costs. An expense has a wider meaning than a cost. Costs constitute the deliberate use of assets and value of live work used to manufacture a given product or to render a service. Thus an expense associated with purchase of a machine will be reflected in the costs of operation of the enterprise in form of depreciation costs. The machine is not used for a single-time manufacturing of a product, but it will be used many times over a longer period to manufacture products. Thus the expense associated with purchase of the machine will be included accordingly in the costs of manufacturing of the product, taking into account, for instance, the production amount and time of operation. Payment of income tax or repayment of a loan installment will not constitute a cost of the enterprise, although we are dealing with financial expenses here. Depreciation of the machine is a cost of the enterprise, but it is not an expense. Differentiation of these terms is very significant from the perspective of creation of budgets of revenues and costs, as well as incomes and expenditures of a construction and assembly enterprise. The greatest share in the total income from sale of a contracting enterprise constitute the incomes from completion of construction orders. Other income, which can be attained, includes income from equipment and transport services,


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as well as sale of e.g. concrete manufactured. If the enterprise has workshops, it may additionally render services for its clients. It allows it to use its assets better. It is necessary to keep in mind that if the fixed assets owned, such s cars, cranes, machines etc. are not working, the enterprise is not making money. Thus the unit costs of its services rendered on behalf of its clients through construction orders are higher. Thus a question arises whether the enterprise has not exceeded the reasonable investment level. The budget of operating revenues must take into account all sale items. However, planning of each of these items will be different. An exemplary sales budget is presented in table 8.2. Table 8.2

Budget of revenues from sale of the enterprise

,,Tel'' Sp. z o.o.

BUDGET OF REVENUES FROM SALE B-1 March 2007

(month) (year)

No. Item name Value in PLN Structure -1- -2- -3- -4-

1. Income from construction services 866 442,53 60,96%

2. Income from sale of concrete 410 000,00 28,84%

3. Income from sale of equipment services 80 000,00 5,63%

4. Income from sale of transport services 30 000,00 2,11%

5. Income from sale of workshop services 10 000,00 0,70%

6. Income from sale of lab services 5 000,00 0,35%

7. Income from other sales 20 000,00 1,41% 8. Total income 1 421 442,53 100%

Source: Own study. Exemplary data Each of these revenue items will be planned differently. Revenues from completion of construction orders will depend on the schedule of works applied. Each stage of the completed construction works is confirmed by a protocol of acceptance; on its basis, an invoice for the investor is issued in accordance with the approved cost estimate. Thus the starting point for planning of this revenue item is familiarity with the schedule of acceptance of works


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separately for each construction project implemented. In the above example, a monthly revenue budget is presented. Revenues pertaining to sale of concrete will depend mostly on the agreements signed with recipients. They specify when they would purchase concrete and provide the dates, because concrete cannot be stored. Usually, receipt of concrete by the contractor is strictly related to implementation of construction works. Thus it is received directly from the concrete plant. Another revenue item includes revenues from equipment and transport services. These revenue items may be planned on the basis of values obtained in the previous periods or on the basis of orders of contractors. In practice, the depot manager estimates the value of revenues on the basis of his or her experience. The manager uses information and data from the previous periods, as well as from negotiations with contractors. It should also be kept in mind that the management board establishes objectives to be achieved in all fields of activity of the enterprise. Thus the value of this item may result simply from the assumptions made by the management board. Depending on the type of workshop services offered, the revenue value will be planned on the basis of agreements or data from previous periods. For instance, in the case of completion of orders e.g. for steel constructions, the revenues will be planned on the basis of agreements signed with the contractor since every order like this is individual. On the other hand, services such as repairs or maintenance of equipment or transport units are rendered on a “day-to-day” basis. Thus the revenues from sale of these services will be planned mostly on the basis of the previous periods, taking into account the seasonality. Revenues from other sales may pertain to various items. In particular, this revenue item includes: services from space lease, re-invoicing of telecommunication services, rental of equipment, lease of buildings etc. or other non-periodical revenues. These items are most often included in the budget on the basis of agreements signed with contractors. The number of revenue items in the budget of revenues from sale will depend mainly on the object of activity of the construction and assembly enterprise and its resources. In particular, it depends on the market of its activity. For instance, table 8.2 includes revenues from sale of laboratory services. Such budget could just as well include revenues from sale of goods. Another example to be considered is the item of sale of materials recovered from the construction site.


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This item can be taken into account in the revenues budget of a given construction project, since most often these materials come from completion of this construction project or demolition of various facilities, or, for instance, sand removal. The budget of revenues from sales may also include separately the item ‘revenues from sale of materials recovered from the construction site’. This will depend on the structure of other partial budgets, such as the procurement budget, or on decisions of the company management. There is no single rule here. This is the strength of the budgeting system. The structure of the budget of revenues from sale presented in table 8.2 pertains to a single month. The budget structure itself will be applicable also to the quarter, year or any other period. The difference will be that if we, for instance, prepare an annual budget, the assumptions for this budget will be less precise than e.g. in the case of a monthly budget. It is due to the facts that when we prepare an update of the budget for the subsequent month, we are able to state more precisely the number of tasks to be completed than one year earlier. Thus preparation of a monthly budget is more reliable. It should be kept in mind, too, that both processes, that is, preparation of the annual and the monthly budget, are used for different purposes. The same pertains to cost budgets. Creation of an enterprise cost budget requires making of certain assumptions, which are most often a result of the applied strategy of operation of the enterprise and its operating tasks. The operating tasks pertain in particular to the schedule of implementation of individual stages of construction projects. The schedule of construction works determines the demand for materials, equipment, transport, human resources and finances. Thus the demand for resources will be decisive for the shaping of individual partial budgets, and as a result, this phenomenon will influence the budget of the enterprise costs. The enterprise cost budget structure must take into account the needs of the managers. The recipients of this budget are the members of the management board, the financial director, the chief accountant or the controlling department. Thus its structure must be general on one hand and on the other – it must present the costs of operation of the enterprise, the processes, maintenance of the infrastructure and individual organizational units. This budget is to be a component of company cost management. Thus the structure of the cost budget for each construction and assembly enterprise will be different. The informational scope of the costs budget of a construction and assembly enterprise may vary depending on its recipient. An exemplary cost budget structure is presented in table 8.3.


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Table 8.3 Budget of company costs according to type

,,Tel'' Sp. z o.o.

COMPANY COST BUDGET B-3 March 2007

(month) (year)

No. Cost item Value in PLN Structure -1- -2- -3- -4-

1. Depreciation 26 580,00 6,65%

2. Consumption of materials & energy 73 750,00 18,46%

3. External services 67 370,00 16,86%

4. Remuneration 147 665,00 36,96%

5. Additional remuneration charges 30 020,29 7,51%

6. Employee benefits 20 330,00 5,09%

7. Taxes and charges 9 243,00 2,31%

8. Other costs 24 605,00 6,16% 9. TOTAL 399 563,29 100%

Source: own study. Exemplary data.

The enterprise cost structure presented in table 8.3 informs us only of the value and composition of costs born and their structure according to type. Thus it does not mention the costs:

• of identified types and in fields of activity of the enterprise, • of construction projects being implemented, that is, the basic activity of

the enterprise, • of maintenance of the production infrastructure and general

infrastructure, • of identified organizational units of the enterprise, • of marketing activities, • of management and operation of the enterprise etc.

Thus, in practice, the informational value of such budget is low from the viewpoint of enterprise management. Due to the weaknesses of such cost budget, the costs of individual areas of activity of the enterprise, processes or important cost centers are not sufficiently


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taken into account in the planning process. Thus it is later difficult to control the results of the enterprise effectively. The budget of costs of the enterprise should take into account the areas of activity of the enterprise, because its informational value increases, thus increasing the comfort of its management. The cost budget format, taking into account the identified areas of activity of the enterprise, is presented in table 8.4. Table 8.4

Enterprise costs budget according to fields of activity

,,Tel'' Sp. z o.o. B-1

THE COST BUDGET ACCORDING TO AREAS OF ACTIVITY OF THE ENTERPRISE

March 2007

(month) (year)

No. Name of field of activity Value in PLN Structure -1- -2- -3- -4-

1. Costs of construction projects and their management 156 593,84 39,19%

2. Costs of activity of the fiber-optic group 35 142,80 8,80%

3. Costs of the equipment & transport depot 46 569,40 11,66%

4. Costs of procurement 35 996,92 9,01%

5. Costs of management and operation of the Company 80 220,33 20,08%

6. Costs of marketing activities 10 850,00 2,72%

7. Costs of building maintenance 17 730,00 4,44%

8. General management costs 16 460,00 4,12%

9. Total costs 399 563,29 100% Source: Own study. Exemplary data The costs budget structure presented in table 8.4 allows us to separate the costs of basic operation of the enterprise and the fixed costs of the enterprise, which


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are associated with its management and operation and maintenance of the infrastructure. Also the cost budget takes into account the division into types of works associated with the basic construction activity conducted so far, as well as new directions, such as activity of the fiber-optic group. It is necessary to keep in mind that within the framework of individual fields of activity of the enterprise, it is possible to include the costs of processes or the most important cost centers from the viewpoint of the managers. An exemplary cost budget, taking into account the above aspect, is presented in table 8.5. Table 8.5

The costs budget taking into account the processes and cost centers

,,Tel'' Sp. z o.o. B-2

COST BUDGET OF THE ENTERPRISE According to responsibility areas and cost centers

March 2007 (month) (year)

No. Name Value in

PLN Structure

-1- -2- -3- -4-

1. COSTS OF CONSTRUCTION PROJECTS AND THEIR MANAGEMENT 156 593,84 39,19%

1.1 Construction project ,,Mirków'' 71 975,60 18,01%

1.2 Construction project ,,Bolków'' 57 202,80 14,32%

1.3 Construction department 14 275,74 3,57%

1.4 Department of Production Preparation and Construction Cost Estimates 13 139,70 3,29%

2. COSTS OF ACTIVITY OF THE FIBER-OPTIC GROUP 35 142,80 8,80%

2.1 Fiber-optic column 10 280,00 2,57%

2.2 Department of Fiber-Optic Lines 24 862,80 6,22%


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3. COSTS OF THE EQUIPMENT & TRANSPORT DEPOT 46 569,40 11,66%

3.1 Costs of equipment units 11 560,00 2,89%

3.2 Costs of transport units 7 880,00 1,97%

3.3 Department costs 27 129,40 6,79%

4. PROCUREMENT COSTS 35 996,92 9,01%

4.1 Warehouse 22 551,52 5,64%

4.2 Procurement department 13 445,40 3,37%

5. COSTS OF MANAGEMENT AND OPERATION OF THE COMPANY 80 220,33 20,08%

5.1 Department of Analyses 15 873,10 3,97%

5.2 HR and Organization Department 7 729,85 1,93%

5.3 Accounting Department 20 671,58 5,17%

5.4 Management Board of the Company 35 945,80 9,00%

6. COSTS OF MARKETING ACTIVITIES 10 850,00 2,72%

7. COSTS OF MAINTENANCE OF THE BUILDING 17 730,00 4,44%

8. GENERAL MANAGEMENT COSTS 16 460,00 4,12%

9. TOTAL COSTS 399 563,29 100%

Source: Own study. Exemplary data The cost budget structure presented in table 8.5 allows for better planning and control of the enterprise activity. It includes the costs of fields of the enterprise activity, taking into account their internal structure. If we examine, for instance, the field of costs of construction projects and their management, this field of activity takes into account the costs of individual orders completed, as well as the costs of management of the construction projects. The costs of construction projects implemented are variable costs. On the other hand, the costs of departments, which manage these projects with regard to cost estimates, material planning, settlement of construction projects etc. are fixed costs of operation of the enterprise. Thus such budget structure allows the managers to draw completely different conclusions in comparison with the cost budget structure presented in table 8.3. There is no single model of an enterprise costs budget. The best budget structure is the one, which helps its users to manage the individual fields of activity of the enterprise and the entire enterprise.


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In table 8.5, the costs of activity of the fiber-optic group take into account, in fact, only the resources of this field of activity, without taking into account the orders completed, which are included in the costs of construction and their management. It is also possible to take into account the individual orders in the field of costs of activity of the fiber-optic group. In practice, it is only the issue of making of the decision with regard to the enterprise cost budget by its management board, that is, the user. Thus a lot depends on the awareness and needs of the potential user of a specific budget. Every solution has its strengths and weaknesses. Therefore, when we make decisions in this regard, it is also necessary to take into account the entire budgeting system, including the structure of the profit and loss account, bookkeeping in this regard etc. Therefore, it is necessary to assume a multi-dimensional view of the enterprise cost structure.

THE BUDGET OF REVENUES AND EXPENSES OF AN ENTERPRISE

As it has been mentioned, for every enterprise, one of the most important objectives is to maintain the financial liquidity or to be able to meet their financial obligations. In the case of lack of such ability, the enterprise finds it difficult to obtain contracts, to purchase materials or to obtain good crediting conditions. The risk of cooperation with it increases from the viewpoint of contractors. Thus on the basis of a budget of revenues and costs, a budget of the enterprise’s receipts and expenses should be prepared. The budget of financial receipts will depend largely upon the basic activity of the enterprise, in this case, on the construction tasks completed. In the construction and assembly enterprises, in practice, “invoicing” of construction works takes place at the end of the month. Thus at the end of the month an invoice is issued for the completed construction costs on the basis of a protocol of acceptance, which is attached to the invoice issued. Thus the receipt of funds due to this should take place in the following month. Therefore, it can be


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assumed that the revenues of the previous month are the receipts of the following month. Of course, it does not always have to be like this. This results simply from the applied methods of settlement between the ordering party and the contractor. Also the value of receipts will depend on the “quality” of the contractor or on meeting of its payment obligations. Lack of timely payments is a great problem in the construction and assembly companies. Loss of financial liquidity has often led to declaration of bankruptcy by such enterprises. In the case of equipment and transport services, all depends on their character. If we are dealing with constant cooperation with the contractor – most often it is a monthly settlement, and the invoice is issued at the end of the month. Thus the receipts due to sale of these services can be expected during the following month. On the other hand, unit services are invoiced on a daily basis, and usually the contractor has 14 days to pay for the services rendered. Therefore, if receipts for services of this kind are planned, these facts should be taken into account. In the case of receipts from sale of concrete, the rules are similar to presented above. However, it is always necessary to keep in mind the agreements concluded with the contractors. The agreement may take into account the payments after the order is completed, or advance payments can be made. Thus there are various possibilities in this regard, which results in consequences in form of the value of receipts from sale of services rendered. This aspect should be kept in mind in particular at the stage of signing of agreements with contractors. In particular, the conditions of the agreement are influenced by the market situation and the market position of the enterprise. In the above cases, it is necessary to assume the appropriate level of risk of lack of receipts for various reasons for each of these categories separately. Other receipt items at the enterprises are returns of deposits for the completed construction orders. The contractor of construction works provides a guarantee. It is associated with a deduction of a part of the remuneration for a service. The deposit is returned after the expiry of the warranty for the works performed. Sometimes the deposit is released in parts in accordance with a schedule established earlier. Thus the enterprise has additional receipts. Another group of receipts consists of credit tranches, interest rates, tax returns etc. They should also be included in the revenue budget. The detailed


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breakdown of receipt items depends mainly on their importance. Therefore, it is necessary to focus rather on the significant receipt items and not on amounts, which are small in comparison with the total receipts of the enterprise. Emphasis is put on time needed to prepare a budget of this type, just like any other. An exemplary budget of receipts prepared on the basis of the above rules is presented in table 8.6. Table 8.6

Budget of receipts

,,Tel'' Sp. z o.o.

BUDGET OF RECEIPTS B-1 April 2007 (month) (year)

No. Item name Value PLN Structure -1- -2- -3- -4-

1. Sale of construction works, including: 755 000,00 50,28% 1.1 Construction project 1 200 000,00 13,32% 1.2 Construction project 2 350 000,00 23,31%

1.3 Construction project 3 35 000,00 2,33% 1.4 Construction project 4 90 000,00 5,99% 1.5 Construction project 5 80 000,00 5,33%

2. Sale of concrete 328 000,00 21,84% 3. Sale of equipment services 72 000,00 4,80% 4. Sale of transport services 27 000,00 1,80%

5. Sale of workshop services 9 500,00 0,63% 6. Sale of laboratory services 5 000,00 0,33% 7. Return of deposit 80 000,00 5,33%

8. Receipts from credit tranches 200 000,00 13,32% 9. Interest rates 5 000,00 0,33%

10. Other receipts 20 000,00 1,33% 11. TOTAL RECEIPTS 1 501 500,00 100%

Source: Own study. Exemplary data The enterprise budget of receipts, presented in table 8.6, was prepared using the budget of revenues from sale. Assumptions were made for individual receipt items, specified in the budget. For instance, it was assumed that receipts from sale of concrete would constitute 80% of revenues from the previous month. On


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the other hand, receipts from sale of equipment services constituted 90% of revenues from the previous month. In this case, there are no defined rules of assessment of the level of receipts due. It depends on the market situation, the contractor, the main area of activity or the position of the company on the local and global market. Each order is associated with a specific risk level, which has to be assessed when concluding the agreement with the contractor. The enterprise managers must take into account the fact that they need the finances for implementation of the tasks planned, that is, for implementation of construction projects and rendering of services. They also need to keep in mind their obligations towards their contractors, employees and various institutions. Over a longer time period, the enterprise must work out a financial surplus in order to survive on the competitive market. The financial surplus allows for investments, as well as for more rational management of the enterprise. Therefore, the appropriate structure of receipts and expenses must always be retained. The budget of the company enterprise will largely depend on the receipts planned. The level of expenses planned should not be higher than the level of receipts. Thus to prepare a budget of expenses, we should use the enterprise costs budget, prepared earlier. Each of the cost groups within the framework of individual partial budget is settled differently, because the mechanisms and causes of costs are different. Expenses associated with the construction projects will pertain mainly to payment for delivered materials, equipment and transport services and other services. In this regard, this is in practice a matter of individual solutions applied by the enterprise and its contractors. There may be various solutions. In general, it should be assumed that in the case of longer cooperation with contractors, the payment deadlines are more favorable. In particular, when it comes to materials. Sometimes, advance payments are required prior to delivery of materials or services. It is also necessary to pay immediately for some material or service items, which are to be delivered later to the construction site. In the case of equipment and transport services, there may be a monthly settlement on the basis of settlement of equipment work and the number of trips. This pertains in particular to those contractors, with whom the enterprise has worked for a longer time and there is mutual trust when it comes to financial settlement of the services rendered. In the case of performance of unit services,


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the payments are made on a daily basis. Usually, the payment deadline is 14 days after delivery of the service. However, it depends on the current market situation and the position of partners on the market. Another significant group of expenses is associated with remunerations for employees and the associated derivative expenses. This group of expenses is associated largely with the company regulations in this regard. In practice, these expenses should be associated with the tasks completed. Subsequently, the remuneration is to be paid to employees. Then expenses related to taxes, social insurance etc. is deducted from this remuneration. In this case, the schedule of the related expenses is regulated by the adequate legal acts, ordinances and individual regulations. In the construction costs budget, internal and external services are provided separately. We are largely speaking of equipment and transport services. This division is reasonable, when the budget of construction costs is used for preparation of the expenses budget. Thus in the budget of construction costs, internal equipment and transport services are included in accordance with the approved rules of internal settlement. Most often, the rates are established to include the costs of internal functioning of the entity rendering services. Therefore, the budget of costs cannot be translated directly into the budget of expenses. The expenses of the enterprise are associated directly with the areas of its activity. Thus on the basis of the budget of costs of the depot, expenses for a given budgeting period will be taken into account. These expenses will be associated with renovations of the transport and equipment units owned, purchase of fuels, employee remunerations, taxes, external services etc. This process will pertain individually to every separate field of activity and each organizational unit. Thus on the basis of the budget of costs of individual fields of activity of the company, a budget of its expenses will be established. An exemplary budget of expenses of an enterprise is presented in table 8.7.


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Table 8.7 A budget of company expenses

,,Tel'' Sp. z o.o. , A BUDGET OF EXPENSES B-1 April 2007

No. Expenses item Value in PLN Structure -1- -2- -3- -4-

1. Construction projects including: 685 000,00 45,65% 1.1 Construction project 1 350 000,00 23,32% 1.2 Construction project 2 290 000,00 19,33% 1.3 Construction project 3 10 000,00 0,67% 1.4 Construction project 4 30 000,00 2,00% 1.5 Construction project 5 5 000,00 0,33%

2. Department of Construction 12 000,00 0,80%

3. Department of Production Preparation and Construction Cost Estimates

11 000,00 0,73%

4. Fiber Optic Column 9 000,00 0,60%

5. Department of fiber-optic lines 20 000,00 1,33%

6. Equipment & Transport depot 250 000,00 16,66%

7. Concrete plant 230 000,00 15,33%

8. Workshop 70 000,00 4,66%

9. Warehouse 21 000,00 1,40%

10. Procurement Department 13 000,00 0,87%

11. Department of Analyses 14 200,00 0,95%

12. HR and Organization Department 7 500,00 0,50%

13. Accounting Department 20 671,58 1,38%

14. Management Board of the company 35 945,80 2,40%

15. Marketing activities 12 000,00 0,80%

16. Building maintenance 20 000,00 1,33%

17. General expenses 45 000,00 3,00%

18. Payment of operating loan interest rates 4 300,00 0,29%

19. Income tax 20 000,00 1,33%

20. TOTAL EXPENSES 1 500 617,38 100% Source: Own study. Exemplary data


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The budget of expenses, presented in table 8.7, takes into account the fields of activity and the separated organizational units and the enterprise infrastructure. The structure of this budget is based on the enterprise budget of costs, taking into account other expenses. Therefore, from a given partial costs budget it is necessary to switch to the expense budget. Then we prepare an expense budget for the enterprise. Of course, we need to take into account the internal settlements and elimination of the cost items, which are not expenses. At the same time, it is necessary to keep in mind those items, which are expenses and not costs, such as dividends, loan capital installments. Such budget structure allows the managers, on one hand, to follow the real expenditures of individual organizational units, and on the other – the structure of expenses in the enterprise. The recipients of such budget structure are the enterprise managers and the controlling department. Such structure allows for an analysis of the company operation. In particular, this is true for the fixed expenses. It should be kept in mind that an important factor in this trade is seasonality and the significant fixed expenses, associated with maintenance of workers and the infrastructure. In the winter season, the infrastructure in form of equipment and transport will be used only to a small extent. Within the framework of each partial cost budget, an expense budget is created as well, taking into account the individual items. This structure is similar to the budget of costs according to type. It does not take into account only those cost items, which are not expenses, such as depreciation, or cost items resulting from internal settlements. The budget of expenses according to type, such as equipment services, remunerations etc. allows the accounting department to use it to make payments to contractors. In particular, this pertains to those payments on behalf of contractors, which allow for good completion of tasks associated with implementation of construction projects and civil law liabilities, such as taxes, social insurance etc. There is also the sphere of performance of these budgets. A question arises, how and with what expenditures such budgets of receipts and expenses should be prepared. Preparation of budgets of receipts and expenses, which have been mentioned, requires:

• a proper preparation of the partial budgets of revenues and costs, • flow of information between the organizational units, • keeping of deadlines while transferring data, • appropriate qualifications of managers and employees, who prepare the

partial budgets,


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• coordination of budget works by the controlling department, • specialist budgeting software.

In particular, the last item on the list is very important. This has to be made clear – without the right software, allowing e.g. to present many variants of the enterprise budget, such budgets cannot be prepared at all. Application of a spreadsheet such as Excel requires too much work and involvement of employees. The costs of obtaining information in this case would be too high in relation to the value of the information presented in the above formats. The objective of the budget of receipts and expenses of the enterprise in a given period is in the first place to present the information on whether the company has the financial means for its activity. Such budgets can be prepared for an established period of one month, quarter, year etc. They allow for better management of the enterprise from the perspective of finances, which determines other aspects. It is difficult to implement tasks, plan investment projects etc. having no money. The budget of receipts and expenses allows for potential changes in implementation of tasks, cutting of expenses etc. in a given period. The financial surplus can be invested, for instance, in short-term financial deposits. In the case of insufficient funds, they can be covered with a bank loan of the appropriate value. When preparing the budget of receipts and expenses, it is particularly important to remain careful. The budget cannot be overly optimistic. It is necessary to take into account the appropriate error margin [27]. Therefore, it is better to switch from the partial budgets of revenues and costs to partial budgets of receipts and expenses, because, as it has been described earlier, there are various reasons and mechanisms of creation of various revenues and costs, which is also translated to the receipts and expenses of the enterprise. Preparation of an annual budget of revenues and expenses will be subject to greater imprecision than in the case of a monthly budget. Therefore, in this regard it is also necessary to establish the periods, for which such budgets are prepared. They are not to be devised only for the sake of having them. They should be used in practice and they should be useful in the enterprise management. In such case, their preparation makes sense.


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CHAPTER 9

CONSTRUCTION BUDGETING

LEARNING OUTCOMES


1. Elements of construction costs. 2. How to prepare and develop construction budget. 3. How to control the costs of construction contract. 4. How to organize works connected with preparation of construction

budget.

CONSTRUCTION COSTS

The following basic terms are associated with implementation of the construction process:

• construction facility, • construction, • construction works, • construction site, • construction product.

The construction facility is to be understood as:

• the building along with technical installations and equipment, • the structure, which is a technical and usable entity along with

installations and equipment


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• components of landscape architecture (such as chapels, places of worship, statues, sandboxes).

A building – is a construction facility, which is permanently attached to the land, separated from space by dividing structures, which has foundations and a roof. On the other hand, a structure is any construction facility, which is not a building and not a landscape architecture facility, as well as building parts of technical equipments (boilers, industrial furnaces etc.) and foundations of machines and equipment, which are separate components of objects constituting an usable entity. Exemplary structures are airports, bridges, overpasses, roads, railway lines, tunnels, technical networks, fortifications, waste dumps. Construction is performance of a building facility or facilities in a specified place, as well as reconstruction, development, extension and rebuilding of a construction facility. The construction site is the space, in which construction works are performed, along with the space occupied by the contractor’s plant and temporary facilities. The construction works are all works performed from the moment of making the site available to the contractors until its acceptance after completion of the task. Construction works include also assembly, renovation and demolition of a construction facility. A construction product is a product in accordance with the legal provisions on tests and certification, created for the purpose of building-in, assembling, installing or applying permanently in a construction facility. Differentiation between the above terms is of importance for specification of costs of a construction undertaking from the perspective of the contractor’s enterprise. It allows for establishing of the scope of construction costs. Every complex construction undertaking requires:

• A detailed technical and technological design, • Specification of technology of works performed, • Material specification, containing information on the quantity, type, kind

of material required etc. • Delivery of equipment, steel structures etc. • Providing of transport units and construction equipment • Employees with proper qualifications


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Good performance of construction works requires the resources presented in fig. 9.1.

Fig. 9.1 Resources necessary to complete a construction order Source: own analysis The costs of a construction undertaking performed by a contractor’s enterprise may be divided into costs associated directly with the construction and the construction servicing costs. Most generally, costs associated directly with the construction project may be divided into costs of:

• materials, • purchase, • remuneration along with additional charges, • construction equipment, • transport, • services of subcontractors, • other, • general construction costs.

CONSTR-UCTION

Materials Steel structures

Technical equipment

Construction equipment

Transport

Subcontra-ctors

Employees with adequate

qualifications

Contractor’s plant & temporary

facilities


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Presented below is a short description of each item of direct construction costs. Costs of consumption of materials include basic materials, taking into account the specific demands of construction works (sand, reinforcement steel, bricks, insulation materials, fascine, sheet piles, aggregates, concrete etc.), as well as other materials necessary for construction etc. Depending on the type of the construction project, costs of in-build specialized technical equipment can be specified separately. The costs of purchase include costs associated with purchase of materials. These pertain most often to the costs of delivery of materials to the construction site, packaging, insurance, commission paid to agents, cost of material tests etc. Remuneration along with additional charges includes costs associated with recruiting employees and other persons performing work within the framework of a given construction project. This cost item includes direct production employees, such as bricklayers, assistants, welders, electricians etc. The scope of these costs depends on their qualifications, experience, the rules of remunerating employees at the company and the contracts signed with them. Remuneration includes as well:

• overtime work, • work performed on the basis of commission contracts and mandate

agreements, • allowances for functions performed and for employment seniority, • bonuses, • lump-sum charges, • allowances for exposure to harmful conditions, • prizes, • remuneration due to illness covered by the employer, • remuneration for leave periods

The number of remuneration components, as it has been mentioned, depends on the enterprise policy and the legal provisions in force. Nevertheless, these items pertain to individual employees on the construction site and thus they are charged to the construction project. Additional charges associated with remuneration are a component of costs of employment. These pertain mainly to deductions for retirement, disability,


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accident insurance, partially charged to the employer. It is also necessary to take into account the charges on behalf of the Labor Fund and the Guaranteed Workers Benefits Fund. Benefits on behalf of employees constitute another item in the group of costs of employment. These include among other things:

• deductions for the Company Fund of Social Benefits (if its creation is obligatory at the company),

• energy meals, • beverages, • cleansing products, • trainings in the field of occupational health and safety, • additional courses for employees (trainings, university) • protective and working clothes, • work travel expenses, • family separation allowances, • personal insurance, • medical tests.

The number and amount of these benefits depends also on the policy of the management board of the enterprise and agreement with organizations of employee representatives, apart from items, which are required by the law (such as the obligatory occupational health and safety trainings). Transport services include in the first place the costs of transport on behalf of the construction project. These are associated with:

• delivery of materials to the construction site, • relocation of construction equipment from the equipment and transport

depot, • transport of the ordered steel structures or technical equipment to be

built-in.

The equipment services pertain to use of specialist construction equipment, such as cranes, diggers, bulldozers etc. Transport and equipment services may be rendered both by own separated organizational units and by subcontractors. This depends on the resources of the enterprise.


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Services of subcontractors include the costs of contractors necessary for the proper maintenance and completion of the construction order. These may include, for instance, installation of scaffolding, shuttering, assembly and delivery of specialist equipment to the construction site and performance of specialized tasks. Other direct costs pertain to other cost items, which do not belong to the items discussed above, and which are not included in the general construction costs. Implementation of a construction order most often requires bearing of costs of external services, which, among other things, pertain to geodetic and geological services, research and design services. The type and cost of services depend on the type and complexity of the order completed The general construction costs, as a rule, pertain to the entire construction and not to individual construction facilities. These costs include the following groups:

• construction management • maintenance of the construction office • contractor’s plant and temporary facilities • maintenance of the construction site and temporary facilities • guarding and securing of the construction site.

The costs of management of the construction project pertain to the construction manager and his/her assistance. These costs include, in the first place, their remuneration along with additional charges. The construction manager has an office as well. The costs of maintenance of the construction office include mainly the costs of office supplies, office equipment (such as computer and software), mobile and fixed telecommunication services, representation costs, company car, rental of office port cabins. Another group of general construction costs constitutes the costs of employee benefits and the facilities for employees. These include the special port cabins, where the construction employees may change, have meals, wash themselves etc. At some construction sites, there are port cabins, in which the employees sleep, especially when the construction site is located in a distant area. It should be remembered that the employees are entitled to allowances for traveling and for separation from their families, cleansing products, working clothes and other benefits. The employee benefits result from the legal regulations in force, as well as the customary practice in the trade. The construction site must be equipped with a water supply, it is necessary to connect power and provide supply of other types of energy, e.g. heating, and to


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remove waste, provide the temporary access roads etc. Sometimes, organization of construction works requires occupation of a traffic lane. The construction site must be appropriately secured, lighted and fenced in order to allow for safe performance of construction works and to protect the outsiders against threats, which may lead to accidents (such as deep excavations, bars sticking out etc.) The contractor – the enterprise performing the construction works- is responsible for all accidents, including accidents involving outsiders at the construction site. The construction site must be also appropriately protected, which is associated with security service costs. It is necessary to keep in mind the fire protection provisions, which specify the fire protection materials and equipment that should be supplied on site. The general construction costs include the costs of preparation of the construction site. The indirect construction costs include the construction servicing costs. These pertain to costs of:

• cost estimate preparation, • production preparation, • procurement, • accounting, • payroll preparation etc.

The production preparation department settles the materials, it prepares the technological standards etc. The department of cost estimates must prepare and coordinate works associated with acquiring of production orders, for instance, it prepares construction cost estimates etc. Other departments, such as the construction department, take care of daily issues associated with relations with offices, permissions, agreements, annexes etc. These are administrative departments, which support the construction process. On the other hand, the manner, organization and functioning of these areas depends on the size and organizational structure of the enterprise. Nevertheless, the following costs can be listed here:

• remuneration and additional charges, • training and conferences, • depreciation of fixed assets and intangible assets, • lump-sum charges, • business trips, • professional literature, • other costs.


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These costs pertain to individual organizational units5 separated in the organizational structure of the enterprise, which have specific tasks to perform. These are contained in the organizational regulations of the enterprise. Also the tasks performed by the specified departments may be ordered to enterprises specializing in services of this kind.

THE CONSTRUCTION BUDGET

A construction cost estimate is a particular type of cost plan, prepared for every large-scale undertaking. It contains some elements, which are also found in the cost budget. These elements include:

• a plan of consumption of production means expressed both in natural and monetary units,

• the period of completion of specific tasks. Preparation of a cost estimate requires involvement of various specialists, such as construction engineers, logistics specialists, electricians, financial managers. This team requires a person working on the construction site, with extensive experience in construction management, since it is necessary to be well familiar with the technological processes. Sometimes, the investor presents a so-called blind cost estimate with a description of technological processes, which are not adequate for a given construction order. This requires specialist explanations, because it influences the costs and the further quality of the entire undertaking. Unfortunately, this fact is sometimes overlooked during the tender process. Application of technologies of lower quality influences the subsequent operation of the facility and the costs of its maintenance. Cost estimates are prepared using specialized computer programmes, which are also expensive. Therefore, after winning a tender, the costs of preparation of the tender bid are initially charged to the construction project. A construction cost estimate is not a sufficient source of objective and verifiable information on a given construction project. This may be due to the fact that the cost estimate is prepared, among other things, for the tender bid, in which its

5 Most often called departments, such as Production Preparation Department, Fiber-Optic Lines Department.


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task is to determine, on the basis of technical standards, the costs of performance of specific activities. The objective of the bid preparation is to obtain an order for performance of a given service. The cost estimate does not always reflect the appropriate level of costs necessary in order to complete the order. The cost estimate is a document designated both for the external and the internal recipient. The cost budget, on the other hand, is a document directed to a specific group of internal users. It also includes confidential information, which should not reach the business environment of the entity [66]. The most significant responsibility center from the point of view of management of a construction enterprise is the construction site. All processes taking place in the enterprise should be subordinated to organization of efficient implementation of the construction works. Other organizational units should be organized in such a way as to ensure the proper use of the resources owned, such as the construction equipment, transport, people, materials, financial means etc. Processes associated with completion of a construction order are presented in fig. 9.2.

Fig. 9.2 Processes associated with construction performance Source: own study

Organization of construction

works PROCESSES ASSOCIATED WITH CONSTRUCTION PERFORMANCE

Performance of the construction

project, including facilities

Preparation of the bid for the

investor Preparation of construction

documentation

Control of construction performance

Coordination of performance of

construction order Construction

settlement Construction management

Delivery of the necessary resources


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On the basis of the project, a specific investment task can be divided into independent tasks – construction facilities, which may be performed simultaneously, subsequently or independently of each other. Each of them is subjected to a cost estimate. Therefore, they may serve as separate cost centers at the responsibility core. The construction cost budget must take into account:

• the costs of preparation of the tender bid, • the construction schedule, • the costs of preparation of the construction site, • the costs of maintenance of the contractor’s plant and temporary

facilities, • the costs of construction management, • demand for materials, • demand for transport and construction equipment, • employment costs, • division into own and external resources.

The budget structure itself must reflect the resources necessary for implementation of the undertaking. Table 9.1 presents an exemplary construction cost budget for a hydraulic engineering enterprise. Table 9.1

Construction cost budget

CONSTRUCTION BUDGET 3246 A

(nr budowy) PROJECT NAME Remont śluzy MONTH - YEAR maj 2006 CONSTRUCTION MANAGER Jan Kowalski Date of signing of contract 3.03.2006 Construction starting date

Date of rendering access to the construction site

ACCOUNT

501-3246; 520-3246


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I COST CALCULATION ITEM Net PLN VALUE COST

STRUCTURE (%)

-1- -2- -3- -4-

1. Consumption of materials 89 570,00 40,37% 2. Cost of purchase 9 828,50 4,43% 3. Employment costs 39 169,19 17,66% 3.1 remuneration 29 930,40 13,49% 3.2 Social insurance 6 108,79 2,75% 3.3 Commission contracts 310,00 0,14% 3.4 Employee benefits 2 820,00 1,27% 4. Overland transport 5 192,00 2,34% 4.1 internal 3 730,00 1,68% 4.2 external 1 462,00 0,66% 5. Overland equipment 5 030,00 2,27% 5.1 internal 4 550,00 2,05% 5.2 external 480,00 0,22% 6. Small equipment 3 700,00 1,67% 6.1 internal 3 200,00 1,44% 6.2 external 500,00 0,23% 7. Water transport and equipment 30 000,00 13,52% 7.1 internal 30 000,00 13,52% 7.2 external 0,00 0,00% 8. External services – other subcontractors 15 000,00 6,76% 9. General construction costs 24 369,20 10,98%

10. TOTAL CONSTRUCTION COSTS 221 858,89 100%

Source: Own study. Exemplary data. The components of the construction cost budget presented in table 9.1 include:

• the construction project number assigned in accordance with the enterprise procedures,

• the name of the construction project, to which the cost budget pertains, • person responsible for the construction project (the construction

manager) • the period, to which the presented cost budget pertains, • additional information concerning the starting and completion of the

construction project, • bookkeeping account numbers, • calculation items of costs applied in the corporate chart of accounts.


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This is the basic information on a given construction project. The budget presented in table 9.1 pertains to the direct construction costs. This budget structure for planning of costs for the internal needs is clear and sufficient. Therefore, it does not include various charges on indirect costs, which also belong to the applied corporate cost format and the rules of settlement of indirect costs. Another issue is profitability of the construction project. In practice, the construction manager should not deal with settlement of costs, which are not dependent on his or her decisions. The costs presented in the budget in table 9.1 do not provide any information on the size of consumption of resources planned. This is not sufficient for management of the enterprise costs. Therefore, it is necessary to provide information concerning the consumption of materials, use of transport and employees. It is also necessary to take into account other subcontractors. Consumption of materials at the construction site results from the assumed schedule of works for a given period. Thus the starting point for budgeting is the cost estimate, which includes the material limits, and a schedule of works. The order and scope of works are decisive for the quantity and type of materials needed. An exemplary breakdown of costs of consumption of materials is presented in table 9.2. Table 9.2

Costs of consumption of materials

MATERIALS C-1 CONSTRUCTION no. 3246 CONSTRUCTION NAME Lock renovation MONTH- YEAR May 2006 CONSTRUCTION MANAGER Jan Kowalski

No.. Material name Measurement unit Quantity Unit cost

PLN/ m.u. Net value in PLN

-1- -2- -3- -4- -5- -6-

1. Concrete B25 m3 110,00 250,00 27 500,00

2. Timber m3 2,50 760,00 1 900,00


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3. Square-sawn timber m3 2,00 510,00 1 020,00

4. Tie rods pc. 300,00 3,00 900,00

5. Pages pc. 500,00 1,00 500,00

6. Keystones pc. 500,00 1,50 750,00

7. Mortar kg 50 000,00 1,10 55 000,00

8. Other materials 2 000,00

9. Total costs 89 570,00

Source: Own study. Exemplary data. A breakdown of costs of material consumption is a part of the construction cost budget. This part of the budget informs us of:

• materials, their quantity and period, in which they are needed for the construction,

• measurement units for each material item • unit costs of individual material items, • costs of individual material items.

When preparing a breakdown of demand for materials in the budget, important material items are planned, taking into account the above data. On the other hand, other materials, which are less significant, are specified only with regard to their value, without providing a detailed breakdown. Otherwise, preparation of such budget would be too laborious. The data presented in table 9.2 is necessary not only for verification of the presented budget by the superiors of the construction manager. They are also necessary for the procurement department for the purpose of ordering them at the suppliers and for preparation of a budget of costs and expenses at the corporate level by the department of economy. The costs of purchase of materials may be planned in various ways. One of the solutions applied is to assume a charge in form of a percentage share of the value of materials planned. Another solution is to plan this cost item in detail. For instance, in the case of concrete, it is necessary to take into account the cost of rental of a special pump. It is also possible to plan in detail some of the purchase costs for the selected material items and use a percentage charge in other cases. An example is presented in table 9.3.


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Table 9.3 Costs of purchase of materials

COSTS OF PURCHASE

No. Material name Transport services

Insurance Pumping service

Other costs

Total costs in

PLN -1- -2- -3- -4- -5- -6- -7-

1. Concrete B25 500,00 500,00 2. Other materials 5 000,00 350,00 3 978,50 9 328,50 3. 0,00 4. TOTAL 5 000,00 350,00 500,00 3 978,50 9 828,50

Source: Own study. Exemplary data In general, when planning the costs of purchase, it is necessary to take into account the significance of this item in the overall construction costs. In the case of preparation of the entire budget of the construction costs, a percentage charge will be applied. If the budget is being updated for a given month, like in the example, it is good to plan the costs in more detail, but it is also necessary to keep in mind the laboriousness of the budget preparation. Another budget item constitutes the employment costs, which include the remuneration with charges and employee benefits. The number of working hours per employees is specified in the cost estimate, taking into account the subsequent stages. Thus the value of remuneration of employees will be a product of the number of work hours and the rate per hour. This rate must be approved in advance. Remuneration charges should be added to it. Sometimes, employees are recruited occasionally to perform some works on the basis of commission contracts. Thus this remuneration item should be placed separately in the group of employment costs for the purpose of cost control. The employee bonuses can also be included separately. This depends on the motivation system and the remuneration regulations applicable at the corporation. Employee benefits must be presented separately in the budget. This allows us to maintain control of these costs. It pertains in particular to costs of working clothes. Other items, such as periodical tests, result from the applicable legal provisions. Information pertaining to periodical tests and their costs should be provided to the construction manager by the human resources department. The number of items of employee benefits depends on the corporate policy in this


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regard. They should be defined for the budgeting purposes. Table 9.4 presents the employment costs divided into remuneration with charges and employee benefits. Table 9.4

Employment costs in a construction project

EMPLOYMENT COSTS H

CONSTRUCTION NAME Lock renovation MONTH - YEAR May 2006 CONSTRUCTION 3246 CONSTRUCTION MANAGER Jan Kowalski

REMUNERATION WITH CHARGES

No. Cost item No. of work hours

Rate PLN/hour

Bonus VALUE PLN w %

1. REMUNERATION 29 930,40

1.1 Basic – construction workers 2 304,00 12,00 5% 29 030,40

1.2 Overtime, Sundays, holidays 50,00 18,00 900,00

1.3 0,00

2. Employee retirement pension premiums 6 108,79

3. COMMISSION CONTRACTS 30,00 10,00 310,00

4. TOTAL REMUNERATION COSTS WITH CHARGES /1+2+3/

36 349,19

EMPLOYEE BENEFITS

No. Cost item Value PLN -1- -2- -3- 1. Energy meals 800,00 2. Working clothes 1 200,00 3. Cleansing products 500,00

4. Periodical tests 120,00

5. other 200,00

6. TOTAL 2 820,00

Source: Own study. Exemplary data


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In some enterprises, the working hour rate for the needs of the budget preparation takes into account the remuneration charge – social insurance and other employee benefits, such as working clothes, energy meals etc. The value of the working hour rate, established in this way, is more efficient at the cost estimate stage. In the case of preparation of the budget of construction costs, it is necessary to separate these items from each other. Otherwise, in the cost budget, the managers lose a lot of cost information, pertaining to employment costs on the construction site. Another group of costs included in the budget are costs of equipment and transport services. Preparation of the budget in this regard requires planning of subsequent stages of the construction works. They will determine:

• the necessary transport and equipment units, • their working time • their presence or lack in the enterprise.

Table 9.5 presents the planned costs of equipment services. Table 9.5

Costs of equipment services

OVERLAND EQUIPMENT D-2 CONSTRUCTION no. 3246 CONSTRUCTION name Lock renovation MONTH - YEAR May 2006 CONSTRUCTION MANAGER Jan Kowalski

No. Name No. of hours Cost (PLN/hour) Net value PLN

-1- -2- -3- -4- -5-

I OWN

1. Compressor 30 35,00 1 050,00

2. Caterpillar crane 70 50,00 3 500,00

3. 0,00

4. OWN TOTAL 4 550,00 II EXTERNAL

1. Bulldozer 12,00 40,00 480,00

2. 0,00

3. EXTERNAL TOTAL 480,00 III. TOTAL COSTS /I+II/ 5 030,00



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The costs of equipment services take into account the division into own and external resources. It is a very important element of the construction budget. It is then used to plan the resources of the enterprise by the equipment and transport depot and it ensures better management of the potential owned. In the case of preparation of the enterprise resources with regard to equipment and transport services, it is important to establish the internal settlement rates. The construction manager must have the appropriate data. The settlement rates may, in some cases, take into account the equipment operation in hours and other units – in days. In the case of transport services, it is possible to prepare settlements as agreed, for instance, for transport of materials, but it is also possible e.g. to plan the costs on the basis of the rate per kilometer. In practice, the cost budget preparation by the construction manager may take into account the division into heavy and “small” equipment. Heavy equipment includes cranes, diggers, bulldozers, etc. The so-called „small” equipment includes welders, vibrators, sanding vehicles etc. The cost item of equipment services with regard to small equipment may be placed as the item „other equipment” in table 9.5. In the discussed example, the construction managers reported a need for a separate budget form in this regard. Thus in the example heavy and „small” equipment is planned separately. As it can be seen, there is no single model of budget forms and it depends on the specific needs of the budget users. For better cost control, costs of other subcontractors are most often taken into account as well. This form takes into account the subcontractor name, the scope and value of services planned. This pertains to services other than equipment and transport. These may include geodetic services, equipment assembly, design, geological services etc. The scope of planning of general costs of the construction project depends largely upon the size and time of completion of construction works. In the case of smaller scale construction projects, it is sufficient to take into account the main cost items as presented in table 9.6. In the case of a larger project, the general construction costs may be divided into:

• construction management, • construction offices, • contractor’s plant and temporary facilities.


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Each of the above cost groups will have an individual cost format. Thus these groups have to be appropriately defined for the needs of budgeting. Table 9.6

General construction costs

GENERAL CONSTRUCTION COSTS G

CONSTRUCTION PROJECT NAME Lock renovation MONTH - YEAR May 2006 CONSTRUCTION NO. 3 246 CONSTRUCTION MANAGER Jan Kowalski

No. Cost item Net value PLN

-1- -2- -3-

1. Remuneration of the construction manager and the assisting personnel

12 000,00

2. Remuneration charges 2 449,20 3. Consumption of power 1 000,00 4. Transport services 1 500,00 5. Fixed telephony services 100,00 6. Mobile telephony services 220,00 7. Internet services 100,00 8. Security guard services 2 200,00 9. Business trips 2 000,00 10. Environmental charges 300,00 11. Lump sum charges 1 200,00 12. Representation costs 300,00 13. Other costs 1 000,00

14. TOTAL COSTS 24 369,20 Source: own study. Exemplary data The format and content of the cost budget may vary [63], [46]. In the first place, it must take into account the user needs and the specific character of specialization of the enterprise. In particular, these are the needs of the construction manager and the enterprise management. The construction budget


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must contain the quantity and type of resources necessary for completion of the order – otherwise, it is difficult to manage the resources of the enterprise. However, regardless of its format and content, it must meet the organizational conditions. The budgeting process must be organized, and each participant of this process must have access to the necessary information and data.

COST CONTROL FOR A CONSTRUCTION CONTRACT

Control is the last function of the management process. It is its immanent part, without which effective business activity cannot be imagined. An enterprise, which carries out all management functions except for control, is doomed to lose on the competitive market. A situation like this could be compared to a well-equipped traveler, who, visiting an unknown land, despite having planned out the route, owing a detailed map and a compass, is unable to determine his current location [50]. The construction manager or an employee responsible for implementation of the undertaking, such as the contract engineer, is interested in the results of his or her activities. Construction projects can be monitored through [114]:

• preparation of a schedule of construction works, • planning of organization of construction works, • substantive supervision by the construction manager, • construction site inspections by the company management, • day-to-day control of construction documents, • comparison of the construction budgets with their performance, • selection of the appropriate tools for construction control, • proper setting of the IT system, for instance, to signal the exceeding of

the material limits. Implementation of these plans – monitoring of completion of construction works – enforces the proper organization of the enterprise.


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Every activity of the enterprise should be thought-out and planned – this is a basis of success of the enterprise. Construction works are characterized by a certain logic of proceeding, which is often enforced by the technology of work. This, on the other hand, is influenced by various conditions, such as the costs, deadlines, environment of the future construction site, further costs of operation of the construction facility etc. Therefore, the construction works, depending on the degree of their complexity, require a specific manner of proceeding in the subsequent stages. Thus the basis for implementation of construction works is their division into specific tasks. The basis for such specification is the construction design. The analysis of the design determines the order of works to be performed, which is then entered in the construction work schedule. An exemplary schedule of works at a certain construction site is presented in table 9.7. The planning of construction works must take into account the technology of performance, planned in the project. Work organization at the construction site requires application of the appropriate equipment, such as cranes, diggers or transport equipment etc. It is also necessary to hire employees of the appropriate qualifications for a given construction stage. This also requires synchronization of works of all participants of the construction process. Therefore, during performance of individual tasks, it is necessary to keep the deadlines specified in the agreement (and / or in the schedule). A failure to keep the deadlines will have specific financial consequences. Therefore, it is necessary to ensure the simultaneous financial planning, which is necessary to ensure the financial liquidity of the company. Planning organization of works, it is necessary to take into account [78]:

• location of individual works in the production process (with regard to technology and organization),

• instructions, process sheets, drawings, models, • work methods and systems, including the occupational health and safety

techniques and technology, • methods of gathering reserves, use of working time, • working tools along with their distribution, • recording and control system (work order sheets, control, test,

measurement record forms) • work processes presented in graphic form using the work diagrams.


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Table 9.7 Schedule of construction works at the construction site

WORK SCHEDULE - construction project no. XXXX A

MONTH-YEAR xxx

CONSTRUCTION MANAGER

xxx

CONSTRUCTION PROJECT NAME

xxx

ACCOUNT (MPK) xxx

No. Specification of

works Days of the month RE-

MARKS 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31

1. Removal of retaining walls made of sheet piles

* * * * * * * * * * * * * * * * * * * * * * * * * * * *

2. Filling in of the excavation * * * * * * * * * * * * * * *

3. Reinforcement of the river shore * * * * * * * * * * * * * * * *

4.

Transport of recovered materials (sheet piles, I sections, pipes) around 800 t * * * * * * * * * * * * * * * * * * * * * * * * * * *

Source: X Construction Works Company as provided in [68]


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It is necessary to remember that the construction works must be performed with due care to ensure the safety of construction employees and the further users. At the stage of the construction work schedule, preventive control of the task completion takes place. This allows us to avoid errors at the planning stage, which result, for instance, from the improper planning of resources necessary for the task completion. This may pertain, for instance, to planning of operation of own equipment and transport depot, making orders for materials etc. Therefore, this stage is very significant for the entire process of control of completion of construction works. During planning, it is possible to lower the costs of performance of a construction task. After its completion, and thus after the costs are born, there is nothing to lower any more [68]. Every construction undertaking requires a budget. The budget must take into account the time of completion of construction works, the individual tasks, the necessary material, human, transport and financial resources. The construction budget cannot exceed the level of costs specified in the agreement between the contractor and the ordering party, for instance, the investor. The contractor must also remember that the order completion must be characterized by a specific profitability. Otherwise, it will result in losses, which may even lead to bankruptcy of the company. The construction manager usually does not influence the agreement signed. Often, the manager is not even able to influence the bid cost estimate, prepared at the stage of preparation of the tender bid. As a result, sometimes – at the time of completion of the order – it is not possible to meet the conditions presented in the bid6. Therefore, practice shows that it is necessary to sign various annexes to the basic agreement. On one hand, this is justifiable, as not everything can be foreseen at the stage of design of the investment project. Moreover, the ordering party sometimes changes its original plans at the stage of negotiations with the contractor. Nevertheless, the construction manager is responsible for the construction budget and all of its parameters. After each settlement of the month, the manager receives from the controlling 7 (economic) department information on the budget performance. An exemplary breakdown of this kind has been presented in table 9.8.

6 The aspect of incremental increase of prices of materials, services or work has been omitted here. 7 Depending on the organizational structure of the enterprise.


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Table 9.8 Performance of the construction budget

WYKONANIE BUDŻETU CONSTRUCTION NAME Construction of facility

MONTH – YEAR May 200X

CONSTRUCTION MANAGER Jan Kowalski

ACCOUNT 501-101 520-101

Construction costs Construction general costs

No. COST CALCULATION ITEM PLAN PERFORMANCE DEVIATIONS

PLN PLN PLN PLN

-1- -2- -3- -4- -5-(3-4) -6-

1. Consumption of materials 79 260,00 80 000,00 -740,00 -0,93%

2. Costs of purchase 6 000,00 5 400,00 600,00 10,00%

3. Personnel costs 21 102,43 22 521,00 -1 418,57 -6,72%

3.1 remuneration 14 173,60 15 000,00 -826,40 -5,83%

3.2 Social insurance 2 892,83 3 061,00 -168,17 -5,81%

3.3 Additional employment costs 616,00 760,00 -144,00 -23,38%

3.4 Employee benefits 3 420,00 3 700,00 -280,00 -8,19%

4. Transport 5 192,00 5 200,00 -8,00 -0,15%

4.1 Internal 3 730,00 4 000,00 -270,00 -7,24%

4.2 External 1 462,00 1 200,00 262,00 17,92%

5. Equipment 5 030,00 4 600,00 430,00 8,55%

5.1 Internal 4 550,00 4 000,00 550,00 12,09%

5.2 External 480,00 600,00 -120,00 -25,00%

6. Small equipment 100,00 0,00 100,00 -

6.1 Internal 100,00 0,00 100,00 -

6.2 External 0,00 0,00 0,00 - 7. Other subcontractors 0,00 0,00 0,00 -

8. General construction costs 19 348,70 21 000,00 -1 651,30 -8,53%

9. Total construction costs 136 033,13 138 721,00 -2 687,87 -1,98%

Revenues account 701-101

No. Item name Plan PLN Performance PLN Deviation PLN -1- -2- -3- -4- -5-(3-4) -6- (5:3)

1. Revenues from sale of construction services 186 000,00 182 000,00

4 000,00 PLN 2,15%

2. Monthly result 49 966,87 43 279,00 6 687,87

PLN 13,38%

Source: own study. Exemplary data


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In the breakdown from table 9.8, we can see the basic items of revenues and costs of an implemented undertaking for a given period, in this case, a month. The breakdown also presents the result of the construction project. The budget performance is analyzed8 by the controlling department and by the construction manager. Any significant deviations from the assumptions made in the budget are explained. Usually, there are some inaccuracies in the breakdowns due to improper description of source documents, inadequate bookkeeping, missing documents etc. The budget control system itself requires preparation and selection of:

• forms, which constitute the construction budget, • structure of the budget performance report, including the forms, • efficient construction control tools, • appropriate bookkeeping accounts, • procedures associated with explanation of deviations, • an IT system.

On the other hand, in order for the construction manager to be able to manage the construction project effectively, the necessary information and data are needed. In particular, these pertain to the costs of completion of a given order. The format of construction costs must be identical in the budget and in the corporate chart of accounts, because otherwise it will not be possible to compare the budget and its performance, and – in practice – to present a breakdown like the one provided in table 9.8. Otherwise, the controlling department employee will have to manage the paper documents and include them in the specific items of the cost format. Thus he or she will be wasting time on unnecessary activities, which are due to a bad organization of the information system of the enterprise. The construction manager will surely not prepare such breakdowns as they are not included in his/ her scope of duties. The construction manager is to receive a breakdown like this. The management is not always aware of this fact. The structure of accounts of costs presented in table 9.9 is adjusted to the cost calculation items in the budget. This allows for quick preparation of a report on budget performance (table 9.8).

8 More on construction budget control in [68]


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Table 9.9 Group 5 accounts Construction costs

No. Account no. Account name Monthly turnover

Cumulative turnover

1. 501-101-01 Consumption of materials 80 000,00 180 000,00 2. 501-101-02 Cost of purchase 5 400,00 14 000,00 3. 501-101-03 remuneration 15 000,00 50 000,00 4. 501-101-04 Social insurance 3 061,00 10 205,00 5. 501-101-05 Additional employment costs 760,00 2 500,00 6. 501-101-06 Employee benefits 3 700,00 12 000,00 7. 501-101-07 Internal transport services 4 000,00 16 000,00 8. 501-101-08 External transport services 1 200,00 3 400,00 9. 501-101-09 Internal equipment services 4 000,00 15 800,00 10. 501-101-10 External equipment services 600,00 2 100,00 11. 520-101-00 General construction costs 21 000,00 52 000,00 12. Total 138 721,00 358 005,00

Source: own study. Exemplary data Thus the construction manager may regularly check „own accounts” provided that he or she delivers the appropriate documents quickly. Unfortunately, in practice, the established deadlines are not met. The construction managers are irritated, because the data is not complete or the value of individual items is unclear. On the other hand, the employees of the accounting department are frustrated, because they cannot close the balance of the month and calculate the taxes. These are very significant organizational problems pertaining to monitoring of the construction process. They influence the efficiency of functioning of the enterprise budgeting system. This process cannot be properly implemented due to organizational problems. Communication difficulties between the participants of the budgeting process pose a significant problem, which is translated to effectiveness of monitoring. The sole comparison of plan and performance is not sufficient for the construction manager to manage the construction process. Usually, it is necessary to „delve deeper”, that is, to reach a specific source document. The manager must know whether all documents booked to his/her “account” are appropriate. How is the manager to know that, for instance, the cost of consumed materials of PLN 80 000 is appropriate? It is necessary to look through documents. An exemplary detailed account assignment for costs of material consumption has been presented in table 9.10.


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Table 9.10

Account assignment associated with material consumption

No. Bookkeeping & document no. Material name Value PLN 1. 501-101-01-410-01 Fa 1/2006 Concrete 30 000,00 2. 501-101-01-410-99 RW 3/M/2006 Timber 1 800,00 3. 501-101-01-410-02 Fa 27/2006 Square-sawn timber 945,00 4. 501-101-01-410-03 RW 342/K/2006 Tie rods 900,00 5. 501-101-01-410-05 Fa 21/2006 Pages 510,00 6. 501-101-01-410-06 RW/4/M/2006 Keystones 1 300,00 7. 501-101-01-410-07 Fa 2/C/2006 Mortar 44 545,00 8. Total 80 000,00

Source: own study. Exemplary data The breakdown presented in table 9.8 is usually prepared within a specific deadline, for instance, around the 20th day of the next month, or when the accounting department closes the month. Unfortunately, this information is already delayed from the viewpoint of current construction management. In the mass of facts, the manager does not always remember about the earlier orders. Many items, for instance, materials, have to be ordered much earlier. The budget performance breakdown will take into account the state as of May 31st, although it is, for instance, it may already be June 20th. Such is the usual settlement cycle at the accounting department. This information will be somewhat outdated. Significant changes may take place between May 31st and June 20th. Therefore, the construction manager must maintain cost records independently, especially for the significant positions. This has been presented in table 9.11.


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Table 9.11 Budget performance along with involvement

BUDGET PERFORMANCE

CONSTRUCTION NAME Facility construction MONTH- YEAR May 200X CONSTRUCTION MANAGER Jan Kowalski

ACCOUNT 501-101

520-101 Construction costs General construction costs

No. COST

CALCULATION ITEM

COST ESTIMA

TE

CUMULATIVE COSTS

INVOLVEMENT

Total costs Deviation

Contract

advancement level

zł zł zł zł zł % -1- -2- -3- -4- -5- -6-(4 + 5) -7- (3-6) -8- (6 : 3)

1. Consumption of materials 320 000,00 180 000,00 50 000,00 230 000,00 90 000,00 71,88%

2. Cost of purchase 124 000,00 14 000,00 3 000,00 17 000,00 107 000,00 13,71%

3. Employment costs 138 377,20 74 705,00 21 061,50 95 766,50 42 610,70 69,21%

3.1 Remuneration 92 000,00 50 000,00 15 000,00 65 000,00 27 000,00 70,65%

3.2 Social insurance 18 777,20 10 205,00 3 061,50 13 266,50 5 510,70 70,65%

3.3 Additional employment costs

7 800,00 2 500,00 2 500,00 5 300,00 32,05%

3.4 Employee benefits 19 800,00 12 000,00 3 000,00 15 000,00 4 800,00 75,76%

4. Overland transport 39 400,00 19 400,00 6 000,00 25 400,00 14 000,00 64,47%

4.1 internal 29 800,00 16 000,00 6 000,00 22 000,00 7 800,00 73,83%

4.2 external 9 600,00 3 400,00 3 400,00 6 200,00 35,42%

5. Overland equipment 39 300,00 17 900,00 9 000,00 26 900,00 12 400,00 68,45%

5.1 internal 32 000,00 15 800,00 9 000,00 24 800,00 7 200,00 77,50%

5.2 external 7 300,00 2 100,00 2 100,00 5 200,00 28,77%

6. Small equipment 100,00 0,00 0,00 0,00 100,00 0,00%

6.1 internal 100,00 0,00 0,00 100,00 0,00%

6.2 external 0,00 0,00 0,00 0,00 -

7. Other subcontractors 0,00 0,00 0,00

0,00 0,00 -

8. General construction costs (other)

78 000,00 52 000,00 4 000,00 56 000,00 22 000,00

71,79%

9. Total construction costs 739 177,20 358 005,00 93 061,50 451 066,50 288 110,70 61,02%

Source: own study. Exemplary data. As it has been mentioned, the manager cannot exceed the costs specified in the cost estimate, for instance, the costs of consumption of materials in the amount of PLN 300 000. Therefore, it is always necessary to relate to this limit value. The cost column presents accumulatively the state as of May 31st according to


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data received from the financial and accounting system, for instance, the costs of consumption of materials amount to PLN 180 000. Thus, theoretically, the manager has PLN 120 000 to use in this cost item. Is it true? However, these are not all construction expenses involved. Let us assume that in April the manager ordered materials for June, and their value will amount to PLN 50 000. Thus the political involvement in costs may amount to PLN 230 000. Although the procurement department will complete the order not earlier than in June, and the accounting department will record this fact around July 20th, the construction manager must keep this fact in mind, because otherwise it will be difficult to implement the budget assumptions or the budget will be exceeded, and thus the order will not be profitable any longer. Thus the breakdown of budget performance must consider such “involvement”. In table 9.11, it is presented in column 5. This allows us to provide a presentation, which is closer to reality. It ensures better control of the construction costs.

ORGANIZATIONAL ASPECTS OF CONSTRUCTION BUDGETING

Budgeting is a team work. Preparation of the construction budget requires ensuring the appropriate organizational efforts. The construction manager, who prepares the budget, must get an appropriate support from employees of individual organizational units. Each of them is responsible for a given area of activity of the enterprises within the scope of their competences. The basic duties of the construction manager include:

• Construction management, • Responsibility for all events on the construction site in accordance with

the building law, • Responsibility for performance of construction works accordingly with

the design, • Caring for rational use of the entrusted resources,


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• Timely completion of construction works for the management of the enterprise,

• Maintenance of the construction log. According to the arguments presented above, the place of work of the construction manager is the construction site – otherwise, the manager will not be able to perform the entrusted duties and thus the enterprise will not achieve the planned objectives. At the same time, it should be noted that the person responsible for construction supervision from the perspective of building law and the economic effects should have the adequate knowledge and skills in both these fields. This person is responsible for many aspects of the construction process and for its economic effect. This responsibility is accompanied by a scope of competences and rights, as well as the possibility of incurring financial obligations within the scope established by the enterprises. Decision-making in this regard allows us to determine the detailed conditions of the managerial contract [47]. The appropriate planning of processes of efficient organization of construction works requires information resources. These pertain to:

• the quantity and type of equipment and construction transport owned by the enterprise,

• the rules and prices of rental of these resources, • the rules and deadlines for ordering materials necessary for construction

performance, • material prices, • human resources with adequate qualifications.

Therefore, the construction manager must prepare the appropriate personal and informational support and have access to the appropriate tools, such as the Intranet. Such support is provided by the appropriate organizational units of the enterprise, which will prepare the appropriate information for the needs of preparation of the construction budget. The procurement department should prepare and then constantly update information on the basic materials, used most often on the construction site. This information should include:

• the purchase prices, • the order conditions, such as the minimum quantity, time of waiting for

the ordered materials,


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• material specifications. An important issue is the identical marking (symbols) of materials. During the subsequent stages of budgeting, a problem arises, associated with the quantity demands at the company level. This pertains in the first place to preparation of the material cost budget by the procurement department. Another important field of information is the demand for construction equipment and transport. Every construction enterprise has limited equipment and transport resources. Therefore, it is forced to take advantage of services of other specialized enterprises, which deal with rental of equipment or rendering of services. The construction manager must file a demand for the specific equipment and transport units at the equipment and transport depot or at the logistics specialist. This demand should include:

• the name and type of the equipment or transport unit, • the planned number of work hours, • a rate, which is to be charged to the construction project for use of these

units, • the planned date of use of a given unit.

The task of the equipment and transport depot manager or the logistics specialist is to prepare information for the construction manager, containing data on:

• equipment, which is currently available, • equipment rental measurement unit, for instance, hour, day, • rates for use of equipment, including transport of the unit to the

construction site, • the planned exclusion of these units for the purpose of renovation or

prolonged maintenance.

It is also recommended to introduce a division into heavy equipment, such as diggers, loaders, cranes and small equipment, such as welding machines, shearing machines etc. This makes it easier for the construction manager to search for information. The type and quantity of the construction equipment used must be compliant with the conditions at the construction site. The construction manager may also specify the type of works to be performed. The depot manager, on the other


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hand, or another person, may specify the means for performance of these works. It is a good moment to establish cooperation between organizational units of the enterprise. Data prepared in this way must be updated as needed to reflect the enterprise and market reality. A certain way to facilitate the processing of this information is use of integrated management systems. The internal rates and rules of settlement of construction equipment and transport should be approved by management in advance. This will allow us to avoid many organizational problems. The same pertains to rates applied when outsourcing these eservices. These rules must be known here as well. Thus the management board should approve the regulations or pass a resolution concerning the rules of outsourcing of these services to external business entities. The regulations should include the following provisions:

• who makes decisions with regard to rental of units (construction manager, depot manager, technical director etc.)

• cases, in which external equipment or transport can be used, • person responsible for technical completion of the order.

In such case, there are many misunderstandings between the depot manager and the construction manager. It should be noted that rental of external units results in an outflow of financial resources from the enterprise. Use of own units is associated mainly with the costs born for:

• consumption of fuel by the unit, • work, • transport to site, • permits etc.

An important factor is the distance between the depot and the construction site, as well as the planned time of work of equipment. Surely, it is not acceptable to cause a situation, in which own equipment is unused and costs of rental of external units are born. Another group of costs consists of costs of management of the construction project and maintenance of the contractor’s plant and temporary facilities. In general, these costs pertain to consumption of power, employee accommodation, business trip allowances, family separation and similar components of remuneration with charges for the management of the construction, transport, telecommunication services etc. There is also the problem of employee benefits, including in particular the working clothes,


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energy meals, beverages, cleansing agents etc. This cost data should be prepared by the economic department in cooperation between the construction manager and the occupational health and safety personnel, since there are certain standards to be followed in this regard. The process of preparation of the construction cost budget must be described in the instruction for preparation of the construction cost budget. This instruction9 must include:

• forms and description of the construction budget forms, • rules of filling out of forms, • circulation of documents associated with the prepared budget, • rules of settlement of equipment and transport services rendered by own

transport depot (optionally), • deadlines associated with preparation of the construction budget.

An exemplary diagram of circulation of documents in an enterprise associated with organization of budgeting of construction costs in a hydraulic engineering construction company is presented in fig. 9.3.

9 Rules of preparation of the instruction for preparation of the construction cost budget have been described in [60].


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Fig. 9.3 Documents circulation diagram Source: own study It should be noted, in particular, that it is important that the budget is confirmed by the superior of the construction manager. It is necessary to make sure that individual unit managers, for instance, at the procurement department, abstain from launching procedures, such as ordering of steel from the steelworks prior to approval of the cost budget of a given construction project by the person authorized by the management board, since it may lead to disorganization at the company. Besides, it influences the planning of resources of the entire company. Constant changes in the resource planning also influences the working time of employees, for instance, of the procurement department, who might be involved in more productive work instead of modification of the plans. It is also necessary to analyze the reasonability of some tasks performed by employees. Their comfort and productivity is probably influenced by the sense of being needed and satisfaction with work performed. Nobody likes to perform certain tasks, prepare reports, plans etc., if they are not to be used for anything. Especially if it requires working overtime.

CONSTRUCTION MANAGER

COMPLETESET

approves

TECHNICAL DIRECTOR

DOCUMENTS CIRCULATION DIAGRAM (A-F)

C D E F B A

CHIEF ACCOUNTANT

TECHNICAL DIRECTOR PROCURMENT

DEPOT MANAGER

CHIEF ACCOUNTANT

Financial budget

WORK SCHEDULE

OVERLAND EQUIPMENT

OVERLAND TRANSPORT

WATER TRANSPORT & EQ

TECHNICAL DIRECTOR

MATERIALS MONTHLY BUDGET


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For the sake of an efficient budgeting process, every construction manager should have access to the IT system supporting budgeting. For a start, it does not have to be an integrated management system, but, for instance, an application created in the spreadsheet. It is difficult to create a construction budget quickly and efficiently without the proper IT tool. In the case of problems with ability to use of applications of this type, it is necessary to conduct the appropriate trainings. The construction managers, before starting to prepare the construction budget, must be trained also in financial accounting, the cost accounts, management accounting etc. It is a basic condition for the entire undertaking associated with introduction of the budgeting to be successful. It should not be assumed that after a training the construction manager will become a managerial accounting specialist. However, the manager must be familiar with the purpose of budgeting and must be convinced of reasonability of this additional work. It is necessary to present budgets as part of the information system used for the company management. The economic department plays a coordinating role in the entire budgeting process in the enterprise. This function is very important. If there is no person or department to coordinate the entire budgeting process in the enterprise:

• we may expect improper functioning of the processes associated with budgeting,

• the budgeting process of the enterprise becomes blurred, • there is no possibility of verifying the size of agreements recorded in the

budgets, • there will be no coordination of works associated with preparation of

other budgets, including the enterprise budget. In the budgeting process, it is necessary to perform the unit budgets earlier. The economic department prepares the enterprise budget on this basis, which is subject to discussion during the meeting with the company management. Then the final approval of budgets takes place and problems occurring at the stage of preparation of individual unit budgets are solved. Another, equally important problem is the corporate chart of accounts, in particular, recording of the construction revenues and costs. The cost calculation format in the cost budget must be compliant with the format in group 5 “Costs according to type of activity and their settlement” in the corporate chart of accounts. Lack of a mutual relation between the cost calculation format in the


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budget and in the corporate chart of accounts makes it impossible or very difficult to control performance of the construction cost budget. Of course, it is possible to check all accounting documents, but can we in this case speak of a sensible budgeting process without the realistic control of budget performance, independent of the construction manager? It is also necessary to examine the costs of the entire undertaking. In practice, these processes can be automated using the appropriate software. In this regard, it is also necessary to discuss the construction of the corporate chart of accounts with the chief accountant. One of the most important aspects of proper functioning of construction budgets are the scopes of competences of construction managers. They are often specified in the managerial contracts. A managerial contract is understood here as a form of completion of a task specified by the superior of the construction manager, for instance, the president of the management board. It is understood both as a contract of employment and a civil law agreement concluded by two entities, for instance, contract for management / performance of a project – a construction task. The rules of concluding internal contracts with the construction manager should be included in the organizational regulations of the enterprise. Introduction of managerial contracts surely enforces a change in the organizational regulations and remuneration of employees. Lack of adjustment of these regulations may result in inefficient implementation and improper functioning of budgeting in a construction enterprise [66]. From the viewpoint of employees, implementation of the budgeting system always causes concerns. It is not surprising, since most often the employees are not aware of the changes that will be enforced by it. Therefore, practically always at the beginning they oppose the budgeting system. They state it is impossible, because some factors associated with the construction site cannot be foreseen (bad weather, rising of water level, who is to be responsible etc.). On one hand, the arguments provided are right. Nevertheless, this is a “catastrophic” view. On the other hand, every enterprise must plan its activities and thus use of its resources and the costs of its operation. Not everyone likes to be accounted for their work, especially if their achievements are not impressive. During preparation of the construction budget by the construction manager, some flaws may be revealed with regard to the


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ability to plan organization of construction works. Besides, with such manner of planning of the construction resources, it is more difficult to transfer the costs of a given month to the subsequent month to obtain a bonus. The efficient construction budgeting process is not possible without:

• well organized work of individual organizational units, • preparation of adequate organization documentation, • good circulation of documents, • preparation of an instruction for devising of the construction budget, • training of the managers and persons associated with the construction

budget preparation, • the appropriate software, • a coordinator of the entire budgeting process at the enterprise, • preparation of the chart of accounts for the revenue items and cost

calculation items in the construction budget, • creation of a database and not only a cost base.

All of these conditions must be met if the company management wants to obtain a well functioning budgeting system.


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CHAPTER 10

BUDGET OF THE CONTRACTOR’S PLANT AND TEMPORARY

FACILITIES

LEARNING OUTCOMES


1. Elements of backup supporting completion of construction. 2. Costs of equipment and transport base. 3. How to prepare and develop budget for equipment and transport base. 4. How to prepare budget form for equipment and transport base. 5. How to monitor equipment and transport base.

COST OF OPERATION OF THE DEPOT

As a result of a market transformation, the construction and assembly companies have changed their business structure. Formerly, these companies owned developed equipment and transport depots, workshops, steel structure plants and other specialist facilities. Today, these areas of operation have been reduced or separated as specialist service companies. Their operation is based on rendering equipment and transport services etc.


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Separation of these areas of operation does not release the managers of these resources from the obligation of planning and controlling them, as well as their use in business operation. This process takes place regardless of the organizational and legal form of the enterprise. The process of budgeting of the contractor’s plant and temporary facilities will be discussed, using the example of the equipment and transportation depot. The basic scope of operation of the equipment and transportation depot10 is rendering of equipment and transport services on behalf of construction orders. These orders may be completed within the framework of own projects, as well as on behalf of external contractors. In particular, this may take place when the depot capacity is unused. This may serve as an additional – important source of income to improve the profitability of operation of the depot. Thus only separation of processes and cost centers will not be sufficient for their effective management. Without the appropriate organizational, financial and technical information, it is difficult to devise and implement an effective system for budgeting of the transport and equipment depot [58]. Therefore, this element should also be kept in mind during this process. The costs of functioning of the equipment and transport depot are diversified. They depend upon many factors: the quantity and diversity of potential owned, the depot size or the tasks implemented. However, the following groups of operating costs can be defined here:

• Costs of maintenance and operation in terms of transport • Costs of maintenance and operation of construction equipment • Costs of human resources • Costs of depot management and administration • Costs of maintenance of the depot building • The department costs.

Presented below is a short description of each group of costs. The costs of maintenance and operation of transport are the costs associated with maintenance and use of transport units belonging to the depot. These costs should include: depreciation, fuel consumption, oils, spare parts, tyres, renovation services, maintenance services, telecommunication services (GPS), insurance, motor vehicles tax, vignettes, environmental charges and other costs that need controlling, such as leasing costs. 10 Other names used are: transportation plant, equipment plant. It depends on the organizational structure of the company, as well as the nomenclature applied.


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The costs of maintenance and operation of construction equipment are costs associated with maintenance and operation of equipment units belonging to the depot. These include excavators, cranes, loaders etc. The cost items will be identical with those associated with transport units. The costs of human resources are associated with employment of drivers and operators. The basic costs include: remuneration, remuneration charges, trainings, working clothes, beverages, other benefits on behalf of employees (identifiable for this group). The costs of depot management and administration are costs associated with management and administration of this part of the enterprise. This pertains mainly to the depot manager, the dispatcher, service employees, who plan the operation of the depot, settle the materials and fuel costs for equipment and transport units etc. The number, functions and the scope of duties of employees result from the applied business model, organization of work in the company and the approved organizational structure. These costs include remuneration, remuneration charges, depreciation of fixed assets, such as computers, which are treated as workplace equipment, depreciation of intangible assets (the software used), consumption of office supplies, telecommunication services, business trips, employee benefits, allowances etc. The costs of maintenance of the depot building are the costs of heating of the building, lighting, water consumption, the real estate tax, insurance and other operating costs. A significant element for separation of individual cost items and their recording are the meters for utilities. The costs of maintenance of the building will result from its operation and technical state. It is also necessary to keep in mind the need for renovation and conservation, which will probably lead to a decrease in the cost of maintenance. The department costs are the cost items not qualified in the above segments. These may include waste removal, charge for perpetual usufruct of land, guard services etc. The above cost groups are characterized by certain mechanisms and sources of origin, which is significant from the point of view of the depot budget model. Familiarity with these groups and their identification allows us to obtain a clear budget. At the same time, it is easy to divide total costs into fixed and variable costs, which facilitates planning and controlling of cots throughout the entire


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enterprise. It also serves as a basis for creation of the corporate chart of accounts in this regard.

THE BUDGET OF THE EQUIPMENT AND TRANSPORT DEPOT

Devising of a budget of the equipment and transport depot requires: • getting familiar with the scope of its operation, • identification of resources at its disposal, • ability to recognize and assess the importance of individual processes in

its effective functioning, • separation of its processes, • identification of sources of income, both internal and external ones, • ability to measure and calculate the costs of maintenance of resources, • ability to measure, group, settle and calculate the costs of processes and

cost centers. An important aspect of budgeting of the equipment and transport depot is selection of the account of costs model. Every model is characterized by different rules of measurement, grouping, settlement and calculation of costs. Therefore, this problem should be taken into consideration during selection, devising and implementation of the model. A starting point for creation of the model of the equipment and transport depot budget is selection of the processes and cost centers. This allows us to get familiar with:

• the areas of functioning, • verification of the actual scope of tasks to be implemented, • resources that are at the disposal of the depot, • its organization, • the scope of information devised, necessary for its proper management, • mechanisms and reasons for occurrence of costs in the depot.

Among other things, the processes influence:


204

• the planning of revenues and costs of the equipment and transport depot, • construction of the cost calculations, • division of the depot costs into fixed and variable costs, • construction of the cost budgets of the equipment and transport depot, • control of cots of operation of the equipment and transport depot and • creation of a corporate chart of accounts with regard to recording of

revenues and costs of the equipment and transport depot. The following basic processes occurring at the equipment and transport base can be listed:

• maintenance and operation of construction equipment, • maintenance and operation of transport units, • maintenance and operation of the depot buildings, • maintenance of human resources, • maintenance of cleanliness and order in the depot area, • maintenance of security in the depot, • services on behalf of the depot and contractors, • depot management.

The transport and equipment units require the proper operation, special treatment, appropriate maintenance, which is also associated with their security at the depot and on the construction site. Also in the area of the equipment and transport depot, there is a requirement of ensuring safety, cleanliness and compliance with the occupational health and safety rules. Maintenance of specialized construction equipment and transport requires recruitment of qualified employees. Sometimes it is not very easy. Therefore, the process of maintenance of human resources can be identified. It is necessary to remember that most drivers are also construction equipment operators. Therefore, it is difficult to assign these resources separately to equipment and transport units, which influences the budget of the equipment and transport depot. Although sometimes, in some construction and assembly enterprises, there are attempts to assign employees to specific equipment or transport units. Another important process, which requires recognition, is the depot management and maintenance. On one hand, this pertains to management of the transport and equipment units. This is usually the task of the dispatcher, who is responsible for the general logistics of the potential to make sure that it is used in the best manner possible. This is associated with the problem of route planning and the appropriate use of the potential. It is also necessary to plan the


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transport of construction equipment to the construction site, settle the working time of drivers, operators and individual units and settle the consumption of materials and fuel. Planning use of individual units, it is also necessary to take into account the shut-off periods for renovation and maintenance. Thus it is necessary to provide the depot service employees, who will take over some of the obligations of the dispatcher and the depot manager. Efficient and effective management of the depot is usually the responsibility of its manager or director depending on the organizational structure of the enterprise. Therefore, it is good to identify the costs of administration and management of the depot in the budget. In the equipment and transport depot, depending on its size and the scope of its tasks, the following cost centers can be identified:

• equipment units, such as a crane or a loader, • transport units, • administration and staff building, • garages, • human resources, • organizational units identified in the equipment and transport depot.

It should be remembered that the equipment and transport depot cannot be treated as separated from the entire construction process. The services rendered by the depot influence significantly the quality and costs, as well as the entire result of the construction order. The costs of equipment, transport and other services influence significantly the construction costs. Thus the organization of construction works influences its operation and the results achieved. If the construction works are not planned well, the depot resources will not be effectively used. The budget of the equipment and transport depot must take into account the sources of income and the separate identified costs of its operation, which are significant for the depot. Also the budget must take into account the cost centers. The equipment and transport depot budget diagram has been presented in drawing 10.1.


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Fig. 10.1 Diagram of the budget of operation of the equipment and transport depot in a construction and assembly enterprise. Source: own study The budget diagram is established thanks to identification of processes, cost centers, which are the components of assumptions made while devising the depot budget. The next step is to prepare the forms that will constitute the depot budget. An exemplary depot budget has been presented in table 10.1. Table 10.1

An equipment and transport depot budget

Equipment and transport depot BST-1

EQUIPMENT&TRANSPORT DEPOT BUDGET March 2007

(month) (year)

REVENUES OF EQUIPMENT & TRANSPORT DEPOT

BUDGET OF OPERATION OF THE EQUIPMENT & TRANSPORT DEPOT

Income from depot

operation

Cost of maintenance &

operation of transport

Costs of maintenance &

operation of equipment

Costs of human

resources

Building maintenance

costs

Depot management

costs

Department costs


207

No. Revenues Value in PLN Structure

-1- -2- -3- -4-

1. Sale of transport services 146 531,25 51,49%

1.1 Including own construction projects 115 800,00 40,69%

1.2 External contractors 30 731,25 10,80%

2. Sale of equipment services 133 055,00 46,75%

2.1 Including own construction projects 80 130,00 28,16%

2.2 External contractors 52 925,00 18,60%

3. Other revenues 5 000,00 1,76%

4. Total revenues 284 586,25 100%

COSTS OF EQUIPMENT & TRANSPORT DEPOT

taking into account the processes identified No. Costs of operation of the depot Value in PLN Structure

-1- -2- -3- -4-

1. Maintenance and functioning of transport 43 533,00 16,17%

2. Maintenance and functioning of construction equipment 96 000,00 35,66%

3. Human resources 70 000,00 26,00%

4. Depot management and administration 22 711,88 8,44%

5. Maintenance of the depot building 20 000,00 7,43%

6. Department costs 17 000,00 6,31%

7. TOTAL /1+2+3+4+5+6/ 269 244,88 100%

Date: Prepared by

Date: Depot Manager

Source: Own study. Exemplary data. The budget presented in table 10.1 allows for identification of revenues and costs, taking into account the recognized processes. It is necessary to remember that identification of processes and cost centers is only helpful in construction of the budget and the real content of the forms. To a great extent, the shape of this


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budget depends on the informational needs for management and awareness of cost administration of the enterprise among the management board members, as well as medium-level managers. The individual budget forms must contain the following information:

• the area of operation of the enterprise, for which the budget is being prepared,

• a symbol of the form, which defines assigning to a given budget at the enterprise,

• tasks or projects to be completed, • involvement of the necessary resources in completion of the designated

task, • the quantity of resources needed and their costs, • revenue and cost items, • the identified significant cost centers, • cost calculations for individual cost centers, • costs of the separated units within the depot, • employees responsible for budgeting, • the period, for which the budget is applicable.

The budget itself, presented in table 10.1, provides only a general overview of the depot revenues and costs. In the case of revenues from sale of services, there is a division into internal sales, or rendering of services for the needs of own construction projects, and external sales, that is, rendering of services on behalf of external contractors. This division is significant due to the subsequent specification of profitability of the depot and construction of the depot profit and loss account. In the case of costs, six main groups have been differentiated. Developing the budget further, it is necessary to create forms taking into account the cost centers. Table 10.2 presents a form for the costs of maintenance and operation of transport units. In the further part, it is also necessary to take into account the quantity of resources consumed, since otherwise no control of their consumption will be possible, and it is an important aspect of operation on a competitive market.


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Table 10.2 Sheet of costs of maintenance and operation of transport units

Equipment & Transport Depot BST-2

BUDGET OF COSTS OF AN EQUIPMENT & TRANSPORT DEPOT March 2007 (month) (year)

COSTS OF MAINTENANCE AND OPERATION OF

TRANSPORT UNITS

No. COST ITEM VOLVO VOLVO SKODA JELCZ JELCZ

Total PLN Structure

DW 45002

DW 45003

PO 54300 WWW 4391

WRA 179K

-1- -2- -3- -4- -5- -6- -7- -8- -9-

1. Depreciation 540 120 660 1,52% 2. Fuel consumption 4 500 3 800 700 6 400 4 500 19 900 45,71% 3. Oils 120 120 0,28% 4. Replacement parts 200 50 220 90 130 690 1,59% 5. Tyres 1 600 800 2 400 5,51%

6. Use of other materials

950 230 1 180 2,71%

7. Leasing 2 000 1 100 4 500 5 100 12 700 29,17%

8. Renovation services

2 300 2 300 5,28%

9. Telecommunication – mobile services (GPS)

70 70 70 70 280 0,64%

10. Other external services

600 150 540 340 1 630 3,74%

11. Insurance 0 0,00% 12. Motor vehicle tax 180 230 320 730 1,68%

13. Vignettes for domestic roads

100 100 0,23%

14. Environmental charge

0 0,00%

15. Other costs 350 150 165 178 843 1,94%

16. TOTAL COSTS 9 790 7 790 3 510 12 145 10 298 43 533 100%

17. Structure 22,49% 17,89% 8,06% 27,90% 23,66% 100%

Source: Own study. Exemplary data.


210

In practice, it happens sometimes that the cost budget only takes into account the cost items without dividing them into processes and cost centers. Such form is not very helpful for planning and control of costs. Usually, in such budget format, the planning process is based on planning of costs on the basis of generally accepted indicators. Therefore, the employee planning the costs of operation of the depot, does not always take into account the individual areas of operation of the depot. Thus, afterwards it is difficult to effectively control the costs of operation of the depot and its individual parts. Each area of operation is characterized by different cost center mechanisms. The process of planning of revenues and costs looks different, when we take into account the separate cost centers and consumption of a certain quantity of the resources owned. If later on we compare the data according to the place of occurrence of costs, the conclusions drawn with regard to the functioning of the depot in comparison with the general cost breakdown may be very different. Table 10.3. presents an exemplary depot management cost budget. Table 10.3

Depot management costs

TEL Sp. z o.o.

BK-1

BUDGET OF THE EQUIPMENT & TRANSPORT DEPOT

Cost of depot management and administration March 2007

(month) (year)

No. COST ITEM Net value PLN

STRUCTURE

-1- -2- -3- -4-

1. REMUNERATION AND CHARGES 13 134,88 57,83%

1.1 Remuneration 10 200,00 44,91%

1.2 Social insurance 2 084,88 9,18%

1.3 Remuneration – commission and mandate contracts 850,00 3,74%

2. EMPLOYEE BENEFITS 6 149,00 27,07%


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2.1 Postgraduate studies 2 100,00 9,25%

2.2 Training „budgeting in small and medium enterprises” 1 149,00 5,06%

2.3 Training „costs of operation of enterprise - workshop” 2 900,00 12,77%

3. BUSINESS TRIPS 855,00 3,76%

3.1 Business expenses 45,00 0,20%

3.2 Railway - Intercity 250,00 1,10%

3.3 Accommodation 560,00 2,47%

3.4 Other 0,00%

4. TELECOMMUNICATION SERIVCES 205,00 0,90%

4.1 Fixed telephones 130,00 0,57%

4.2 Mobile phones 75,00 0,33%

5. IT SERVICES 900,00 3,96%

6. OTHER EXTERNAL SERVICES 500,00 2,20%

7. SUBSCRIPTIONS & SPECIALIST LITERATURE 423,00 1,86%

8. USE OF CONSTRUCTION MATERIALS 345,00 1,52%

9. OTHER COSTS 200,00 0,88%

10. TOTAL /1+2+3+4+5+6+7+8+9/ 22 711,88 100%

Number of employees 3

Date: 23.02.2006 Sporządził: R. Woźniak

Date: 24.02.2006 Zatwierdził: J. Kowalak


Preparation of the depot budget and individual budget forms is not sufficient for the proper functioning of the budgeting system in the enterprise. It should also encompass among other things:

• incorporating of the depot budget in the budget of the entire enterprise, • instruction for preparation of the depot budget, • components of budget control to encompass the depot, • the corporate chart of accounts within the budgeting scope, • the IT system for management of the depot budget, • management of the enterprise budgeting system.

The model of the enterprise budgeting system must encompass the above elements. Moreover, at the stage of implementation, the devised budget project


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must be verified with regard to: • the approved project assumptions for the budget forms, • the possibility of budget preparation in a specified period of time, • the company database content, • the circulation of documents associated with budget preparation, • control of use of budgets in company management.

Devising and implementation of the transport and equipment depot in a construction and assembly enterprise requires numerous organizational and analytical tasks. In the first place, it is necessary to specify the informational demands among the users, who will use the budget to manage this area of activity of the company. Then it is necessary to recognize the processes and cost centers. In the next step, to prepare the budget forms, the budget preparation instructions and the budget control system.

MONITORING OF ACTIVITY OF THE EQUIPMENT AND TRANSPORT DEPOT

Every enterprise must have a system of monitoring of its activity. In particular, such resources of the enterprise as construction equipment or transport must be effectively used. Otherwise, when the market situation worsens, the managers may suddenly face a completely different reality. It is necessary to take into account the fact that the costs of use and maintenance of resources of this kind are mainly fixed costs. They constitute a significant share of the general costs of the enterprise. In particular, outside the season of works. Therefore, it is necessary to determine how the system of monitoring of the transport and equipment depot should be organized? What tools should be used for this purpose? Monitoring of individual areas of activity, as well as the entire enterprise, starts with planning. If the employees do not know what to do, if they are not familiar with the objectives, it is difficult to monitor anything. A budget is only the tool for planning of the enterprise operation. After its implementation, it should be verified. The budget control system can be


213

effective only if it is well organized. The system components include an appropriately designed database, which allows us to construct a breakdown of financial, organizational and technical information, the budget and the profit and loss account. The equipment and transport base, as one of the areas of activity of the company, must also be evaluated. Therefore, it is necessary to select the appropriate tools. A basic tool like that is a profit and loss account; an example is presented in table 10.4. The aim of the equipment and transport depot is to perform tasks on behalf of own construction projects. The surplus production capacity can be used for completion of orders of contractors. Therefore, the profit and loss account must take into consideration this division. Another problem is how to settle the internal services on behalf of own construction projects, and thus establish on one hand the profitability of construction projects, and on the other – the profitability of the construction and equipment depot itself. In fact, it is a serious problem, since such settlement must take into account the real work performed by transport and equipment units11. Otherwise, the costs of unused production capacity (maintenance and preservation of units etc.) will be charged to construction projects. This will lead to an improper result. This may lead to wrong decisions being made. The costs of functioning of the depot must be grouped accordingly. Therefore, the profit and loss account includes the following cost groups:

• maintenance and operation of transport units, • maintenance and operation of equipment units, • human resources, • management and administration of the depot, • maintenance of buildings, • department costs.

This cost division takes into account the specific character of operation of the depot and the applied cost account model, as well as the budget model, presented in table 10.1. The scope of the above groups of costs should be determined in detail. An exemplary profit and loss account for the equipment and transport depot is presented in table 10.4. 11 More information on settlement of internal services can be found e.g. [65], and on construction of internal prices – for instance, in [23].


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Table 10.4 Profit and loss account for an equipment and transport depot

No. Item name Transport services

Equipment services Other Total PLN

-1- -2- -3- -4- -5- -6- 1. Revenues from sale of services 146 531,25 133 055,00 5 000,00 284 586,25

1.1 own 115 800,00 80 130,00 x 195 930,00 1.2 external 30 731,25 52 925,00 x 83 656,25 1.3 other services x x 5 000,00 5 000,00

2. The costs of maintenance & operation of transport and equipment units

80 094,50 96 718,50 176 813,00

3. Profit margin after coverage of unit maintenance costs (1-2)

66 436,75 36 336,50 5 000,00 107 773,25

4. Human resources 78 328,20

5. Result for services /3-4/ 29 445,05

6. Costs of management and administration of the depot 22 711,88

7. Cost of maintenance of depot building 20 556,38

8. Department costs 17 000,00

9. Result of operation of depot /5-6-7-8/ -30 266,83

10. Depreciation 38 000,00

11. Depot operation result excluding depreciation /9-10/ 7 733,17

Source: own study. Exemplary data This tool is not very complicated and it does not require any special activities. It is sufficient to prepare the corporate chart of accounts appropriately. Moreover, it is necessary to differentiate between the analytical and control accounts. However, in the first place, it is necessary to think over the entire structure of the profit and loss account. It must be associated with the budgeting system, the accounting policy and it must take into account the demand for information from users. Thanks to such structure of the profit and loss account, the managers have a precise idea of the financial operation of the depot. In particular, it allows for separation of fixed costs (of maintenance of resources) and variable costs (performance of services). In activity of this kind, fixed costs are a significant part of the general cost structure and they exert substantial influence on the result of the enterprise operation. Therefore, effective use of the owned resources is very important.


215

In the presented profit and loss account, the depot result was separated, taking into account the depreciation and without taking it into account. This is aimed at presentation of profitability of the depot and it allows for a different view of the results of this operation. This information indicates to the enterprise managers that lack of this cost item means incurring of an internal debt. It may be a proof of lack of the appropriate investment policy. Over the longer perspective, it may lead to a situation, in which the company will not be able to implement its services due to lack of replacement of the property owned. Another question arises, pertaining to the structure of the motivation system of the depot management. Should the bonus include the depreciation amount or not. Should only the bonus take into account the financial results? There will be many questions like that. Nevertheless, such profit and loss account may serve as a part of the motivation system. The financial information, which includes the presented profit and loss account, is not sufficient for the appropriate assessment of operation of the depot. It is also necessary to analyze the use of the resources owned. If the construction equipment or transport is not working, the enterprise is not making a revenue, and thus it makes no money. The depot manager should receive from site managers data pertaining to the planned use of construction equipment, transport and other depot equipment. This data is necessary to plan the use of these resources. A depot employee must manage these resources effectively. Without this data, it would be difficult to sell the surplus of production capacity. In general, the employee will not be able to answer the question whether there is any surplus of production capacities and for what periods without having the information on the internal demand. This requires a good information flow and a database, available for the interested parties. One of the tools for planning of equipment units is a work schedule for the owned equipment and transport. Such schedule must include at least a list of units, their use, working time, the period, for which it is prepared. An exemplary schedule of work of construction equipment is presented in table 10.5.


216

Table 10.5 Equipment work schedule

Source: Own study. Exemplary data It is not difficult to prepare a schedule like this. Perhaps it is not a very sophisticated tool, but it is very efficient. It provides us with a lot of information on the planned use of equipment, available work capacities and working hours. It is necessary to remember that the presence of an equipment unit on the construction site does not indicate continuous work. However, it would be difficult to move it to other construction sites. It might turn out too costly. Therefore, it is a good idea to mark the planned work time of equipment. This data can be used, for instance, to plan the fuel consumption. Then it is easy to switch from the material planning to the depot cost budget. Of course, it is necessary to prepare the appropriate data, such as the fuel consumption norms. The budgeting process is to support the enterprise management. One of the components of effective management is definition of objectives. In this case, the enterprise management board should establish objectives to be achieved by the equipment and transport depot. Such objectives may include, for instance, the appropriate level of the financial result. It is only one of the assessment parameters.

Transport & Equipment Depot

CONSTRUCTION EQUIPMENT WORK SCHEDULE (rok)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 19 20 21 22 23 24 25 26 27 28 29 30 311. Power generator2. Power generator

3. Power generator 4. Piledriving hammer5. Piledriving hammer

6. Digger

7. Digger

8. Digger

9. Loader

10. Loader

11. Bulldozer

12. Bulldozer

13. Compressor

14. Compressor

15. Roller

16. Compacting machine

17. Caterpillar crane

18. Caterpillar crane

19. Truck-monted crane

70 hours

130 hours

18 hours

12 hours

200XApril(month)

15 hours

100 hours (until called off)

80 hours

30 hours

25 hours 80 hours (until called off)

130 hours (return)

30 hours

Month daysUnit nameNo.

40 hours

(year)

18


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Other parameters of assessment of the depot is the degree of use of the production capacity of the depot. Therefore, at the budgeting stage, the manager of the depot should know whether it will achieve a given result or not. It is always necessary to keep in mind that the construction equipment, whenever it is not working, brings no profit to the enterprise. We can always ask for the reasons for differences. The reasons may vary and they may include the market situation, a failure to take into account the seasonal character of construction works, the objectives of the management board being too optimistic etc. Therefore, the established objective may also be changed, and in fact, it should always be verified in accordance with the specified rules. Table 10.6 shows a comparison of the level of task performance with the plan and the objective to be achieved. Table 10.6

Level of task performance and the objective achieved

Time of work of equipment [h] Deviations [h]

No.

Name of equipment units

Objective

Performance Plan Perf. - Plan Perf. – Obj.

-1- -2- -3- -4- -5- -6- (4-5) -7- (6 : 5) -8-(4-3) -9-(8 : 3)

1. Compressors 360,00 325,00 300,00 25,00 8,33% -35,00 -9,72%

2. Caterpillar crane 300,00 270,00 250,00 20,00 8,00% -30,00 -10,00%

3. Crane 320,00 240,00 250,00 -10,00 -4,00% -80,00 -25,00%

4. Diggers 340,00 280,00 250,00 30,00 12,00% -60,00 -17,65%

5. Power generators 280,00 278,00 260,00 18,00 6,92% -2,00 -0,71%

6. Loaders 360,00 300,00 220,00 80,00 36,36% -60,00 -16,67%

7. Bulldozers 300,00 230,00 240,00 -10,00 -4,17% -70,00 -23,33%

Source: Own study. Exemplary data The desirable results are the smallest possible deviations between the planned objective and the actual work performed by the construction equipment. Breakdowns of this kind can be used for the planned investment projects in this regard or for liquidation of the unused equipment units. The aim here is not to generate the subsequent tables with numbers, but to construct an efficient system of monitoring of the resources owned. Such monitoring will not be functioning well without preparation of an IT system in this regard (databases, document flow, motivation system etc). Also for


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monitoring, using the above tools and generating reports of this kind requires a good IT system. In this case, a spreadsheet will not be sufficient. The gathering of such data would be too time-consuming for many employees. Moreover, the employees would focus on copying data from one spreadsheet to another and verifying the proper copying. This makes the monitoring process much longer and it does not allow us to focus on analysis of data and on decision-making. Thus, there would be no noteworthy effect of monitoring organized in such way. Finally, it is also necessary to take into account one more aspect. It is the use of the monitoring system for management of the enterprise. Both the management board and the depot manager must be interested in the system. Otherwise, a monitoring system implemented in this way will not be efficient. It cannot also be treated as a tool for repression of the manager. Of course, it does not mean that we give up the enforcement of the approved strategy. The monitoring system is aimed at implementation of this strategy and selection of the best possible solutions. This will allow us to introduce changes more quickly and efficiently, since the employee team should be responsible for drawing conclusions. Then they should be introduced and implemented efficiently. Otherwise, the monitoring system will not be efficient.


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CHAPTER 11

CONTROL OF ACTIVITY OF THE ENTERPRISE

LEARNING OUTCOMES


1. General costs of operation of a construction and engineering enterprise. 2. How to plan general costs of operation of a construction and

engineering enterprise. 3. How to control general costs of operation of a construction and

engineering enterprise.

THE NATURE AND SYSTEM OF CONTROL OF ACTIVITY OF AN

ENTERPRISE

The enterprise activity requires constant monitoring as its environment is constantly changing. Well organized monitoring of activity requires precise specification of:

• the entity authorized to conduct observations and take advantage of their results,

• the entity subject to observation, • the subject of monitoring, that is, tasks subject to observation and the

measures,


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• the dates and frequency of observations, • sources of information on the task completion progress, • ways and forms of gathering information on the task completion

progress, • ways of gathering and processing of information, • way of presenting, including visualization, information on the task

completion progress [48]. In the organizational structure of the enterprise, the monitoring of its activity is usually dealt with by the economic department, the department of analyses of the financial and accounting department. As a result, the designated department is obliged to prepare the defined scope of information until the specified deadline. Monitoring of activity of the enterprise takes place through:

• planning of activity of the enterprise, • budget preparation, • budget performance control, • preparation of an adequate multi-stage and multi-block profit and loss

account, • analysis of processes, • devising and analysis of the system of assessment measures for

individual fields of activity of the enterprise. It is necessary to differentiate between monitoring and control. Control is a management tool associated with the management system; its task is to verify the assumptions and selection of means and assessment of performance of the planned tasks [98]. The basic control tasks at the enterprise are [86]:

• Stimulating of activities to support the implementation of the policy approved by the enterprise management,

• Efficient control of the company assets, • Providing the management with reliable information on the progress of

business activity, • Creation of a basis for good economic decisions to be made by the

management, • Stimulation of effective business activity, • Early detection of threats to achieve the results specified in the long-term

plan, • Revealing of problems and irregularities in the progress of business

activity, • Counteracting ineffective use of assets of the enterprise.


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The above tasks of control provoke us to ask: when to start monitoring of activity, and thus control of events in the enterprise and how to do that? Another important issue is the quantity and type of resources to be used to make sure that the costs of the process are not higher than the value of information obtained and specified in the report on the inspection conducted. Monitoring of day-to-day activity of the enterprise should start with checking of the budgets prepared. The budgets pertain to various fields of the enterprise activity and they are prepared by various organizational units, responsible for these fields of activity. The initial budget control allows for verification of the tasks and resources involved prior to their acceptance. After verification of the delivered budgets and their approval, implementation of tasks specified in the budgets commences. Of course, not everything can be planned precisely (it is not the purpose here) due to the changing environment of the enterprise activity. For instance, if in the middle of the month the trading department acquires a new client, which purchases an additional quantity of products offered by the company, such as concrete, sale – and perhaps production – will increase. Thus the sales and production budgets, prepared earlier, become outdated. Budget control is a comparison of financial and non-financial data contained in the budgets with the results achieved, verification of the assumptions and selection of means and assessment of implementation of assumptions made and the processes taking place in the enterprise. This definition leads to certain assumptions with regard to devising of a report on the budget performance and its objectives. The basic objectives of budget control12 are:

• Examination of compliance with budget performance and the enterprise objectives,

• Examination of effectiveness of activity of organizational units and the enterprise as a whole,

• Examination and assessment of real implementation of processes taking place in the enterprise,

• Determination of the causes of deviations, • Defining of employees and organizational units responsible for these

deviations, • Analysis of processes in the enterprise subjected to observation, • Specification of methods and possibilities of elimination of causes of the

observed deviations. 12 Own study on the basis of [55], [98]


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The proper planning of a budget form allows us to simplify the budget preparation, because it establishes certain mechanisms or a philosophy of planning in the enterprise. It does not allow us to prepare the budget freely and thus to plan freely the areas of activity of the enterprise. Thus, information and data to be contained in the budget is planned in advance, which facilitates the monitoring of activity of the enterprise. Later on, these will be necessary for effective budget control. After the end of the month or another settlement period, the manager should receive from the economic department information concerning the budget performance, for which the manager is responsible. This information should include:

• the value of planned and real revenues and/or costs, • deviations of real values from the planned values, expressed as absolute

values in PLN and relative values in percentages, • a list of cost and/or revenue items, which the manager of the economic

department or the financial director views as doubtful in terms of the deviation, to which the manager responsible for the budget performance must relate.

In this case, it is very important that the manager has information on the results of his/her activity. This allows the manager to plan the activities better and thus to organize work better; it is a component of learning for the entire organization. At the same time, the management board of the enterprise (through its economic department) is informed in the report of the problems arising in the enterprise activity. After the end of the month (or any other settlement period), there is time for assessment of results of activity of the enterprise. A useful tool in this case can be a multi-stage and multi-block profit and loss account. This is particularly true for enterprises, which are engaged in diversified economic activity. The tool is simple and it does not require substantial resources. It is enough to plan appropriately the corporate chart of accounts, and then such profit and loss account13 -in form of a report – may be generated automatically by the financial and accounting system, not even a very complicated one. The profit and loss account provides a general image of activity of the enterprise and serves as a source of information and 13 The profit and loss account mentioned, prepared for the purpose of the enterprise control, is the same as the profit and loss account prepared in accordance with the act on accounting.


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suggestions necessary to conduct the budget control, which is a component of monitoring of the company activity Preparation of a sole breakdown on deviations of real values from the planned ones is of no use other than serving as a basis for yet another report. It is also necessary to be able to draw conclusions from it. Organization of monitoring of the enterprise activity depends on its size, activity types and the needs of the management board. Thus it is necessary to select the adequate tools for monitoring and the methods. In some enterprises, a simple financial and accounting system and a spreadsheet are sufficient. In others, due to the diversity of their activities, it is a complex IT system. Nevertheless, the budget preparation, its assessment before and after performance and the profit and loss account may serve as significant elements of organization of the enterprise activity monitoring. Moreover, they are effective and not very expensive. However, sometimes objections arise that these solutions are expensive and that enterprises cannot afford their implementation. Budget control is a significant element of the budgeting process. Unlike it could be expected, the nature of budget control does not start and it is not limited only to an analysis of deviations or examining of the past. It starts at the moment of preparation of the budget form, which contains a specific path for planning of various areas of activity of the enterprise. It is not an acceptable solution to limit ourselves only to examination of value deviations; it is also necessary to take into account deviations with regard to use of resources of the enterprise and their correlation with the planned objectives. These objectives should be included in the strategy of activity of the enterprise. Budget control must be focused on improvement of the processes taking place in the enterprise and not on permanent searching for persons to blame. Of course, it does not mean accounting employees for the designated tasks.


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PROFIT AND LOSS ACCOUNT OF AN ENTERPRISE

The profit and loss account is usually prepared for the internal purposes of the company management. At the same time, it is incorporated into the reporting system as a component of the informational system of enterprise management. In this case, the provisions of the act on accounting do not apply. The managers themselves specify the content of the profit and loss account. In preparation of the profit and loss account for the enterprise, we use the model of a multi-stage and a multi-block profit and loss account and a variable costs model, which have been discussed in detail in literature on profit and loss accounts and managerial accounting. The profit and loss account prepared by the enterprise for its internal purposes should:

• enable us to get familiar with the value and quantity of products and services sold,

• provide the important data for running of a flexible sales policy and calculating of the lower price limit for the contractor,

• take into account the profitability of individual products and services offered by the enterprise,

• take into account the profitability of individual areas and types of activity of the enterprise,

• take into account the profitability of individual departments and the entire enterprise,

• provide information on costs of operation of separate process lines, infrastructure maintenance, organizational units,

• present the human resources costs and workplace costs in various fields of activity of the enterprise,

• provide information on costs of enterprise management, • allow for devising of motivational systems for the enterprise.

The objectives presented above influence the profit and loss account in the enterprise. Chapter 3 presents and discusses an exemplary profit and loss account for the equipment and transport depot. The profit and loss account of the depot presents only a selected area of activity of the enterprise. Another example of use of the profit and loss account for the purposes of management has been presented in example 11.1.


225

Example 11.1 The subject of activity of the construction enterprise is production and sale of construction mixes produced on the basis of cements, aggregates and derivatives of combustion of hard coal. The enterprise is also engaged in trade and service operation. After preparation of the profit and loss account, on the basis of accounting information for one of the months, it turned out that the service activity was not profitable. The president of the management board was surprised by this fact, since his calculations showed that this area of activity was profitable. Upon verification of the source documents (not only accounting evidence) it turned out that an employee issued invoices for sale to the contractors, but not all services were included for this month, unlike the costs of these services. The revenues from a part of services rendered were recorded in the subsequent month. In other words, the rule of commensurate revenues and costs were not followed. Nevertheless, the matter was explained very quickly and it became a signal for changes in the circulation of documents in order to avoid such situations in the future. The example shows how on the basis of proper recording of revenues and costs this data can be used for enterprise management in creation of a profit and loss account. Presented below is a profit and loss account for a construction and assembly enterprise. The result for individual construction orders will depend on the assumed profit and loss account model in the enterprise. In particular, it depends on the applied rules of settlement of indirect costs. Another component is application of the rules of settlement of costs between individual organizational units of the enterprise, such as the equipment and transport depot and the construction projects. These are the major internal components, which influence particularly strongly the results of the enterprise, including the construction projects, presented, for instance, by the accounting department. Selection of the profit and loss account model has its consequences for the rules of grouping, settlement and calculation of costs. In many enterprises, philosophy of the full costing model is applied in practice. As a result, many accountants are used to a situation, in which they must specify the settlement keys for indirect costs. In fact, they do not have to do it as in practice it is not necessary. This problem will be presented in example 11.2.


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Example 11.2 A construction and assembly enterprise has the Department of Construction Management, the Department of Cost Estimation, the Department of Finances and Accounting, the Department of Human Resources and the Management Board. The enterprise also includes specialized transport and equipment units along with their management. In the examined period, they were fully engaged and their operation was adequately settled among four construction sites. On the basis of data from analytical and control accounts, the Department of Finances and Accounting has prepared the profit and loss account of the enterprise for the management board. It took into account the division of indirect costs among the separate construction projects. Table 11.1 presents the results of each construction project. Table 11.1

Profit and loss account of the enterprise, taking into account the indirect costs

No. Item name Construction A

Construction B

Construction C

Construction D

Total PLN

-1- -2- -3- -4- -5- -6- -7-

1. Revenues from sale 521 727,56 407 800,79 142 522,29 445 671,22 1 517

721,86

2. Direct construction costs

320 939,30 317 988,10 89 590,99 216 543,34 945 061,73

4. Construction Management Dept.

32 601,23 32 301,44 9 100,71 21 996,62 96 000,00

5. Dept. Of Cost Estimation 18 338,19 18 169,56 5 119,15 12 373,10 54 000,00

7. Dept. Of Finances & Accounting

52 977,00 52 489,84 14 788,66 35 744,50 156 000,00

8. Dept. Of HR 20 375,77 20 188,40 5 687,95 13 747,89 60 000,00

9. Management board & MB services

41 250,84 32 243,12 11 268,65 35 237,38 120 000,00

10. General management costs

6 875,14 5 373,85 1 878,11 5 872,90 20 000,00

11. Results for construction projects

28 370,09 -70 953,54 5 088,08 104 155,50 66 660,13

Source: Own study. Exemplary data. Table 11.2 presents the groups of costs subject to settlement along with the basis for settlement.


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Table 11.2 Indirect costs and the basis for their calculation

No. Costs Basis for cost settlement 1. Construction Management

Dept. Direct construction costs

2. Dept. Of Cost Estimation Direct construction costs 3. Dept. Of Finances &

Accounting Total direct construction costs, Cost Estimation Dept. And Construction Management Dept.

4. Dept. Of HR

Total direct construction costs, Cost Estimation Dept. And Construction Management Dept.


Revenues from sale

6. General management costs Revenues from sale Source: Own study The bases for settlement of the above cost groups may be different from those presented in table 11.2. This depends on the applied rules of settlement of these costs. Nevertheless, these costs are always to be settled in accordance with the same rules during the fiscal year. On the basis of table 11.1, it can be seen that the enterprise has achieved a positive result for its basic operating activity in the amount of PLN 66 660,13. Out of four construction projects, three have reached a positive result. The best result was achieved by construction project D in the amount of PLN 104 155,50. Construction project B recorded a loss in the amount of PLN 70 953,54. Is the image of the enterprise presented in table 1 true? Example 11.3 Let us thus analyze the profit and loss account of the enterprise without settlement of indirect costs. It has been presented in table 11.3. Table 11.3

The profit and loss account of the enterprise without taking into account settlement of indirect costs.

No. Item name Constr -uction A

Constr -ction B

Constr -ction C

Constr -ction D Total PLN

-1- -2- -3- -4- -5- -6- -7-

1. Revenues from sale 521 727,56 407 800,79 142 522,29 445671,22 1 517

721,86

2. Direct construction costs 320 939,30 317 988,10 89 590,99 216 543,34 945 061,73

3. Results of construction 200 788,26 89 812,69 52 931,30 229 127,88 572 660,13


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projects

4. Construction Management Dept. 96 000,00

5. Dept. Of Cost Estimation 54 000,00

6. Result of construction activity 422 660,13

7. Dept. Of Finances & Accounting

156 000,00

8. Dept. Of HR 60 000,00


120 000,00

10. General management costs 20 000,00

11. Operating result of the enterprise 66 660,13

Source: Own study. Exemplary data. The image of the company presented in table 11.3 differs slightly from its image presented in table 11.1. On the basis of table 11.3 it is visible that all construction projects are profitable. Where do the interpretation differences come from? It is necessary to take into account, in particular, the costs of individual groups of costs settled previously, that is, individual departments. The level of these costs is identical in both examples. Moreover, they do not influence the final result of the enterprise, which is exactly the same and amounts to PLN 66 660,13! The costs of these departments would probably be the same – even if the enterprise encountered a stoppage due to weather conditions, for instance, the weather would be too cold for construction works. These are simply the fixed costs of operation of the enterprise. Moreover, they usually show little sensitivity to the current level of engagement of the enterprise, that is, the construction projects implemented in a given period. It is thus not surprising that the management board, and – in particularly – the construction managers – get irritated because of the arbitrary assignment of costs of individual organizational units to construction projects. The costs born by individual organizational units influence the result achieved by the enterprise. The enterprise must generate a margin of profit on its services to cover these costs. Surely, it is necessary to keep these costs in mind and to maintain them at a reasonable level. Lowering of these groups of fixed costs will influence the result of the enterprise, but they will not influence the direct


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costs of construction. Thus it is not necessary to settle them for the internal needs. Fig. 11.1 presents the shaping of fixed and variable costs in one of the construction and assembly enterprises.

0

500 000

1 000 000

1 500 000

2 000 000

2 500 000

3 000 000

3 500 000

VII VIII IX X XI XII

FIXED

VIARIABLE

TOTAL

zł

Fig. 11.1 Fixed and variable costs of a construction and assembly enterprise in the 2nd half of the year. Source: Construction enterprise X We should also note the influence of the approved rules of settlement of equipment and transport units on the construction projects as their improper settlement results in distortion of the results of these projects. In the example, it is assumed that the units were fully engaged at the construction sites. In the case of their partial engagement it happens that after the arbitrary settlement of their costs according to construction projects, the construction projects cease to be profitable. Such settlement is erroneous; the construction projects are also assigned the fixed costs of their maintenance, which is not justified by the manner of operation. Therefore, it is necessary to specify in advance the internal rates for the equipment and transport services in the enterprise. Then, depending on the actual level of their engagement at the construction sites – the costs should be appropriately assigned to them. Such


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solution forces the manager of the equipment and transport depot to search for a market for sale of the offered services. The above example illustrates the consequences of the applied rules of settlement of indirect costs of the enterprise. The shape of the profit and loss account of the enterprise will largely depend upon the type of its activity and the informational needs of the management board. The informational needs should be defined first, and the profit and loss account should be constructed afterwards. Then it is necessary to devise and implement the appropriate corporate chart of accounts to allow its further preparation. The concept of a multi-stage and multi-block profit and loss account is quite simple. However, the devising and the effective implementation of a short-term profit and loss account based on this concept is not as simple as it might look. The benefits of the short-term profit and loss account for the enterprise management are sufficiently significant to face the difficulties associated with its implementation. We will find it profitable, when the implemented profit and loss account is associated with:

• the objectives that the management board wants to achieve • individual products and services offered • workplaces • process lines in separate organizational units • areas of responsibility in individual organizational units • the resources owned • the organizational structure • the applicable motivation system • the system of monitoring of activity of the enterprise.


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RECORDING OF THE ENTERPRISE REVENUES AND COSTS

The main question to be asked in this regard is what are the information needs of the users with regard to the revenues and costs of activity of the enterprise, which may be satisfied by the accounting department thanks to the appropriate bookkeeping system. This is the starting point for preparation of detailed analytical and control accounts. The information users must specify the type of information and data expected from the accounting department. It should be kept in mind that the corporate chart of accounts is a component of the entire system of information for management of the enterprise. Therefore, it should be adjusted to this system as well. Recording of revenues and costs in every enterprise depends on such factors as:

• the legal regulations, • the needs in terms of enterprise management, • the internal cost reporting system, • the internal resolutions e.g. of the supervisory board, • the cost control system, • the type of internal reporting system, • the statistical office requirements, e.g. cost information in report F-01,

DG-1, Z-06, • the needs of managers of individual departments within the

organizational structure of the enterprise, such as the controlling department.

Recording of revenues must ensure specification of revenues e.g.:

• from individual construction orders and even the implemented construction stages or facilities,

• from equipment and transport services, • from sale of construction materials, • from other orders subject to budgeting.

The size of the enterprise, the type of works performed and the diversified assets will largely determine the organization of the costing system. Therefore, we have to answer the following questions:

• what kinds of costs were born by the enterprise in a specified period of time,

• to what products or services they pertain,


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• in which organizational units these costs were born, • who or which department is responsible for these costs.

The operating costs of the enterprise are entered in group 4 Costs according to type, group 5 Operating costs according to activity type and group 7 Associated revenues and costs. Each of these formats plays a specific role. Cost recording in accordance with group 4 Costs according to type and their settlement pertains in general to costs born at the enterprise level. Analysis is developed only to the extent allowing for preparation of the profit and loss account and other obligatory internal reports. Usually, such cost recording does not allow the managers to obtain an extensive view of the enterprise costs of operation. Recording of costs in group 5 Costs of operation according to the functional and calculation format is used to record the costs of activity of the enterprise according to type of activity, taking into account the separated processes (e.g. of marketing, production, technology etc) and cost centers or products and services. In general, cost recording in a construction and assembly enterprise with a well developed organizational structure should enable the measurement and familiarity with costs of:

• completion of construction orders, • transport and equipment services on behalf of contractors, • construction manufacturing, • maintenance of transport and equipment units and water transport units14, • maintenance of the enterprise infrastructure (such as buildings,

workshops) • maintenance of human resources • processes taking place in the enterprise, such as security, management,

operation of the enterprise • advertising and public relations, • fixed and variable values.

Such cost recording enforces separation of centers responsible for results and costs, processes and cost centers in the enterprise. This work should involve managers responsible for individual areas of activity of the enterprise.

14 In hydraulic engineering enterprises.


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The accounts belonging to group 7 Associated revenues and costs are used e.g. for recording of revenues and costs of operation of the enterprise, which includes sale of construction services, transport services, steel structures etc. Data from the bookkeeping records of this group may be used for preparation of a control profit and loss account of the enterprise for the management board, taking into account:

• revenues from various types of activity of the enterprise (such as construction manufacturing, transport and equipment services etc.)

• costs of orders completed by the enterprise, • costs of maintenance of transport and equipment units, • costs of human resources, • costs of maintenance of the enterprise infrastructure, such as the

administration buildings, • costs of management and operation of the enterprise.

Such format of the profit and loss account requires rethinking and preparation of the appropriate analytical and control accounts and the appropriate cross-postings from group 5. It is not sufficient to just record the costs of operation of the enterprise. It is also necessary to take into account the system of classification of bookkeeping evidence and its comparison with source documentation delivered by construction managers or other employers. Inconsistencies may sometimes be significant, especially when determining the value of work in progress. The construction and department managers do not always realize the consequences of delivery of cost documents at certain dates or their erroneous settlement. It is thus recommended to establish an association between the rules of the profit and loss account and the system of internal organization and control of production, since the system of analytical recording of costs of construction and assembly production, even if it is very well organized, is unable to ensure cost control and determination of a realistic financial result and profitability if the cost documentation, as well as sales, are not proper, reliable, timely and properly assigned to accounts. Experience of many years has shown that the quality of this documentation is not sufficient. In the case of many orders, the cost level is incommensurably high or low, and in extreme cases, only production without costs is entered or the opposite –costs without production. The reasons for these improper relations are mainly:

• errors in assignment of cost documents


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• performance of works not specified in the cost estimates (such as additional works)

• including of costs of defect elimination in the current production costs, • incomplete or unreliable lists of non in-built materials, • overstating or – less often – understating of value of works performed • erroneous valuation of works, • recording of works performed by subcontractors without the proper

increase of costs, • costs of performance of works completed invoiced in the previous

year [8]. It should be added that introduction of a budgeting system partially eliminates the problems discussed earlier, since it forces (particularly the construction managers) to:

• record the tasks to be completed in a given period • breakdown the necessary materials for performance of construction

works, • order the construction and transport equipment adequately to the tasks

performed, providing the dates of rendering these services at the depot, • specification of the necessary specialists for task completion, • specification of services of subcontractors, • specification of financial means for implementation of tasks entered in

the budget. The budget control by management of the enterprise allows for verification of the plans of the construction manager and reasonability of the planned use of resources at the planning level, which then influences the costs of the construction order. The accounting system of the enterprise is to ensure [97]:

• making of economic decisions, • performance of analysis and control, • gathering of documented data for the economic analysis, • conducting of all financial settlements resulting from the operation, • cooperation in terms of construction of the economic information

system. Without a proper measurement of costs of processes, the costs of their management, maintenance of resources and their recording, it is not possible to


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talk about any management of the enterprise costs. Improper input data (e.g. lack of the appropriate measurement of costs) cannot guarantee and enable the proper assessment of situation of the enterprise and thus making of the right decision. The state of knowledge regarding costs is a consequence of the results and quality of cost measurement, both in terms of planned and real costs. Therefore, the cost information provided to users must be included in various information formats. It is also important that information gathered in the cost accounts will serve as a basis for cost estimates for tenders organized by public investors (central and local government administration) and private companies. It is worth underlining that the type costing displays must be a component of the entire informational system of the enterprise. Thus designing of the corporate chart of accounts as apart of the informational system of the enterprise management cannot be analyzed only from the point of view of the accounting department as this limits us to a single perspective. Equally important is the viewpoint pertaining to the enterprise management or creation of a system of control of its activity, including the budget control.

REPORT ON ACTIVITY OF THE ENTERPRISE

A balance sheet and a profit and loss account are not sufficient for the needs of management of an enterprise. On the basis of these documents, it would be difficult to make decisions on specific activities. These documents do not provide the following information:

• the origin of revenues of the enterprise, • profitable construction orders of the enterprise, • the sales structure of the enterprise, • the sale structure according to recipients, • the state of receivables and liabilities, • the costs of functioning of individual areas of activity of the enterprise, • the costs of organizational units, • the costs of infrastructure and its use, e.g. machines.


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There may be even more questions, and they may change depending on the current situation of the enterprise or the trade, in which it operates, and the information needs of the management board. A report on activity of the enterprise should include: the profit and loss account, the budget performance, a sales analysis, the state of receivables and liabilities, an analysis of costs of operation of the enterprise, use of resources and conclusions. Such report should not exceed 15 to 20 pages including appendices. The starting point for such report is the enterprise profit and loss account, which provides a general presentation of main revenues and costs of its operation. Unlike the formal profit and loss account, it is prepared taking into account the information needs of the management board. In particular, it presents the profit margins for products and fixed and variable costs of the enterprise. In the regular operating activity, an important issue is the coverage of current costs of operation. In construction and assembly companies, which have the full construction base, that is, the construction equipment, transport and workshop, the fixed costs are significant. This part of the report should inform us of the general situation of the enterprise, taking into account the profitability of individual areas of its activity. This part of the report is also to relate to:

• the approved plan for a given month, • performance of the plan over the entire year and • the strategy of operation of the enterprise, • the state of receivables and liabilities, • information on profitability and liquidity of the enterprise.

In particular, it is necessary to take into account the relation of receivables to liabilities, because it is necessary to maintain the financial liquidity of the enterprise in this regard. Another important part of the report on activity of the enterprise is its budget performance. This part of the report should present the plan-performance situation along with deviations for the enterprise in the partial budgets. The partial budgets may include the budgets of construction projects, the transport and equipment depot, individual organizational units. Examples of such breakdowns have been presented in the previous chapters.


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The information content of this part of the report must take into account – as a summary – the reasons for significant deviations from the budget, both positive and negative, for individual areas of activity of the enterprise. It means that if the planned values (both with regard to quantity and value) have been significantly exceeded, it requires explanation in the report. Of course, we are not talking about values such as PLN 500, even if the deviation from the budget amounts to 20%. It is necessary to specify the deviation value for each budget in advance. The result of this part of the report should be conclusions pertaining to a detailed analysis of selected processes from the perspective of their implementation at the company. A significant component of the report is analysis of sales, divided into the areas of activity of the enterprise: construction services, services supporting the construction process, construction manufacturing. Thus this part must take into account:

• revenues from sale of construction orders, services and production in terms of plan-performance

• the profit margin obtained for individual orders (profits from sale – costs of orders)

• structure of revenues from sale, • structure of revenues and profit margins for the key recipients, • analysis of receivables, especially from key clients.

This part of the report must result in presentation of the potential threats pertaining to the improper structure of sales, such as becoming dependent of the key client, information whether new key clients are being acquired, if there are no threats to implementation of the strategy applied by the management etc. and conclusions. The value of costs by type is necessary to prepare the profit and loss account by nature format, but this information is of little practical significant for the enterprise management. Will knowledge of the costs by type, entered in the profit and loss account, tell us anything about the cots born for individual construction projects, orders, maintenance of machines or specific organizational units? Probably not.


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This part of the report should discuss the costs of operation of the enterprise, taking into account the individual areas of its activity. In particular, this should pertain to:

• costs according to type, • costs of operation of individual organizational units, • costs of maintenance of machines and the enterprise infrastructure, • the evolving tendencies in the costs of operation of the enterprise.

The result of this part of the report is signaling to the management board of the enterprise the causes and mechanisms of costs and proposals for a detailed analysis of these fields of activity, which are associated with threats of a failure to implement the financial and non-financial plans in the future. On the other hand, a breakdown of costs by type may serve as an information concerning some trends occurring in the enterprise. The next part of the report should pertain to use of its resources. Many enterprises do not attach great importance to this problem. Afterwards, everyone is surprised why the cots of orders completed for the clients or the products manufactured are so high and the enterprise is not competitive on the market. Therefore, it is necessary to show how the machinery stock is being used. Of course, we are talking about the significant equipment and transport units, specialized concrete plants or machines and not “small tools”. Therefore, the planned time for use of equipment should be specified in advance, as it has been shown in chapter 3, using the example of construction equipment. This time must take into account the number of work shifts, seasonality, the maintenance planned, statistics of breakdowns etc. Probably the use of the production capacity of the machines owned will depend on many factors, which are typical for each company. It also depends on the specific features of the trade. A result of a failure to take advantage of the production capacity is an increase in the real indirect costs charged on specific orders or products, such as concrete. Somebody has to “bear” this “load” of shared costs. Its influence on the margin obtained for a production order does not require a commentary. For the sake of comparison, it is also important to take into account the time of work of the machine operators. The difference between the working time of machines and their operators should not be too great. It should be limited to the


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time for preparation and completion or a planned shutdown of machines for the purpose of maintenance by the traffic maintenance department. Control of these components of the enterprise allows for their better use. This information cannot be found in the balance sheet or the profit and loss account. An employee of the economic department should also analyze the operation of the organizational units, which are important from the perspective of the construction process. This can be presented using the example of analysis of costs of consumption of materials at the construction site. Table 11.4 presents a breakdown of consumption of materials at a construction site, compared with the plan. The construction manager is responsible for construction of materials. The procurement department is responsible for obtaining of these materials. Therefore, the construction manager cannot be held responsible for exceeding of costs, if it is due to the price of purchase. The procurement department is responsible for such exceeding. Therefore, if during a short period, such as one month, the unit costs were exceeded too much, it is necessary to answer the following questions:

• how is the material price database organized by the procurement department,

• what is the awareness of contractors in terms of functioning of the construction project (distance from the supplier, prices of materials etc.)

• how is the monitoring of the market of manufacturers of construction materials ensured,

• what are the negotiations with contractors, • are there any planned scenarios if the supplier fails to complete the order.

Thus it is necessary to analyze the process of procurement of construction materials in the enterprise [68].


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Table 11.4 An exemplary report on performance on the budget of materials

BUDGET PERFORMANCE REPORT - MATERIALS

CONSTRUCTION NUMBER 3221 CONSTRUCTION NAME Construction works MONTH-YEAR August 1998

CONSTRUCTION MANAGER Jan Kowalski

ACCOUNT (CC) 501-3221

VALUE QUANTITY UNIT COSTS

No. Material name

Meas. unit

Perf (PLN)

Plan (PLN)

Deviation PERFOR-MANCE PLAN DEVIATION Perf

(PLN/mu) Plan

(PLN/mu) Deviation

zł % PLN/ mu %

1 fascine m3 25 600,00 25 896,00 -296,00 -1,14% 1 600,00 1 660,00 -60,00 -3,61% 16,00 15,60 0,40 2,56%

2 crushed stone t 14 588,00 14 560,00 28,00 0,19% 521,00 520,00 1,00 0,19% 28,00 28,00 0,00 0,00%

3 cobblestone t 19 760,00 20 800,00 -1 040,00 -5,00% 260,00 260,00 0,00 0,00% 76,00 80,00 -4,00 -5,00%

4 breakstone t 1 619,66 1 600,00 19,66 1,23% 80,50 80,00 0,50 0,63% 20,12 20,00 0,12 0,60%

5 TOTAL 62 856,00 -1 288,34 -2,05% Source: [68]


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If the economic department intends to analyze the implementation of the processes in the enterprise, resulting from the budget analysis, it is necessary to include such proposal in the report on budget performance. It must include at least:

• a list of tasks to be performed, • the time scope for performance of individual tasks, • the deadline for performance of the specified tasks, • the employee responsible for the task performance, • the employee responsible for coordination of the task performance.

Lack of a list and schedule of tasks with regard to analysis of the processes taking place in the enterprise will lead to a situation, in which nobody will know for sure what to do, and the team will grope for a solution. It is thus better to focus on pre-defined tasks and to establish deadlines for them. Then we can expect a realistic effect. Also after analysis of these processes, it is necessary to prepare a report with the proposed improvements. Otherwise, we will be losing time just to show that “something is being done” and give a false sense of satisfaction to the superiors. It should be underlined that the structure of the report on activity of the enterprise for the needs of its management is adapted to its individual needs. There is no single “formal” recipe for preparation of such report. In the first place, the management board must define the information that it needs and the applicable period. This is the starting point for further works on preparation and modification of the report. Otherwise, sometimes the economic reality of the enterprise shapes such reports. The report should end with conclusions, also on the tasks to be performed by individual managers of organizational units to improve the processes in the enterprises. This may result in e.g. lowering of production costs, which will increase the profit margin of products, introduction of new services on the basis of the enterprise assets etc.


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