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Why Applying Direct Personnel Expense (DPE) and Overhead to Projects is a Waste of Time
Written by Mike Brennan
Time and time again, I hear a similar answer to my question, "Why do you want to apply DPE and overhead to projects?" The answer all have a common theme: owners and/or managers of the firm do not want to confuse project managers in regard to project profitability. Some real responses are paraphrased below:
- "When the project status report shows a profit of $100, I want it to be inclusive of all DPE and overhead expenses."
- "Project Managers think they can spend up to the budget, so I want their budget to include all the firm's expenses."
- "If we don't burden raw cost, everyone will know everyone else's salary."
There is some truth to number two. Project Managers (PMs) in general want to spend up to their budget, but can't that budget be a raw cost budget or a budget based on the billed value (spent)? Most project managers I’ve met in A&E firms have college degrees, and most of these degrees are in engineering and architecture. These are smart people. Rather than dumbing down, watering down, or, in my opinion, confusing the concept of profitability with burdened cost, can't we educate the PMs on the concept of gross margin? Is there anything at all confusing about raw (unburdened) cost? To me the subject of burdened cost is more confusing than the concept of gross margin.
Here are my arguments against burdening raw cost:
- DPE and overhead rates or percentages are a guess. I agree they are an educated guess, but nonetheless they are a guess. Estimates are a guess. Now we are burdening our guess with another guess.
- DPE and overhead rates have to be calculated and monitored. Rates change. Typically the changes are calculated after their intended through date, leaving the project with a "blended" rate. (In Ajera and Portfolio, rates can be back-dated, hooray!).
- Have the owners or managers of your firm ever "discussed" (argued) about what the rates should be when an employee in Chicago charges a project based in Wichita? Any time spent discussing DPE and overhead rates is time not spent managing the firm or the firm's projects.
- Sometimes PMs argue or rationalize that the rates applied to their project were incorrect and their project was indeed profitable.
- Net Labor Multiplier is based on raw cost, so both raw cost and burdened cost have to be tracked.
Here are my arguments for using raw cost:
- Raw cost is black and white. "Cost is cost". No arguments.
- PMs can be educated or trained to manage their projects against a cost budget or most likely a fee/spent budget. When contract - spent = 0, the budget is gone. Using a fee budget is an apples-to-apples basis with the contract amount. Profitability can be measured at a gross margin basis. If the estimate is based on cost, the estimate will have an estimated gross margin. How did the actual gross margin compare with the estimated gross margin?
- Is your firm guilty of this statement? "Our overhead rate, I think it is 150%, but we have not adjusted that rate in years?" So why bother applying it?
- Is you firm guilty of this statement? "So what numbers are we looking at, raw cost or burdened cost?" Eliminate this type of discussion by eliminating burdened cost.
DPE and overhead rates can still be calculated for audit, billing, and other purposes - just don't apply it to projects for reporting and management purposes. Use spent to manage the projects, and gross margin to measure the profitability of the project, and forget the part in the middle (DPE and overhead).
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