Week 9.1_LanreGiwa_Company Overhead

Problem Recognition / Identification

In an engineering company, top management during the weekly meeting explained to senior managers that the company has consistently lost jobs bided for due to the high all-inclusive charge out rates / Labour rates of the Engineers for design projects. Therefore, top management directed the project controls manager to come up with feasible alternatives to address the problem and figure out a way of reducing the labour rates of the Engineers.

Root Cause Analysis

Analysing the reason for the high Labour rates, the Project Controls manager compared the rates of engineers from the current year to 5 years ago and came up with possible reasons for the high labour rates as listed below:

1. Yearly national inflation leading to yearly review of staff emoluments
2. The company moved its main office from a smaller, cheaper building to a bigger Building in a more prestigious location. Invariably, the rent payable shot up in multiples of the previous building.
3. Five years ago, the company ran a monopoly of the business of engineering design, currently, more companies do engineering design, hence, the jobs are split amongst the companies now.
4. Currently, there are more staff in management cadre compared to 5 years ago. The company pays for more people that do not charge on projects thereby forming part of the company’s overhead.
5. The ratio of direct labour to indirect labour (Operations staff: Services staff) ideally should be 10:1 for an engineering design company. However, the current ratio is about 1:1

All these points drastically shot the indirect (Overhead) cost very high and when added to the labour rates, the final charge-out rate was high.

Development of Feasible Alternatives/Solutions

The Project Controls manager came up with the following alternatives to address the problem and reduce the overhead rates:

Alternative 1 – There should be no increase in the salaries or total emoluments for the next couple of years so that Labour rates can relatively remain the same over a longer period of time.

Alternative 2 – Main office building should be relocated to a cheaper area, smaller place or the company should acquire a permanent building.

Alternative 3 – Company should be more aggressive at getting jobs that will level out or minimize the overhead.

Alternative 4 – Company should reduce the overhead by reducing the number of staff at managerial positions by any means that would be fair.

Alternative 5 – Company should review its CAPEX and OPEX to reduce the overhead.

Alternative 6 – Reducing the ratio of services staff (Indirect Labour) to Operations staff (Direct Labour

Possible Outcomes and Cash Flow of Alternatives / Solutions

Alternative 1: Stagnating salaries or slashing salaries will make the company lose the best and brightest members of staff. When you pay peanuts to workers, you get monkeys to work for you. This option would generally demoralise staffs working in the company and this may have negative impact on the quality of deliverables and productivity and would cost the company more by going through re-work.

Alternative 2: The rent/lease payable on the prestigious building is seriously shooting the value of the overhead. While it is agreeable that the building is spacious and attractive to clients, on performing a cost / benefit analysis, it would be better for the company to either get its own permanent building or move to a cheaper office accommodation.

Alternative 3: This is a very critical an inevitable decision to be made by the company. Re-engineering of the company will ensure that business development department and other staff are more aggressive at getting jobs. Every department will be tasked with looking for jobs for the company and a revenue target will be applicable to every department. With this method, more jobs will be earned and this will reduce the overhead.

Alternative 4: Allowances paid to senior management is a large chunk of what is spent annually. A good way of reducing the overhead is to reduce the number of staff at the management cadre or maintain the staff and ensure that the senior managers all work on projects to earn money for the company.

Alternative 5 – Generally, reduction in expenses (CAPEX & OPEX) would reduce the overhead and filter down to the reduction of the Labour rates.

Alternative 6 – Reduction in the ratio of indirect labour to direct labour will reduce the overhead and ultimately reduce the labour rates of engineers

Selection Criteria of best solution

• Decision must not affect the smooth running of the company
• Decision must be a permanent and dynamic solution to the problem of high labour rates
• Decision must have a human face by considering the staff welfare and not to demoralize staff
• Decision shall be aimed at creating more jobs for the company.

Analysis and comparison of the Alternatives/Solutions

For alternative 1, the company may temporarily apply this method but it has to be very careful because this method will affect the moral of the staff involved. The best hands will leave the system. When there is continuous brain drain within a system, this is a potential time bomb for the organization. Target costing technique may be used to study the trend of things in the industry and tailor the final labour rates in line with the expected cost. This can be done by adding a marginal profit, reducing the labour cost and overhead so that the end value will be the expected cost within the industry.

For alternative 2 and alternative 5, the primary aim is for the reduction of cost. The cost of leasing a big building will increase the overhead cost of the company. One must be aware that the bigger the building, the more expenses required to run and maintain the building. Hence, cost elements like security, fumigation, cleaning, electricity bills, alternative power, diesel e.t.c will all increase. Therefore, it may be a good idea to either buy a building or move to a smaller and cheaper office to reduce cost of rent and OPEX.

Alternative 4 can be used as a double sword. Senior managers can be either be posted back to the parent company or the managers can start to do consultancy jobs that will generate revenue for the company. Option 6 would reduce some of the inefficiencies within the system by making people more productive.

Another way of analysing the situation is that instead of reducing cost, the company can proffer ways of increasing revenue. This brings the analysis to alternative 3 which is focused at getting more jobs. To re-iterate this approach, the higher the number of engineering man-hours expended by the company, the lower the value of overhead and the lower the Labour rates. In the table below, I have considered a company’s overhead using 250,000 man-hours and 800,000 man-hours for my analysis. In table 1, one will see that with 250,000, the over head amounted to =NGN= 3,000 per staff per hour while table 2 shows =NGN= 937.50 as overhead after using 800,000 man-hours for the analysis.

	BUDGETED OPERATIONAL EXPENDITURE	AMOUNT (=NGN=)
A	APPROVED TOTAL EXPENDITURE	1,000,000,000.00
B	SALARY FOR CHARGEABLE PERMANENT STAFF	400,000,000.00
C	SALARY FOR CHARGEABLE CONTRACT STAFF	150,000,000.00
D	SALARY FOR CHARGEABLE TEMPORARY STAFF	60,000,000.00
A-(B+C+C) =E	NEW TOTAL	390,000,000.00
F	CAPEX / MOVABLES	75,000,000.00
E+F =G	NEW TOTAL + MOVABLES	465,000,000.00
H	TOTAL SALARY FOR NON CHARGING PERMANENT STAFF	150,000,000.00
I	TOTAL SALARY FOR NON CHARGING PERMANENT STAFF IN SERVICES	135,000,000.00
G+H+I = J	GRAND TOTAL	750,000,000.00
J/250,000	OVERHEAD RATE PER HOUR	3,000.00
Note: Estimated Hours for 2009 is 250,000
	BUDGETED OPERATIONAL EXPENDITURE	AMOUNT (=NGN=)
A	APPROVED TOTAL EXPENDITURE	1,000,000,000.00
B	SALARY FOR CHARGEABLE PERMANENT STAFF	400,000,000.00
C	SALARY FOR CHARGEABLE CONTRACT STAFF	150,000,000.00
D	SALARY FOR CHARGEABLE TEMPORARY STAFF	60,000,000.00
A-(B+C+C) =E	NEW TOTAL	390,000,000.00
F	CAPEX / MOVABLES	75,000,000.00
E+F =G	NEW TOTAL + MOVABLES	465,000,000.00
H	TOTAL SALARY FOR NON CHARGING PERMANENT STAFF	150,000,000.00
I	TOTAL SALARY FOR NON CHARGING PERMANENT STAFF IN SERVICES	135,000,000.00
G+H+I = J	GRAND TOTAL	750,000,000.00
J/800,000	OVERHEAD RATE PER HOUR	937.50
Note: Estimated Hours for 2009 is 800,000

Best Alternative to be Selected

Based on all these analysis, I would recommend a combination of option 2, 3 and 4 will be the best solution at reducing the overhead costs of the company. Put another way, combination of a lower rent for office building, company expending more man-hours and reduction of management staff overhead will ultimately reduce the overhead cost of the company. Another important tool of reducing overhead is “value added selling” i.e. there is a limit to cutting the overhead cost of the company, at a point, the company has to be dynamic by thinking of more ways to generate revenue. Value added selling is a sales technique used to offer more inherent value of services or products to clients for their utmost satisfaction. The value added service to be added can be identified by performing a customer feedback or evaluation survey. With this , the clients will help the company identify areas of improvement and areas where they may offer more services to generate more revenue.

Performance Monitoring / Post evaluation

The outcome of the action points can be monitored by evaluating the trend of things as per comparing the company’s rates with other design companies to see how competitive the rates are and the volume of jobs that would be won and executed by the company against the estimated hours planned per annum. Secondly, a customer evaluation form shall be issued to all clients at the end of any project. This can be used for continual improvement for the quality of service delivered.

References:

1. AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-8, P.8.2-8.8 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

2. Sulliven, W. G., Wicks, E.M., Koelling, C. P., et al. (2009). Engineering Economy (14^th ed.), P.27 table 1.1. New Jersey: Pearson Education.
3. Gary Cokins, Activity Based Cost Management, www.wiley.com
4. www.accountingcoach.com/online...course/36Xpg01.html
5. Brassard M, Ritter D. The memory Jogger 2. Tools for Continuous Improvement and Effective Planning.2010.