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Contractor Management Controls
by Bob L. Harrell, Jr.
There’s a
great story about a town with a clock tower that rang
every day at exactly noon. The man in charge of the
tower called City Hall each morning to confirm the exact
time before adjusting the clock. Everyone in the town
knew for certain when the tower clock rang; it was
straight-up 12:00 noon. One day, after many years on the
job, the bell tower man happened to ask the city hall
clerk how he always knew the exact time. “That’s
easy,” the city hall clerk replied, “I rely on the clock
tower.”
This
circular logic is how many large, otherwise
sophisticated manufacturing plants “manage” financial
accountability over their industrial contractors. They
create a PO and send it to the contractor. The
contractor performs the work, keeps track of hours,
equipment and materials used, then prepares and submits
an invoice. The contractor is both the bell tower
and City Hall. Contractor invoices are often in
error (it’s not really 12:00 noon). The hours are
inaccurate and the rates or math are wrong. It’s not
unusual for the error to equal 10% of the average
invoice. The planning and scheduling, and execution of
the work are first rate, but the financial control needs
upgrading.
This
business problem has been in existence for over thirty
years, with little improvement. If anything, the
problem looms larger because of a renewed emphasis on
financial responsibility as a result of Sarbanes Oxley.
The huge increase in outsourcing hourly labor work has
also magnified the problem: the error rate has stayed
the same while the volume of contractor spend has risen
ten-fold. The result is hundreds of millions of dollars
in overcharges across any single industry.
The
following results from an actual audit of the top five
contractors for a single refinery site shows a 14%
overcharge rate in dollars, and 10% in hours.
How can this
problem be so widespread, particularly in the
manufacturing plant industry where great strides have
been made toward 99.999% reliability? The answer is
simple but the solution is not. Except for the
occasional historical audit, there is no easy way to
know that error exists, nor is it easy to measure its
impact on the bottom line. It takes a great deal of
effort to inspect contractor timesheets and complete
accuracy is difficult to attain. For example, who can
remember if the person who clocked out four hours early
six months ago was really sent on an errand or just left
early? Audits also do not provide value for managing
plant contractor expenses in real-time. It usually takes
30-45 days at best to even receive a contractor invoice
and longer to validate it.
The fact is
that a contractor may be great at executing mechanical
work, providing IT support, or performing administrative
duties but he or she is not the world’s best time keeper
or cost accountant. Yet, the owner is completely
dependent on the timesheets and invoices offered by the
contractor. ERP systems can automate much of the payment
process; however they can not and do not evaluate the
quality or accuracy of the hours reported by the many
contractor firms demanding payment. Instead, payment
authorization is granted by the owner’s field supervisor
as the first (and often only) line of defense against
contractor timesheet and invoice errors. Unfortunately,
the supervisor truly has no way of knowing if the hours
on the timesheet are right. Assumptions are made by
everyone involved, and the result is a normative 10%
error rate. When a plant spends $100 million in
contractor costs annually, that comes to $10 million
spent unnecessarily.
Why does
this problem persist? In order to achieve financial
accuracy, all the pieces of the puzzle must be in place
and connected. All too often the pieces reside in
separate silos and under disparate authorities. For
example, the timesheets are the responsibility of the
contractor foremen and timekeepers; gate logs are kept
by security and facilities; individual schedules are
managed by the contractor; contract terms and conditions
are in a file drawer in procurement; and work orders and
purchase orders are locked inside of a project
management system. Although the latter two are captured
in ERP systems, they have no basis for validation of
costs in real-time.
Of course,
it is possible to manually spot-check gate logs and
compare them to timesheets, or write a program to do so.
Various time and attendance programs often perform some
combination of these activities. Unfortunately this
presents a false sense of security and accuracy. Neither
gate logs nor timesheets reliably account for the
contractor who shows up early for coffee or spends extra
time getting to the actual work site from the front
gate. A scant fifteen minutes is actually 3% of the
workday. Multiply that by $50 million dollars and you
have $1.5 million in overpayments due to what could be
called ‘fuzzy time.’
What about
the individual who badges in and “works” even though he
wasn’t assigned (required, given the work orders
scheduled for the day)? The only way to catch these
errors is to perform a multi-way comparison between:
·
the perimeter
security system badge time in and out,
·
the
contractor’s dispatch log (shift assignment) for each
craftsmen,
·
the contract
Terms & Conditions (business rules) concerning show up
early/late; leave early/late
·
cumulative
time-on-site for the work week to automatically
calculate Straight and Premium time
·
And a half
dozen other variables.
Ironically,
it is the contractors’ timesheets—currently the
foundation of determining pay—that’s the least reliable.
Determining
accurate hours spent on work is only half the solution,
however. It’s impossible for your first line folks
(foreman, supervisors, and contract administrators) to
know the terms and conditions of the hundreds of
contracts. Yet it is critical to have a clear
understanding of the subtle complexities of every
contract in order to determine, for example, when
overtime is to be paid. For example, a contract states
“overtime is paid after 40 hours of work a week,
regardless of where those hours were worked”. So, if the
worker put in 39 hours at Client 1 during the first four
days of the week, and 8 on Friday at a Client 2, the
second client pays 1 straight and 7 overtime hours!
While this would be nearly impossible to validate by any
measure, it serves as a convincing example of how
important contract terms and conditions are to the
accuracy of expenditures. Even though contracts are
generally complex, replete with vague legalese,
incomprehensible commercial terms and conditions, and
incomplete rate structures that lead inexorably to
undetected time reporting and invoicing errors, they
can’t be ignored.
So, the
foundation for achieving financial accuracy on
contractor invoices is:
-
Knowing
when someone is scheduled to be on-site,
-
Verifying
that information against when they were actually
on-site, and
-
Validating
the net result against the terms and conditions of
contracts.
This can be
done manually or with software, but it can’t be done
sufficiently unless all parts are included.
The
confident reader is probably thinking that unit
pricing—that darling of European processing
industry—avoids all of these problems. However the blush
of utopia fades in practice. Unit pricing merely
replaces the challenges of managing thousands of
contractors with the even greater challenge of managing
tens of thousands of unit conditions. Case in point: one
plant had 120,000 conditions in a single contract,
exceeding the capacity of their ERP system. The
compromise, a mix of Unit Pricing and Time & Materials,
with a little Lump Sum thrown in for good measure,
inevitably leads to change orders and a call for the
same rigorous attention to cross-checking and validation
that pure time & material contracts demand.
That leaves us with the question of how to definitively
eliminate inaccuracy in contractor invoices. Financial
accountability demands we can no longer accept “not
knowing” about the problem. The common method of
auditing selected contractors provides a historical
snapshot, but is subject to the ability of supervisors
to remember the details of exceptions. It is also
limited in scope.
The
alternative to an historical audit is to create a
process that prevents errors in the first place. Most
homegrown processes only address part of the problem, at
best, and simply automate faster pay of inaccurate
invoices at worst. For example, linking the gate access
system to the time and attendance system is a step in
the right direction, but time on-site is not the same as
billable time and speaks not at all to straight
time/premium time split. Thus, these types of processes
are usually more focused on automation than accuracy. As
a result, they capture only half of the errors in labor,
and none of the errors for equipment and material.
Only a
process that compares time sheets against gate access
data, but also verifies them against contractor
schedules, and then validates the net time against the
contract terms and conditions can achieve the desirable
99.999% accuracy.
Once a
process is in place that accurately tracks who is
on-site, who is supposed to be on-site, and how much
time they are allowed to bill for, it is easy to include
data about safety certifications and expirations for
those individuals, thereby meeting OSHA 1910
requirements as well. Add work order allocations and
delay codes, and the system becomes the foundation for
measuring and improving productivity and wrenchtime.
While not required, the ability to link to a plant’s ERP
system is beneficial, eliminating duplicate entry and
allowing for quick entry of calculated costs into
accounts payable.
In an ideal
situation, real-time costs are completely accurate so
that contractors and owners can agree on the costs on a
daily basis. This eliminates the need to wait for an
invoice and many companies have been able to negotiate
quick pay terms of 2%. From the contractor’s point of
view, they are relieved to know that the amount paid was
exactly the amount earned and that there is no danger of
receiving a letter demanding credit some months in the
future.
Using this
type of process, one contractor was able to reduce a $16
million accounts receivable balance to > $10,000. A
major refiner, at one of its larger refineries, was able
to reduce contractor timekeeper headcount from 13 to 3
after implementing a more reliable and automated
process. “The juice is worth the squeeze” is how one way
of saying that the effort of putting a reliable tracking
system in place is well worth the financial rewards. It
is absolutely possible to achieve complete, real-time
accuracy, pay the right amount on a timely basis and at
the same time use the associated data to improve
operations, maintenance and construction in your
business.
About the
Author:
Bob
Harrell is a process industry financial executive with
over thirty years’ experience in internal auditing and
consulting. He has also been on the other side of the
table as CFO and COO of a large contract services
company. Bob founded Management Controls, Inc. in 1989,
and began working with some of the largest refining and
petrochemical companies in the world in 1990 to design
an automated real-time contractor management system,
TrackSoftware, now in its fifth major release. Every
day, Track Software manages over 15,000 contractor
companies, 25,000 contracts, 120,000 contract personnel
and over $1 billion in contractor spend. Mr. Harrell is
a frequent speaker at audit associations, contractor
management events, and industry trade shows. He can be
reached at
bharrell@www.mccorp.com
or by calling 281-590-5881 x111. |
