Has your organisation ever won a customer order where everything appears to run smoothly until, suddenly, your project controlling comes with the alarming message that nothing adds up? Especially in the machinery and equipment industry, often producing large custom and complex products, we have seen too many financial leaders worrying about how to prevent their profit margins from slipping away.
For its Global Construction Survey, KPMG interviewed executives from over 150 organisations around the world that carry out significant capital construction and engineering activity. Key findings of this KPMG Survey include:
- 46% of the respondents say only few projects exceed the original bid margin. In the EMEA-region (Europe, Middle East and Africa) this figure rises to 56%.
- 54% failed to identify upfront the issues that later caused margin erosion.
- Only 36% of the respondents feel their project review processes are “very efficient”.
Why you should track gross margin
Gross margin isn’t something that every organisation thinks of tracking on a weekly and/or monthly basis. Most of them rely on their mark-up formulas and assume that gross margin will naturally flow from there. But gross margin is too important to be left unattended. It’s right in the middle of everything. It flows directly from sales, it’s a leading indicator of profitability and cash flow, it’s the euros that cover the expenses, and it’s the critical element in measuring how productive your inventory investment is. Because of that, you should gain valuable insights by understanding what exactly is driving your margins.
Why you should keep margin erosion under control
Margin erosion (also known as profit erosion) is a very common issue, by which particularly the machinery and equipment industry is affected since they often produce large custom products with long lead times. Margin erosion defines the loss of margin euros that occurs once you have won a customer order. More simply, it is a gradual reduction in gross profits over time. Profit margin erosion can be caused by many things. Some of them, such as scope creep, poor resource management, human errors, poor quality control, lack of sufficient inventory, etc. are relatively easy to keep under control by putting a few processes in place. The most important but also most complex cause for margin erosion, however, is Non-Conformance Costs (NCCs).
Click here to download our E-Book and learn how to keep your Non-Conformance Costs under control and improve your profit margins.
How scrap, re-work, warranty and other Non-Conformance Costs decrease your project margins
Non-Conformance Costs (NCCs) are additional costs that are not part of the original project plan, and result in the creeping margin erosion that can be found throughout many project-based businesses. We define them as all deviations between the preliminary and final costing of your customer projects. NCCs may include scrap, re-work, warranty, over-consumption, price variations and costs for additional customer requirements throughout the project. The construction of the Berlin Brandenburg Airport for instance was preliminary cost estimated at €2.4 billion but has already breached the €6 billion mark with a lot of rework that had to be done with regards to noise protection, cabling, the baggage system and many other things. This airport originally hoped to open its doors in 2011, but is now not expected to be completed until after 2017. In the project-based machinery and equipment industry, bad monitoring of Non-Conformance Costs can even jeopardise the future of the organisation. The Pennsylvania-based steel tubing manufacturer PTC Steamless Tube Corporation for instance was forced into bankruptcy after overruns in costs and delays in time for the construction and installation of a large mill-project in Hopkinsville, Kentucky (USA).
How to keep Non-Conformance Costs under control and stop them eroding your profit margins
Whilst cost variances cannot be completely avoided in the project business, there are steps that can be taken to minimise (or at least forecast and account for) Non-Conformance Costs. You can find them in our free E-Book “How to prevent your profit margins slipping through your fingers” and discover them in our webinar recording “Getting To Grips With Non-Conformance Costs”. After this, you will know how to prevent Non-Conformance Costs further shrinking your own profit margins. At PIKON, we can help you keeping your Non-Conformance Costs under control with our own consulting solution, drawing on over 20 years of experience of working with project-based businesses combined with our unique 3-point consulting approach. Please click the button to find out how to get to grips with Non-Conformance Costs with PIKON.