The Magic of Value Engineering
You’ve got to love a good old-fashioned sweeping statement. Back in the day, my old boss used to say, ‘my door is always open’. Which was more or less accurate unless you had a complaint or wanted to discuss remuneration, in which case its metaphorical hinges would suddenly need a strong dose of WD40. Then there are classics such as ‘all politicians are corrupt’, which is almost certainly a sweeping statement but can be worryingly difficult to disprove. And, of course, there’s ‘fast food is bad for you’, which may be broadly accurate if you’re comparing it to celery. However, it completely ignores the not-insignificant emotional uplift I get from having a cheeky pain au chocolat on my morning travels.
Or, from the property world, what about; ‘all property developers are rich?’ I have an inside track on this because I teach both new and existing property developers as part of my day job. And I can share two particularly relevant insights. Firstly, most people who engage with developers act as though this statement is true. And secondly, first-time developers are usually not particularly wealthy. Okay, they may not be on their uppers, but it’s not a big stretch to guess why they want to develop property, and it’s not usually because they already have the riches of Croesus. Unfortunately, that doesn’t stop the rest of the world from thinking and acting as if they have; call yourself a property developer, and you’ll find that most people will assume that the shiny new Range Rover in the car park is yours.
There are two key reasons why this perception exists. First, most successful developers ARE wealthy, so everyone tends to get tarred by the same brush. Second, it takes a fair amount of cash to develop property, and many people wrongly assume that this money comes from the developer’s own pocket. Let’s debunk this myth first because the reality is very different. Development finance is hugely leveraged from the developer’s perspective. Where a landlord might typically need to put down a 25% deposit to acquire a property, a developer can secure the bulk of their deposit for their land or property purchase from private investors, meaning that their personal cash investment requirement is significantly reduced. It’s just one of the reasons why property development is so attractive. Whether it’s landlords looking to get the cash to grow their portfolios, architects and other industry professionals or tradespeople looking to leverage their industry knowledge, business owners looking for extra profits, or simply everyday folk looking to create a decent pension or improve their financial situation; the amount of cash they need to invest in a development project can be surprisingly small. But while the returns can be significant, they are not risk-free. There are many pitfalls that that can seriously derail the unwary traveller financially, which need to be considered. Because one of the key features of development is that the developer not only gets paid last, they only get paid whatever is left in the pot. In theory, this should be the largest slice of the pie, but in practice, this is where the risk comes in. It’s critical that the developer is on top of costs throughout every project stage because every penny of overspending ultimately comes out of their own pocket as reduced profits.
There are several stages in the development cycle where costs are a major consideration, and one of these is the tendering process, where you’re looking to get contractors to quote for your project. If we look at the project sequentially, you, as the developer, will have done significant due diligence before reaching the tendering stage. Not only will you have run some detailed numbers on the deal to make sure that it stacks in principle, but you’ll also have put together a shortlist of contractors you want to invite to quote for the job. To do this, you will also have put together a detailed specification with the help of your project manager and cost consultant so that the contractors who are quoting know precisely what they are quoting for, right down to the last widget. So, what could possibly go wrong, you may think? Well, in the world of property development, the answer is almost anything, which is why most experienced developers have grey hair and long holidays. And the tendering process is certainly not immune to unexpected hiccups. Create the perfect tender document, and you can expect several things to happen. Some contractors you send it to won’t bother to respond. That’s because tender responses involve a lot of work on a contractor’s part, and if they’re already busy or think their chances of winning the tender are remote, then some may decide it’s not worth the effort. Also, the quotes that you do get can vary wildly. You’ll get one quote that looks like you’ve commissioned the Burj Khalifa and another that looks tantalisingly (and, if you’re being honest, suspiciously) cheap. In the former, the contractor probably doesn’t need your work, but if you’re prepared to pay a premium, they’d be happy to oblige. In the latter, the contractor is desperate for your work and is quoting low, hoping they can claw themselves back into profit by claiming extras along the way. Neither is a good look, but you should also receive quotes that fall into the middle ground and will align more with your expectations.
However, there are times when, whichever God is in charge of tendering, decides that today will not be your day. You’ve found the perfect contractor; their tender response is professional and comprehensive, and they come highly recommended by others in your professional team. But their numbers won’t stack. In fact, all of the sensible tender responses are just too expensive for the deal to work. Which means you don’t have a deal, despite all of your due diligence and perfect tendering. There’s no way you can go ahead with a project that doesn’t make enough profit, and your commercial lender won’t lend you the development finance if it doesn’t, so you’re dead in the water. So what can you do?
Luckily, there’s a process you can use that will help you find a solution to this dilemma, and it goes by the rather grand name of ‘value engineering’. I know it sounds like something that might happen behind the scenes at Aldi, but in reality, it’s simply the process of reducing the cost of producing a product without reducing its quality or how effective it is. In this instance, you need to materially reduce the cost of building your new flats or houses without materially impacting the value of the flats or houses themselves. I’ve lost count of the times I’ve used value engineering on a project, and in my forty years in the industry, it’s nearly always delivered results. So, let me share exactly what you need to do as the developer to wave your value engineering magic wand.
At a high level, value engineering involves getting your team of professionals in a room and getting them to bring their respective talents to bear to find a solution that everyone agrees will work. So, the first thing you need to do is alert your team to the problem, namely that you’ve got a great project they will all be involved in, but the numbers don’t currently work. Most of the team will already be aware of the project as they’ll have already given their input during your due diligence stage. To be clear, the team in question will include your design team (architect, structural engineer, mechanical and electrical engineer), your preferred contractor and certain selected subcontractors, your cost consultant/quantity surveyor, and your project manager. Your team’s task will be to change the design or specification of the project so that it costs less to build and therefore enables you to hit your required profit margin.
So, everyone is now up to speed with the problem and what needs to be done. The next stage is in two parts. First, take a large slab of Lurpak from the fridge, leave it to soften overnight, and then apply it liberally to the egos of your professional team. Buttering up goes a long way in getting people onside, and you’ll get better results if people are motivated to help you fix the problem rather than seeing it as an inconvenience. You are but a humble developer and they are the ones with decades of experience and expertise in their particular field, so be prepared to lay it on nice and thick. Second, offer to pay them for their time. Yes, these people have a vested interest in getting the scheme to work because if it does, you’ll be able to keep them on and they’ll earn the rest of their fee. But they won’t have factored in the expense of a cost engineering exercise into their numbers, so make sure you offer to beef up their remuneration to cover it – it will make it a win-win from their perspective and a positive outcome will be well worth it from yours.
The next stage is to arrange a value engineering brainstormer which you will host in your role as developer, albeit you might also want to secure the assistance of your project manager. Get your team of professionals around the table and set out the problem and the objective. Do some more ego-buttering for good measure, and make sure you’ve brought in the posh biscuits, as brain food may be required. But don’t think you can simply light the fuse and retire to the corner of the room to munch Garibaldis. You need to be the facilitator, ensuring the dialogue doesn’t stall and encouraging contributions from all participants.
So, you’re in the brainstormer, and things are starting to happen. The biscuits are taking a pounding from all sides, and people’s creative juices are flowing nicely. It’s now time for you to unleash one of your secret weapons, which some would call the stupid question strategy, but which I prefer to think of as a variation on the ‘Five Whys’ approach invented by Sakichi Toyoda and which is still used by Toyota to solve engineering problems to this day. Stupid questions are one of the cornerstones of sound value engineering, and the logic goes something like this. Technical people can often get buried in the detail and fail to see the wood for the trees.
The developer has no technical knowledge and should ask the same questions that any self-respecting eleven-year-old would ask. ‘Why can’t we just build around it?’ and ‘Why can’t we just knock that wall down’ are two questions your design team is unlikely to raise, but it shouldn’t stop you from asking them. Often, their responses will prompt further questions. Frequently I’ve asked a stupid or obvious question only to discover that the answer prompted others to come up with a different way of solving the problem. This works because people aren’t always able to think laterally when solving a problem. When asked about customer input in the development of the Ford Model T, Henry Ford famously said, “If I’d asked people what they wanted, they would have said faster horses”. Because the reality is that there can be many ways of solving a problem and having someone who’s able to ask all the obvious or stupid questions can be a great way of having the whole team look at things from a different angle.
You’ll soon find that once all the characters start thinking about the problem, a certain alchemy takes place. Design teams love to design, so present them with a design problem and watch their creative juices start to flow. Your preferred contractor will also add significant value to this process. Design teams can be great at devising theoretical solutions, but it’s the contractor that will need to turn it into a reality. By ensuring you have the contractor in the room (and possibly some key subcontractors), you’ll be able to stress-test the feasibility of the ideas that come from the design team. Considering that the contractor has a juicy contract hanging on the outcome of the brainstormer, they may offer to attend for free. I recommend selecting your leading tender respondee and telling them the gig will be theirs if the value engineering team can get the numbers to work.
The solutions that arise from value engineering aren’t always simply a fundamental change to an aspect of the design – it can also involve using more cost-effective solutions to achieve the desired result. I recall one exercise where one of the protagonists had recently worked on an overseas project involving the use of laminated panels in bathrooms. Switching to this solution meant we could avoid using tiling and wet trades, which were both expensive and time-consuming.
Value engineering can also be used if you encounter a problem once a project is on site. Imagine that your contractor or design team has alerted you to what they euphemistically refer to as a bump in the road, but which, in reality, looks more like a massive cliff-face from a financial perspective. This is where the ‘all developers are rich’ mindset usually kicks in. You can bet your bottom dollar that your team’s first solution will be that you’ll need to spend more money to fix the problem. Because apart from the physically impossible, most construction problems can be solved with a blank cheque, and the effort involved on the professionals’ part in spending more of the developer’s money is precisely zero. They may even see their fees increase as a result.
Less experienced developers often defer to their team’s ‘spend more money’ recommendations like you would if your dentist said you needed a filling. But instead, you’re going to make it plain as a pikestaff that there’s no extra cash available. There’s no contingency fund, secret bank account, or excess profits. In other words, everyone needs to find a Plan B because there isn’t a Plan A. And if a Plan B can’t be found, the project will stall, which is good news for no one, including your professional team. The critical point is that you should have this conversation with your team even if you do have a secret Plan A, namely some cash available that you can use if all else fails. And then you implement the same value engineering process as set out above.
This approach is invariably successful because your team hasn’t previously thought of solutions other than telling you to spend more money. Only once they know that there’s no more money do they get their thinking caps on and start thinking of other ways of solving the problem. So if you find yourself in either of these scenarios, I highly recommend trying value engineering, as it can make all the difference. Just be sure to swing by Aldi first to pick up the all-important Lurpak and Garibaldis before you do.