Chapter 19
Most of this chapter is boring. It ends with something interesting. Something from a previous chapter.
The problem is this: one company, doing multiple projects, where all of those projects use a shared resource, and (if I understood correctly) that shared resource is a bottleneck for each of the projects. So there are multiple critical paths (one for each project), and all of those critical paths have a shared point, a bottleneck.
Chapter 20
The chapter starts out continuing the storyline about the MBA students figuring out the cost of delay in their project.
“There is no penalty for our company being late. On the contrary, it helps us." "How come?" Aggressively, he answers.
"Let me tell you the full story. At the time we sign the contract, our prices are very low. Competition is so fierce that we don't have any choice. You can win or lose a bid on a three percent difference in price. Everybody is cutting everybody else's throat.
"Where do we make our money?" He pauses for a second as if waiting for me to answer.
I don't know the answer.
"On the changes!" And then he elaborates. "Our motto is, the client is always right. They want changes, we won't argue, we'll gladly do them, the more the better. But at this stage we are not afraid that our dear client will turn to our competitor, so they pay. Handsomely." Ted looks as if he has just revealed the secret of his trade.
So there's an incentive for these companies to bid low, knowing that the bid price isn't the full revenue because things will be added later.
“Before I give up, I try to understand more about his business environment. "Aside from the money you overcharge for the changes, what is the damage to your client of having the buildings ready three months late?"
"I don't know, but isn't that his problem?”
It is his problem, but if you can solve it, then you potentially have something you can use to win bids over your competitors.
“Actually, I can give you more than one example where a three-month delay bankrupted a developer." Smiling, he adds, “Thank God it's not our problem. We get paid one way or another... I think."
“After a moment of silence, he says, "You might have a point. I'd better check how much money we lost because developers went bankrupt. As a matter of fact, their tight cash flow affects us all the time. They delay their payments to us."
So the effect on their client actually does have an effect on them. If they go under, they don't pay the rest of the unpaid balance of the bid.
But also, I think reputation should be considered. If your company delivers late, and then your client goes under, I think that would have an effect on your company's reputation -- doing a deal with you makes companies fail due to your slow delivery times. That negative reputation will lead less demand for your company's work. That means you'll have to lower your bids even more than you've done in the past, which means lower profits. So then there will be incentive to accept changes (to get extra revenue), resulting in more delays. Sounds like a downward spiral into bankruptcy.
“One way to 'encourage' a contractor to reduce lead time is to attach big bonuses to early completion and big penalties to delays."
Yeah I mentioned the possibility of attaching big penalties to delays in an earlier blog post about an earlier chapter. A bonus for finishing earlier makes sense too, at least in this scenario regarding construction.
“There are some bids that have small bonuses, but nothing like what Johnny is talking about. But the bonuses are not the problem; penalties are. "Show me a contractor," I say, "who would agree to penalties, even small ones. Their margins can't support it. What do you want? That they'll go bust?"
“Not at all. But Rick, imagine a contractor who knows he can deliver three months faster than anybody else."
“Look, contractors know about future projects well ahead of time. They have their connections, and updated lists periodi-cally appear in their professional magazines. What a fast contractor has to do is get in touch with a developer before a formal request for proposal is out. Contractors usually have good connections with several developers, so it shouldn't be a big problem. And then, all our fast contractor has to do is persuade the developer to put, in the request for proposal, a demand for relatively short lead times and hefty penalties."
Ah so the idea is to get the developer to adjust the bid request to be ideal for them (the contractor trying to win the bid) before the bid request is even made, causing the other competing contractors to shy away (cuz they don't understand the logic of it) and not even put in a bid.
“I see your point. If the request for proposal specifies relatively short lead times coupled with penalties, no other contractors will dare to bid. The developer will get a much higher return on his investment with much less risk, and the fast contractor will make much more profit." I smile at Johnny. "You are right after all. What contractors have now is not a win-lose, it's a lose-lose. The developers suffer from long and unreliable lead times, and the contractors suffer from a throat-cutting, price-sensitive market."
“And the contractor who realizes it can have a tremendous competitive edge," Johnny continues my thoughts. "Such a contractor could take the market while commanding good prices. The problem is that, like everybody else in projects, contractors think that they cannot do a thing to cut their lead times. The first ;ones to wake up will make a killing."
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