How to Handicap Project Profitability Like a Vegas Bookmaker
Imagine if bookmakers in Las Vegas accepted bets based on their loyalty to their favorite teams or just a hunch. They would be out of business after the first round of betting.
They understand their chances of making a profit well before the game because sports handicapping is an applied science. They isolate the risk factors, weigh them according to historical performance, and using a scientific approach, determine the odds. As new information comes in…they learn more and alter the odds.
More Information = Greater Certainty
The $64,000 Question
Why do so many construction projects fail to produce a profit, despite the fact that “When we undertook them we were sure they would be profitable?”
Our research shows that the reason so many apparently profitable projects generate unexpected losses is a need to improve our skills at project selection and analyzing risk. It’s time to introduce science into project selection…and resist any suggestion that we can make money on any project. We can’t sign contracts based solely on our need for work while ignoring risk factors that lurk in the background of every potential project.
Lurking Risk Factors
The primary cause of hundreds of contractor failures stems from losses on projects that the company never should have undertaken…because they had limited or no successful prior experience with similar work. Some projects were disasters even though they were only slightly different than the firm’s experience.
· Unlike manufacturing, where operations improve with repetition, construction enterprises do not usually have enough repetition from project to project to benefit from familiarity and experience.
· Project risk is project-specific, so each new job must be assessed against past experience. The closer a new project lies to the average of previous projects, the more likely the contractor will achieve its estimated targeted performance.
· The team a contractor puts on a project will also affect the measurement of risk. Specific project experience is individual–not institutional. Experience is accumulated and housed in our key people. Just because your company has built profitable projects in the past that is no guarantee that a new team can complete the next project at a profit.
· Project location is also a risk factor lurking in the background. A local contractor will face added risk when attempting its first project in another state, as will a contractor with experience in rural and suburban areas taking its first foray into a big city.
· Unusual project features also create risk. Most buildings in the U.S. are rectangular, and our roads, highways and tunnels are straight. Round buildings and curving tunnels dramatically increase risk.
The Science of Project Selection
Although many of the firms who failed to consider lurking risk factors are no longer in business, accounts of their struggles on thousands of projects provided my research team with a solution. It gave us a measure of the importance of experience broken down by categories. That research, in turn, allowed us to develop an easy-to-use Project Selection Program that measures the potential for success using applied science.
Project Selection Program
Our research showed that the potential success of a project for a particular firm depends exclusively on the quality and quantity of the organization’s experience with similar work.
In creating the program, we classified the experience factors and statistically weighted them based on the historical frequency and severity of their occurrence. The primary aspects that affect anticipated performance (risk) are project size, type, and location. Other key factors include the project team, owner, and unusual features. From these weighted measures, we produced a numeric scale of potential risk.
This new Project Selection Program provides an accurate measurement of project selection risk based on what is known and unknown about a potential job at a given point in time and how well that work matches the firm’s experience. [read more button—connect to this subject in the manual]
Contractors, subcontractors, owners, and designers are invited to download the tool right here