Out of WACC
One of the benefits that I have discovered from joining and expanding my network on LinkedIn is that I have been able to find people that I wanted to talk to. Here is an example of such an exchange, assembled in chronological order.
Sent: Thursday, July 05, 2012
To: Gary R. Heerkens, MPM, CPC, PMP, CPM, CBM, CIPA, PEng
Subject: RE: Join my network on LinkedIn
Gary, I spotted your article "Out of WACC" on page 18 of the October 2011 issue of the PM Network, so I wanted to get hold of you to ask you a question.
I agree with your statement: "In a business context, it [the WACC] determines whether the projects they [project managers] manage should even exist." But how do you manage the analysis of in-house IT projects where labor, the major cost, is all on the corporate payroll? Not only does no one know the real unit labor cost (that's a secret known only to the Human Resources department) but no one tracks time against the project anyway!
And that doesn't even start to think about collecting evidence of benefits actually achieved to validate the original projections for the project.
To this Gary replied on July 9:
I'll answer your questions and comments - but you must bear in mind that many of the common practices in place at companies today are incorrect, leading to much confusion about good practices ...
Regarding the use of "in-house" labor on projects, such as IT projects
A proper project financial analysis simply evaluates the cash inflows (benefits)
vs. the cash outflows (project-related costs). To do a proper project CBA, it
doesn't matter a hoot whether project resources are on the payroll or not. The
contribution of the in-house resources to the cash outflow load is simply the
number of hours they're expected to work on the project times their "fully-burdened
charge out rate" (which leads us to your second point ...
Labor charge rates are a well-kept secret
This is symptomatic of a dysfunctional organization. The fully burdened charge out rates should be widely published and well known. Period. The reality is that a PM cannot do a proper project cost estimate without knowing these rates.
No one tracks time against the project anyway
This is a very true statement that you make. Again, however, my response is nothing more sophisticated than these are lazy and/or dysfunctional organizations. I had the pleasure of growing up at Eastman Kodak Co., where - as a project manager - I knew the project costs down to a few dollars at any given point in time - an enormously valuable weapon in maintaining budget. Witness the fact that in my 20+-year career, I overran just two projects on cost.
Collecting evidence of project benefits actually achieved
In my training class, "The Project Management MBA", this ranks among my strongest recommendations to attendees is that their organization immediately begins measuring actual benefits realization. This is one of the primary weapons against what I call "benefits fraud" (outrageous, unsubstantial claims of benefits), a huge problem in many orgs today.
Gary R. Heerkens, MPM, CPC, PMP, CPM, CBM, CIPA, PEng, MBA
President, Management Solutions Group, Inc.
To which I could not help adding:
Thanks, Gary, for your detailed reply.
Not to unduly belabor the point, but having access to people's individual pay rates is problematic at best.
- Because it exposes people's personal information and that may be a breach of privacy laws, and
- Because HR does not want people coming in and complaining that they are getting less pay than some other person at apparently the same level in the organization.
However, some average of the relevant pay scale might be sufficient for the purpose.
Also, collecting project specific time-to-project is also problematic. I know that, I've tried it.
- People don't enter their times until the end of the week by which time they have no idea what they did on Monday, especially if they are "multi-tasking".
- Where do they book departmental meeting time? And
- To say nothing of coffee break and washroom time!
Under a contract, these figures are buried in contract unit or lump sum prices and overhead.
It's a real challenge.
And the same day Gary was again good enough to clarify:
Regarding your comments about individual pay rates
Fully burdened charge rates do not divulge what individual people make in their paycheck, so there are really no privacy issues; companies that have their act together publish these rates routinely. Properly constructed internal charge rates only identify broad job classifications (i.e., "Jr. Engineer", "Sr. Engineer", "Engineering Manager", etc.) and hourly rates that are inflated with SADA expenses in a way that masks actual hourly wages by 20-40%, typically.
And on your second point [collecting accurate time-to-projects]
You are absolutely correct. Even though a company may have a sophisticated charging system, this is no guarantee that folks will charge truthfully and accurately. And yes, dealing with "lost time" hours is one of the largest problems.
Plus, I love your website - stunningly informative.
Of course, I had to ask what "SADA" means. Again, Gary was good enough to respond:
I probably should have been more explicit in my comments to you. I was really mentioning SADA as one example of the manifestation of all indirect costs incurred by a company, but didn't really make that clear with the way I wrote my comments.
In general terms, bean counters calculate a firm's burden rate by dividing the total of all indirect labor hours (project management folks are generally indirect labor, by the way) by the total number of direct labor hours (the folks who actually make the widgets or supply the services for a firm).
The direct answer to your question is: "Sales, Advertising, Distribution, and Administration". This set of indirect costs would, of course, be more prevalent in the case of a product-based firm.
Now all of that is very interesting, because when I worked as a consulting engineer, our markups were ideally 150%, 125% on government jobs and 100% at the very minimum. That had to cover payroll burden and all office overheads including down time.
So let's not kid ourselves. None of this is as simple as it seems on paper.
1. WACC: Weighted Average Cost of Capital.
2. Markup: The amount added to our base hourly pay rate to provide for overhead costs and profit.
3. Burden: The government's statutory requirements to provide for government services and benefits, around 30%.
4. Down time: The cost of my time spent on "SADA" that was not being directly charged to a client.