Yellow Iron, Black Smoke
Yellow Iron, Black Smoke
Budgeting and cost management (It's no good knowing something if you don't do something about it)
In this episode, Mike Vorster and I talk about budgeting, earned value, cost management and planning for the future. We're covering material from Mike's overhauled book, Construction Equipment Economics, V2. Be sure to check it out at cempcentral.com.
Welcome to Yellow Iron,Black Smoke, your podcast for engaging conversation on construction equipment Economics and Management. I'm Michael Kelley, your host in today's episode, Mike Vorster. And I talk about budgeting, Earned Value cost management and planning for the future. We're covering material from Mike's overhauled book construction equipment economics, version two, be sure to check it out at CEMPcentral.com. Hello, Mike.
Mike Vorster:Michael, a pleasure to be with you. It's funny how time passes, and we we've covered a lot of ground and I hope that our listeners find some at least of the ground we've covered to be interesting. Really enjoyed it. Yeah,
Michael Kelley:yeah. So today, we're going to talk a little bit about budgeting and Cost Management. And I always laugh when I look over that notes, you know, and try to figure out what we're going to talk about and like budgeting and Cost Management, you think that there's anybody who's gonna even get a listen to a podcast about people talking about budgeting and Cost Management sounds so dry, but it's not. It's one of the most fascinating parts of equipment management, as far as I can tell.
Mike Vorster:Yes, that's essentially why I didn't call it why we haven't called it budgeting and cost control. It's not about control. All right. You can't control a costume already experienced. But you sure as Hank can manage costs in the future. And so I tend to prefer the phrase cost management, because that's what it's all about. And I think that's what we're going to talk about, how do you manage costs to the future?
Michael Kelley:So we spent a couple hours talking about the rate last time, and how we estimate the rate, calculating the rate or estimating the rate? And it seems like those these two things are pretty well linked, especially when you read through the book. Can you give us a little blurb on how that ties together? How does it How does the rate tie into the budgeting and the cost management?
Mike Vorster:Yeah, well, the rate, our estimated cost of owning and operating the machine through its life cycle. rate is, of course, one of the determinants of the budget for the machine. And so if we express our rate in terms of dollars per hour, to generate our budget, we need to record how many hours Jean has worked? In other words, we use the rate as one of the components and one of the determinants of this Earned Value budget, the other determinant of courses. All right, how much work have you done? Because you earn your budget by doing work in the value budgeting world?
Michael Kelley:So an earned value budget, how is that different than from like a fixed value budget or what's an earned value budget?
Mike Vorster:Well, the construction industry really lives and flourishes on the Earned Value budgets. Because a fixed budget or a monthly budget, you take budget every month. And in order to earn your budget, all you've got to do is get up on the morning of the first of the month, and then you've got your budget for the month, okay, or as they're a lump sum budgets, where you get a budget for completing a certain phase of the work. Earned Value budget, which is what the construction industry lives on. You earn your budget by doing work. And so if you want the budget for asphalt paving, you earn that budget by completing a certain number of square metres of asphalt paving at a rate per square meter. If you're wanting to earn a budget for a machine, then you earn your budget poured into the number of hours the machine works or days or weeks the machine works at a given rate per hour, day or week. My focus is entirely on the basis of Earned Value budgets. But of course, therefore, your Earned Value budget isn't only your rate. And we discussed last time the complexities and risks and uncertainties in estimating dollars per hour or dollars per week. But you've also got a record hours worked or weeks deployed to be the the other determinant of your Earned Value budget.
Michael Kelley:So you're saying that when we're calculating a budget for a machine, we're saying we're saying how much money do we have for this machine? I'm going to repeat this back to you to make sure I understand this. Let's say I have two identical D eight dozers. All right, Caterpillar D eight, and one of them in a year's time. I've worked 400 hours. And one of them I've worked 1600 hours or four times as much. Oh, if I understand, right, that that Caterpillar da that I've worked 1600 hours, I should You'd have, roughly speaking, depending on how you do your budgets, four times as much money to spend on repairs and maintenance and depreciation, etc. than I do on the on the similar date that I only worked 400 hours because I've only earned a quarter of the budget on the second machine.
Mike Vorster:Yeah, yes, yes. And think about it in terms of a fuel budget, you can't have a monthly fuel budget. Because the way you the way to gain on your monthly fuel budget is to switch the machine off perfect. Yeah, no workout done. But I put I have a gain on my fuel budget, please give me a bonus. Because all I did is woke up on the first of the month, and I got a chunk of money for my fuel budget. Well, no, no, no, you've got to turn the machine on. And you've got to run it in order to earn your your fuel budget. Right. And it's the same for exactly the same for your repair parts and labor and your maintenance budget as well. Learn about different when it comes to your earning costs, which are by and large, fixed monthly costs, which you then recover by earning through utilization, the target number of hours that you've used when you've caused your when you've turned your monthly costs into an hourly cost.
Michael Kelley:Gotcha. So so you end up with two things you need to calculate then when you're talking about budgets for equipment, you have to know the dollar amount, right? But you also have to know how much you worked. It sounds that sounds simple, but it's not always as simple.
Mike Vorster:Yes. And one of the things we're going to chat about is that when when it comes to operating costs, then if there's a budget variance, it's because you've used more parts and labor, you've used more if it's a fuel budget, if it's an earned value fuel budget, and you got a negative variance, it's because fuelers cost more. Alright. But of course, with regards to owning costs, the big uncertainty is hours worked. In other words, you've under recovered the fixed cost. And so budget variances really vary, the cause of budget variances vary tremendously according to the type of cost.
Michael Kelley:Gotcha. So one of the things that I noticed in the book was that it's actually figure 7.14. So for those of you guys who are listening, and aren't, you know, mowing your lawn currently, or driving in the car, most of you are doing it like I do, those are the two times I always I always listen to podcast is mowing the lawn and driving in the car. So that's not going to work for you. But there's a figure in the book figure 7.1. And I think it's a really interesting one. Could you describe that chair for those of for the ones who are on the line more for
Mike Vorster:removing the loan? Well, that's the key issue. And we touched on a slightly the difference between sort of cost control cost management. And figure 7.1 shows that in my opinion, at least, cost control. Cost Management is a cyclical process. Because figure 7.1 is a is a cost management cycle, if you wish, it starts with a thing called define where you sort of define your intended course of action. You define your budget, you set your goals, and so on, and so forth. So that's step one, in this five step circle. Step two is you measure where you are. So I was going to, this is my budget for the machine per hour and put in my expected number of hours. Then in step two, I measure what have I actually spent, how many hours have actually worked, and so on and so forth. So step one is budget. Step two is not actual and variance. So step two is define is measure. Then step three is analyze. And that is, it's no good knowing there's a bunch of variance without trying to find out why, right. Step three is analyze why. And then step four in the cycle is evaluate the impact. Is this thing important? Is it not important? Is this going to be ugly? Is it gonna cause everything to go wrong or right? And what's the what is the evaluate the impact of this situation that you find yourself in? And then Step five is where a lot of folks sort of don't get it? Right is act, because you've got to do something about it. All right. Sure. So there's no good knowing something unless you do something about it. Right. Or, like I say, you know, success doesn't come from knowledge, but success comes from the use of that knowledge or hiding? And so those are the five steps define your intended cause of action. In other words, set your benchmark, set your goals, measure, where are you relative to those benchmarks and those goals, analyze why you then evaluate the impact that you like that that situation is likely to have. And then step five, do something about it. Yeah.
Michael Kelley:What's interesting when you and I hear you talk about it, it's like, thinking about all the people we've worked with over the years. And there's some people who are really good at that last step. But don't do the first few. They act, they act very well. They're good at acting. They're the they're the they're the ones who have a very good gut feel, oftentimes, and they just go out there and start swinging when they see a problem. And then on the other side, there's a lot of people who are good at coming up with budgets and coming up with measuring variances and looking at things and even the an analysis, but they're maybe not so good at the acting. And it sounds like what what you're advocating here is for the two types of people to, to sit down and talk to each other.
Mike Vorster:Yes, yes, for the first three steps, define and measure and analyze. Those are sort of quantitative. But then to evaluate an act, that's, that's a judgment call, if you wish, and that's the that I think, is what separates the great organizations from the also ran great organizations use the data to drive action. Sure, hence, what you're describing is if you, if you divine define, measure and analyze, you might have analysis paralysis, or if all you do is evaluate an act, you could easily find yourself in a situation where you're not using your data to drive your decisions, and you're doing irrational decision making. Alright, so yeah, it's got to be a data driven decision, or data driven action is you've got to do the Define, measure, analyze, now I know where I am. Then you've got evaluate and act. Yeah, yeah. Can you take a story? Let's do it. Let's compare another story. That's why they're here. But that at least, that's why they came back. That's why they came back. Because what I'm going to tell what I'm going to how I'm going to explain because, to me, this cycle is cost management cycle. Alright. That is what it's all about. So I'm going to illustrate it with imagine that you're flying. You're flying from Wellington, Florida, Palm Beach, Florida, to Portland, Oregon. Okay. Now you hope that your captain has filed a flight plan is defined his intended cause of action. He said, this is where I think I'm going to go. So we hope that your captain's done step one, find ended cause of action, and is drawn on a map somewhere, a line that goes from Palm Beach to Portland, Oregon. Step two, measure, we hope that once in a while, the captain looks out by the window and says, I can see where I am. And so he's set a course of action. And once in a while, he then measures his actual position relative to his intended course of action. Let's imagine he looks out by the window and says, looks an awful lot like the Washington Monument to me. Now, he's got to analyze about what he's going to do. Alright, if he's looked at if he's flying from Palm Beach to Portland, and he looks out by the window and sees the Washington Monument, he's got to say, this is not good. All right, he's gonna say I'm, I'm a whole bunch east of where I want to be. And he's gonna analyze that situation. Step four. And then he has also got to evaluate the result of his analysis is going to say, this is not going to be a successful fly. Right?
Michael Kelley:Well, it'll be successful, but maybe we'll end up in Portland, Maine.
Mike Vorster:Okay, your geography is better than mine. But he's, he's gonna say, hey, this isn't where I want to be. And he's got to say, What do I do about it? Yeah, and he should, in fact, say, I need to turn left. Okay, now what it's going to get you to back to Portland, Oregon is the fact that he can get hold of that aeroplanes control stick and cause the aeroplane turn left.
Michael Kelley:Yeah, and hopefully he's looking at his fuel gauge at the same time to make sure that he still has enough fuel to make it there.
Mike Vorster:Instead of doing something else, that's part of the evaluate All right, if I turned left, would I would this be a successful flight? Do or do I need to land somewhere else because my fuel gauge tells me something else. So really, if we take this captain of ours or the successful flight of ours, he had to define his intended course of action. He had a measure where he was relative where he wanted to be, right. He had an analyze whether that was good, bad or indifferent. Then how to evaluate what his options were, then he had to do something to give rise to a successful flat. That's what cost management is. That's the difference between controlling an aeroplane and managing a successful flight. Right, right. Yeah. Yeah. So
Michael Kelley:and we're just applying that now with our budget is our flight plan. And we're we're building the tools so that we know where we're going. And also building the tools so that we can take control, we can grab that the yoke or the stick, depending on which kind of airplane you're flying. And we can, we can correct course,
Mike Vorster:we can do we can do the right thing or the appropriate thing to correct cause almost a definition of a tragedy is knowing that you're in trouble and not being able to do something about it. Right. Okay. Now, have I seen tragic situations where folk have known they're in trouble? Or they suspect they're in trouble? And they're not able to do something about it? Absolutely. I think we all have, we've all been in a situation like that. Sure. A part of this cost management is avoid becoming a cost tragedy.
Michael Kelley:Yeah, exactly what and that's, it's it's rare that you can't do anything about it. When you're talking about equipment. It's often that you don't want to be if if you have a bunch of hard truth staring you staring you down. Know, if you have a piece of equipment that, you know, the The boss is saying, she's been so good to us, and the equipment and the numbers are saying we got to sell this thing, that that's not a tragedy. That's just a hard decision. But where that piece of equipment contributed to the company going under, now, now, we've experienced that tragedy. Yeah, yeah. So in the past, we've talked about the level of detail about that plan. So let's, let's talk about that first step a little bit here, the flight plan, the flight plan, step, what, how are we going to how are we going to detail this out? What's the appropriate level, and I find this a lot that this is where people get hung up, partly because you have the guys that I was talking about that would like to act, right without looking at numbers. And you have the guys who would really like to dig into the numbers and make sure that they're very, very precise. And it's oftentimes difficult for them to communicate, what's the appropriate level that facilitates the conversation? We've talked about this in the past, but I think it's worth revisiting. Now. How do we marry that up so that we're not so global, that we're saying something's wrong, but we don't know what, and we're not so granular that we can say that this screw cost us 27 cents to buy? And 38 cents to install?
Mike Vorster:Yep, yep. Yep. Yep. The really the conversations we've had in the past about level of detail, or, I think been very, very telling. And thank you for sort of prompting those conversations. Because truly, if you, you know, the old saying about can't see the forest for the trees, I think there are a lot of folk who have a level of detail in their cost information that is so coarse, that it doesn't direct them to the right action. But then there are some folks who have level of detail in their cost information, which is so fine that they just get lost in the woods and don't know where they're going. Now, bearing in mind that budgeting and Cost Management isn't just collecting information about cost. It's also collecting information about revenue, all right, because your machine will have costs and we will buy parts and we will use labor and we will use all sorts of stuff and we will are a cost recording system will collect all these costs. But how do we collect the allowable budget revenue? All right, how do we take budget to offset against the actual and so while a lot of people sometimes have a lot of detail in their cost information, by coding costs to a unit level or by coding costs, only costs and operating costs, and this is not this bowl, Are these consumables? What are their breakdown their revenue, because your level of detail is really defined by the level of detail at which you break down your act, your budget, your revenue, side of your budget, alright. And so, as an absolute minimum, in my opinion, you got to have cost and revenue had a unit or worst case rate class level says you can take a unit level decisions board is for a certain rate class of machines.
Michael Kelley:So, when you say that rate class, what are you talking about? a certain size of machine typically?
Mike Vorster:Yep, yep, a certain size machine or machine with a certain capability. In other words, estimate, think about estimating, if an estimator thinks he's going to send a whole truck to a job site of a certain capacity or truck, then he doesn't know which particular unit is going to send, he just knows he's going to send this size and capacity of Horcrux to the job site is a great class, because all our walk trucks have that class of that size and capacity, have the same rate.
Michael Kelley:Yeah. And you do want the estimator to know whether he's sitting at a 735. are they sending out a 725? Right, that's appropriate for the estimator to well to estimate to estimate that this is they're going to need the 735 out there, and therefore, they're going to be spending this much money per hour. Yep,
Mike Vorster:yep. But not necessarily, which one if you own a dozen of them? Right? Right, right. Because there might be the unit might be this one that's brought from here, or this one is brought from here, or maybe a rental one that you brought in. So you don't know which 735 but you know, it will be at that rate class machine. Okay. So you absolutely need to know what a certain class and category of machine costs, because that's what matters need to know. All right, you need to fix your rates according to that class and category of machine. But then you also need to divide your costs in my world into at least four cost types. Okay. And that is all your owning costs. Because with owning costs, they largely fixed when you exit do they are largely monthly or monthly costs or annual costs. They're not directly proportional to the number of hours worked in your big risk is utilization, right? Sure. Yep. And then next major cost type is, of course, all your owning all your operating costs, which are really dependent on the number of hours you worked. And where utilization isn't as important as your ability to manage the rate at which you consume parts, labor, consumables, and so on and so forth. Fuel, you have to set fuel aside as a different cost type. And all your indirect you need to look at put a careful magnifying glass on those. So to me, the minimum level of detail is right class, and principal cost time, okay? Go coarser than that. And you won't be able to grow down and get information that you want for defining the right kind of action. Or go finer than that. And you might get yourself just lost in too much detail.
Michael Kelley:Sure. And one of the things that often comes up in conversation is how people track fuel and the fuel costs. And we have a lot of different implementations of that right, very similar fleets, with very different approaches to how they track fuel by itself. But one of the things that unifies them, once they've gotten to the for these forecast types and tracking their costs that way, is that they're able to have a budget or an earned budget that says this is how much I should have spent on fuel. And then they can say this is how much I did spend on fuel. And with the people that are missing that when it's too coarse. They say, well, we're either good or bad on the whole equipment as a whole, but we don't know if it's because we spent too much when we bought the machine because it's breaking down too much or because the price of fuel has gone up. And the people who are more fine than that, then they're they're looking at the fuel in and they're saying that we know on individual pieces of equipment, how much fuel we've used, but they don't necessarily have the ability to match that up with how much they should have spent. So their cost information. Very fine, but they don't know how much they don't have anything to compare that to. I know exactly how many trees there are in the forest. But I don't know exactly how many trees there should have been.
Mike Vorster:should have been. Absolutely, absolutely. And, you know, so for folks who go to courts, and all they know is that, let's imagine there has been an egg in the equipment account, the equipment, the actual cost of owning and operating their fleet being greater than what, what they've charged their jobs, and they just know that their equipment account is has got a negative variance on it. Now, do they know why they got the information they need to take the right decision? Okay, now, true stories. And I've seen this happen many, many times, there's a negative variance in the equipment account, well, we've got to do something about it, I'll tell you what we'll do, we'll get rid of a bunch of mechanics. And instead of buying OEM parts, which are really expensive, we're going to buy non OEM parts. Instead of buying this great fuel, we're going to buy this and so we're going to cut cost, okay, because there was a negative variance in the equipment account. And then you look at it more carefully. And you say, Now, tell me, what was the utilization last year? Oh, well, the machines didn't work an awful lot. Well, did you overall under recover your owning costs was that negative variance due to an over under recovery of owning costs? Sure. Now, that negative variance might be due to an under recovery of owning costs. Now, if you've gone and fired a bunch of mechanics and decided to buy non OEM parts and cut operating costs, you're doing, essentially exactly the wrong thing. Right or
Michael Kelley:so you absolutely need information, and a level of detail that drives your decision making. And it sounds like what you're saying is that we have to have that level of detail. On the cost side, that is how much we have spent. And on the revenue side or the cost recovery side, which we've been using that interchangeably, right revenue and cost recovery. In other words, we have to have the it broken down on the revenue side, not something that we normally hear about in construction, except for possibly on like unit billing jobs and that kind of stuff. But we're talking about a arbitrary Breakdown Structure not imposed on us by our customers, or anything like that. We're breaking down our revenue or the cost recovery, that we're charging the jobs.
Mike Vorster:Yes. And we're accustomed to doing it in construction micro because when we when we build work, we say what is the labor budget for this job? What is the budget of this job? What is the materials budget for this job? What's the subcontractor budget for this job. And so we're accustomed to comparing in field operations, we're accustomed to comparing actuals with labor equipment, materials and subcontractors, budgets. Now in equipment, we got to put ourselves in a position where we can compare actual owning costs with budgeted owning cost, actual operating cost with the with the budgeted operating costs, we've got to put ourselves in a position where we generate an earned value budget for operating costs compared to actual operators with that. Now, this breaking down of your revenue is what very few people do. And of course, if you that, if you don't break down revenue, into at least the four principal cost types we've chatted about, then you're only going to have to be able to have one line in your equipment Cost Report. Okay. And these one line cost reports really are hardly worth the time, energy and effort that goes in it. In other words, to come back to our pilot of our of our plane is flying us from West Palm Beach back to Portland, Oregon. If he looks at by his window, and he sees a suspension bridge, he's got to be able to say whether that's that the Goethals bridge leading to New York, or the Golden Gate Bridge leading to San Francisco, right. He's got to be able to break bridges down to a certain level of detail. So he knows whether he turns right or turns left. Yeah. And he can't just look out by the windows.
Michael Kelley:Right, right. Right. Exactly. That has to be meaningful information. Yes, actionable information. Yeah. Yep. So the question then if we want to break down the revenue, how do we I think that the breaking it down, breaking down the revenue into those For buckets, basically saying that, all right, we want to have a budget for how much we're going to spend for operating costs and how much we're going to spend for fuel, and how much we're going to spend for indirects. And how much we're going to spend for ownership costs or especially depreciation. Having a budget for that is is good, right? But how do we go from having a rate per hour at $5 per operating hour? How do we go from that to having a budget for those four lines,
Mike Vorster:but we've calculated those at $5. According to set number of cost categories, or cost types. And if we then use the cost types that we use in the rate calculation, are the same cost types as we use in our cost aggregation process. And then we can take those same cost types, which we used in the rate calculation to split our $85 an hour, because you know, the components of that $85 an hour rate. So you know, how much of that 85 came from your estimate of owning cost, your estimate of operating cost your estimate of fuel, right? So, you've got the level of detail in your rate calculation, okay. And then what we do is we switch that together to get your $85 an hour. And we forget the fact that we had all that detail. Sure. And then we don't access that detail that we had in the rate calculation, to then produce a revenue breakdown structure that we can then compare without cost breakdown structure.
Michael Kelley:So effectively, what you're advocating here, is not charging $85 an hour to the job. But instead, charging $45 an hour for owning to the job, and $25 an hour for operating to the job and $10 an hour for fuel to the job and $5 an hour to indirects for indirects to the job. I think that adds up to 85. But I already got my math wrong there.
Mike Vorster:Well, and I didn't track your math. But the point is, you can charge the job at $5 an hour, because if I'm running construction and running the projects account, then I don't then that $85 is fine for me. But once I see it inside of the equipment account, then I want to break it down. Because of the equipment account. I don't want to do budget actual variance, I want to do budget, actual variance for owning costs are going to do budget actual variance for operating costs. So that breakdown of your charges need to only occur once you get to the management of the costs in the equipment account. Yeah, you only make one charge against the job. But flow of revenue, once it hits the equipment account has got to be split into the various components of the equipment account. So are most people doing it that way? Already? The folk have got a handle on their equipment account, and on the cost management of their equipment account, do it that way? Okay. The folk who don't do it that way, have no data that they can use for the analysis of their equipment account?
Michael Kelley:Yeah, that's it. I agree. What I see is that the people who are doing it that way, have the ability on an ongoing basis. Analysis, Quinn easily. The people who don't do it that way, spend an awful lot of time once every two or three years. poring through spreadsheets, trying to find that data. And not necessarily knowing what kind of data that looking for is main problem. But they're poring through spreadsheets. And they're they're exporting from old accounting systems and from equipment management systems. And they're looking at timecards. And that kind of thing, trying to figure out where our problem is.
Mike Vorster:If you've got detail, you can always drill down, you can always roll detail up. Yeah, you can always drill down to get detail. But if you haven't got detail, then you're in the sort of forensics world of this every day is finding your way through time prior to doing this and getting caught in all sorts of forensic analysis of what went wrong. You shouldn't be using it you should be using current data of what the situation is in with each of the principal cost types in your equipment account set. You can take timely, data driven decisions for right that's the difference between cost control and Cost Management. When I'd go back to the old phrase of You know cost is budget actual variance. Cost Management is budget actual variance. That's cost control really budget actual variance. I go one more I go budget actual variance action. I go bV a. va va. Yeah. Actual variance action. Yeah, and you can't get it by principle cause type, you can't take data driven action, you can choose and use your prejudice. And if your prejudice is over mechanics are lazy, then your action will probably be with mechanics, when a Churchill hose of the situation is something to do with utilization. Sure, right. Yeah,
Michael Kelley:so if we have these four lines, then and and let's and I can say that the the, many of the companies that have been working on their, on managing their equipment for years and years, and I can say they have world class equipment that they have these, they have the ability to track their budget, or what they expect to spend, versus what they actually spend at these levels. I would say that there's a lot of people who have, you know, to line cost reports, right? owning an operating, or they'll have three line owning, operating and fuel. I've seen one person who effectively has five lines, they have owning, operating indirect fuel, and profit, because they expect their equipment to be a profit center, right. And so there's revenue, but there's no cost associated with that line. The there's various different implementations of this, but many different people have gotten to the point there. So if you are there, if you are a company that has been able to track your breakdown your equipment revenue, such that you can aggregate your equipment costs, you can compare them side by side, then what do you do? What do you do about it? Well, variances,
Mike Vorster:let's imagine instead of the four minimum lines in your cost report, let's imagine you have sufficient lines in your cost report that you can say, what is my budget for depreciation? What should I have expected my depreciation? What was what? How much depreciation? Did I recover? By doing work? Alright, budget Earned Value budget for depreciation, and what were my depreciation charges. Now, there's no uncertainty in the dollars in value, they're your risk there is utilization. But am I working enough hours to recover to earn my carrot, my Earned Value budget to offset my monthly depreciation charges, you can then zoom in on utilization. Or if you've got lines that look at repair parts and labor, and you've got a line that looks at fuel. And if your budget over it is an increase in the price of fuel, then you know that my machine is running on budget for repair parts and labor. It's the fuel unit price of the fuel that's causing this problem. In other words, you've upped the level of detail you need to take the right decisions, or how about this another story? When somebody shouts fire, you've got to know which door to take. Yeah, right. Yeah, now, I've seen too many companies look at their equipment account. And if there's, um, recovered equipment costs, and they call it the abyss, in many cases, about black hole or something like that. Somebody's shouting fun. And because they haven't got the level of detail in particularly their revenue breakdown structure, they don't know which door to take. Right. So the difference between said what we're talking about effective cost management is not knowing that there's a fire is knowing that there's a fire, but then also knowing which door to take. Yeah, I mean, what to do about it?
Michael Kelley:Well, it really comes down to there. There's different people who are responsible for different things that companies use, and who do you Who do you ask, Who do you ask to fix the problem if you don't know whose problem it is?
Mike Vorster:And and let's go to that one. The one that I see routine times there is that there's a pig in the equipment account a black hole in the equipment account. And you do and, and the equipment manager and that black hole is due to lack of utilization and recovered owning costs chairman and manager do about that? Absolutely nothing because an equipment manager can't go on to a job site, improve utilization, right. That's a construction process. That's the right machines in the right place. Is that the right time? That's the right size. That's the planning and flow of the work. And equipment manager can improve utilization of the machines. That's an operational issue. All right. So you've got to put if there's a problem, if there's a budget overrun and negative variance, you have to identify that negative variance, and put the remedy of that negative variance at the feet of somebody, you can do something about it. I can't remedy a negative variance that you have caused, right? In fact, if if somebody asks me to remedy a negative variance that you have caused, all it's going to happen is you and I are going to become bad friends. Right? Now, if somebody asks me equipment manager, to remedy a negative variance that has got its feet in you owning costs and utilization, then all it's going to happen is I'm going to make bad friends with the construction gods, right? That negative owning cost variance should put be put at the feet of the construction guys allocate a risk to the people who can manage it. Right? Put Matt negative variances at the feet of the people who can do something about it.
Michael Kelley:Right. And so so what we're talking about really here this whole, in this whole hour is is generating a tool using budgets and costs to end in cost management, to be able to ask the right person to fix the problem, or at least be able to put it at the feet of the right people. If it's a fuel variance, then don't blame the people who are buying the equipment.
Mike Vorster:No. And if it's a few variants, don't blame a mechanic. Right? Okay, because the mechanic can do nothing about appeal variance. If it's a few variants, started looking at the focus of buying the fuel or fixing the price of the fuel estimated the future cost of the fuel. Your remedies are completely different to the remedies that you need to implement if there's a repair parts variance. Yeah, okay, there's a repair parts variance. Now let's talk to the maintenance vote. Now. Let's talk to the mechanics. Now let's talk to the field technicians. Because that variance lies correctly at their feet. Yeah, it's owning cost recovery variance, don't talk to your mechanic about an owning cost recovery variance permit to do nothing about it.
Michael Kelley:So so. So we To summarize, we have to have, we have to be able to say that we have identified that we have four very different types of costs, owning costs, which, and then we have indirect costs, which are somewhat related to that. And we have operating costs are repairs and maintenance, and fuel. And so those four, right, the purchase price, the indirects, the repairs, and maintenance and the fuel, I have very different characteristics from June, since we have those since those exist, since that's something that's forced upon us, we don't have any control over those things, that those things those costs are going to happen, then we have to manage those costs, how are we going to manage those costs, we're going to have an earned value budget. That is we're going to break our rate calculation or at $5 an hour into those costs, so that we can say, here's how much we've earned for those four categories. So then we can say, based on how much we've earned, this is how much we've spent, and we can see whether we have a positive or negative variance. Yes, absolutely. What we're trying to do with this chapter in the book,
Mike Vorster:absolutely, that's what I've been trying to do for the last 14 years or so is create a situation where you can go, where you can do do your way you move from cost control to cost management, because you will never manage a cost unless you put the responsibility for that cost at the feet of someone who can do something about. And as you've said, equipment is a an amalgamation of equipment costs are a are a total of four, very, at least four very, very different cost types. And you have to manage each of those cost types with a skill, care and diligence that each cost time. Yeah, the thing that's interesting is that each of those cost types take different aptitudes. attitudes, because someone who's got the aptitude and attitude needed to negotiate a first class financing deal, or to get down to the detail administration needed to license and insure their machines most effectively and efficiently, are going to have that you had an attitude needed, or ability needed to manage repair parts. And to properly maintain a machine, these things not only do these costs behave are not only do they have to incur these costs differently, they behave differently. And the aptitudes and skills needed to manage them are also very different. So we really have at least four very different animals in this paddock. Yeah.
Michael Kelley:Yeah, well, I feel like that, if this is one of the things that once companies break through this, when they have the ability to do their revenue, when they've broken down the revenue into those four categories, when they and they're able to summarize, usually, it's that way, they have to break apart their revenue, and they have to summarize their costs in order to marry them up. Once they've broken down the revenue, and they summarize their costs, they have a variance that there are some things that become very obvious. And it's the the things that are wrong, at every company are always different, right? There's there's always different types of problems, some problems, some companies see that it's simply a preventative maintenance issue or, or, you know, they're not paying attention to what, what the machines are telling them, right. And so they're just breaking them down, they're always breaking down on the job, those kind of things. And some people are, have a tough time finding and purchasing the right type of equipment or selling their equipment. So there's a lot of different things. But I do feel like that those that have been successful in getting this have been well served into the future by having it over and over and over again, equipment is a substantial portion of your costs job as a portion of your revenue, then well, it might be time to break those down into at least four categories and really understand those four categories. Right? Well, cool. I think that explains it. I'm, I think the work that goes into building that shouldn't be underestimated. It does take a fair amount of thought and and work and configuration to have a cost summary at four levels and to have a revenue breakdown at four levels and marry those up. But it's definitely worth it.
Mike Vorster:Yes, and fortunately, today's technology, producing a multi line cross report is just as easy as producing a single line cost report just as long as you have your sub rates. Because if you, if you can multiply at $5 an hour by the number of hours that machines work, you can multiply$45 an hour my number of hours of machines work, and $20 an hour by the number of hours that machines worked. And you can you can generate Earned Value budgets for each of the principal cost apps just as easily as you can generate an earned value budget for the $85 an hour, right? Yeah, yep. Yeah. It's just another another 300 multiplications, each of which take a nanosecond. Yeah, exactly. Exactly. So a couple of words for summarize, know that it is about producing actionable information, okay, write your level of detail, right? Know that you can not drill down any further than your level of detail gives you all right. And then know that it's about breaking down your costs, your revenue, as well as your costs. We're good at cost breakdown structures, but we're really bad at revenue breakdown structures. And the key point that I really want to leave with the listeners is you don't manage, you can't manage a cost if you can't put the budget variance at the feet of the person who can do something about it. Right. It comes back to people back to people. Yeah, yeah, I agree. That's it for today, folks. See you next time.