How do you improve project margins

Margin erosion

Do you know that: Your company has won a customer order and everything seems to be going smoothly until suddenly project controlling warns that the costs are getting out of hand? In mechanical and plant engineering in particular, with often very customer-specific and complex large-scale projects, we have already seen a large number of CFOs who are concerned about shrinking project margins.

How to keep your winnings from slipping like sand through your fingers

As part of its Global Construction Survey, KPMG surveyed executives from over 150 companies from all over the world in the field of investment projects and mechanical engineering, with the following results:

  • 46% of respondents said that only a few of their projects achieved the profit margin that was originally planned for when the tender was submitted. In the EMEA region (Europe, Middle East and Africa), 56% say that.
  • 54% could not determine in advance which factors or problems later led to the loss of the margin.
  • Only 36% of the respondents thought that their methods of reviewing their projects were "very efficient".

Why you should track gross profit margin in the first place

Many firms keep track of their gross profit margin (net sales minus the cost of goods sold relative to net saleshardly, least of all monthly or weekly. You simply rely on the surcharge calculation and assume that the gross profit margin will come out of it as a matter of course. But: the gross profit margin is too important to be neglected. Because it is at the center of all business activities: It results directly from the sale, is the most important measure of profitability and cash flow of a company, it brings the euros that cover the costs and, last but not least, it is the decisive element when it comes to it It's about determining how productive your inventory investments are. Therefore, understanding what exactly is driving your profit margins up and down can provide valuable insight.

Why you should keep margin erosion small

Margin erosion (also known as profit erosion) is a widespread phenomenon that particularly affects the mechanical and plant engineering sector, as very expensive, customer-specific products with long production times are often manufactured here. Margin erosion determines the loss of profit that occurs after a customer order has been landed. Put more simply, margin erosion is the creeping reduction in gross profit over the duration of the project. It can be triggered by many factors. Some, such as the creeping increase in project size, poor resource management, human error, poor quality control or lack of sufficient inventory, can be kept in check quite easily by putting in place the right processes. The most important, but also the most complex reason for margin erosion is non-conformance costs (NCC).

How rejects, reworks, warranties and other NCCs eat up your profits

Non-compliance costs (NCC) are additional costs that were not included in the original project plan and that ensure that the profit creeps away. NCC can be found in many companies that work primarily on a project basis. For us, NCC are all deviations between the preliminary costing and the final costing of your customer projects. This can include costs for produced rejects, for rework, for guarantee services, for additional consumption, price fluctuations and for additional requirements by your customers during the project period.

An example: the Berlin-Brandenburg airport was originally supposed to cost 2.4 billion euros, today we are already at over 6 billion euros. These additional costs were caused by a lot of improvement work, e.g. B. in terms of noise protection, cabling, the luggage transport system and many other things. The airport actually wanted to open its doors in 2011, but it is currently not expected to achieve this goal in 2017.

In project-based mechanical and plant engineering, the inadequate monitoring of the NCC can even endanger the future of the entire company: The steel pipe manufacturer PTC Seamless Tube Cooperation from Pennsylvania, USA, was forced into bankruptcy after the budget and the time constraints for production and installation of a major milling project in Hopkinsville, Kentucky, USA, had been excessively exceeded.

How to keep your non-conformance costs under control and secure your profits

Even if not every cost variance can be completely avoided in the project business, you can still take measures that minimize the NCC (or at least make it predictable and understandable). We have already discussed this in an article.