At a Crossroads— Is Value-based Compensation the Answer?
Publication: Leadership and Management in Engineering
Volume 6, Issue 4
Abstract
This paper acknowledges three major issues facing the civil engineering profession today: (1) civil engineering salaries have not increased at the pace of most other professions and engineering disciplines; (2) civil engineering practice is increasingly being viewed as a commodity; and (3) civil engineering leaders have concluded that an expanded body of knowledge, requiring additional education compared to today’s requirements, will be required to successfully practice in the future. At the same time, U.S. enrollment in engineering is declining. The paper suggests that one cause of these problems is inadequate compensation for civil engineering work due to almost exclusive use of time-based fee structures. It draws an analogy between the use of time-based fee structures and fee bidding, the latter practice being one that ASCE went on record opposing in 1987. However, the paper presents data that show the practice of fee bidding has diminished little in the intervening years. Based upon this fact, the paper concludes the appropriateness of fee bidding or time-based fees is a function of project complexity. Simple, straightforward projects may be suitable for fee bidding and time-based fees, while more complex projects are not. A methodology for implementing value-based compensation similar to a system used by the medical profession is described.
The challenges facing the civil engineering profession today are enormous. The July issue of Civil Engineering noted that in the thirty-three-year period between 1955 and 1988, inflation-adjusted average starting salaries in the civil engineering profession increased a total of only 7 percent, while the average salary for employees in all occupations increased 35 to 45 percent (“Wanted: Civil Engineers” 2005). More recently civil engineering salaries have remained static and below those of other engineering disciplines and most other professionals. Although not necessarily as a result, student interest in engineering is declining and the number of American students earning bachelor’s degrees in civil engineering peaked in 1981. The article warned that if the United States does not produce enough engineers, “employers will simply find another way to get the job done, even if that means sending jobs overseas.” At the same time the leadership of ASCE has recognized that civil engineering is a demanding field that requires a broader knowledge base and combination of skills to successfully practice as a professional today, compared to past. To this end they have agreed upon the body of knowledge needed to practice in the future, the attainment of which will make the first professional degree the equivalent of what is now the master’s degree. An obvious concern is that a longer education relative to other disciplines will make civil engineering an even less attractive course to pursue.
We have also seen a continued trend on the part of the public to view engineering services as a commodity. This trend was well described in a recent white paper by Flavell et al. (2005). When engineering software for the personal computer first came into being, it was heralded as a tool that would allow engineers to design more precisely and evaluate alternatives more quickly, all at lower cost. The profession embraced the advent of the computer and promoted its power to transform the industry. Such a good job of promoting the computer was done that clients now think that the computer alone resolves design issues associated with a project. This has served to commoditize the industry. Since all engineers use computers and software to “design” a project, all engineers must be the same. Therefore, why should a client pay more than the lowest cost that engineering services can be purchased for?
At the same time engineers are observing that the economic health of the civil engineering profession is being undermined by time-based fee structures (Strogoff 1997). The importance of receiving adequate fees for engineering services is vital for an engineering practice to thrive. Today, the most common complaint from engineers is, “I’m busier than ever before, but I can’t seem to make any more money.” Without adequate compensation, offices cannot be adequately equipped, salary structures are not adequate for attracting and retaining highly qualified staff, incentive to assume additional risk is lacking, and other problems are created. A 1997 article in Engineering News Record (Fanning 1997) by a principal for PSMJ Resources, which publishes an annual survey of design fees, noted: “[T]he economic health of the design profession is being undermined by time-based fee structures.…[U]ntil we break the time-spent vise, we will continue to feel the squeeze on the economic benefits that our profession provides.” Bidding for design work tends to further erode profit margins. New project delivery methods such as design/build have produced benefits for clients and owners, but have not improved the engineer’s profit margin.
A recent article in DesignIntelligence, the monthly journal of the Design Futures Council (“Redesign your profits” 2005) stated:
A brutal fact of reality for architecture and engineering firms is that prevailing pricing and compensation methods—setting fees on the basis of direct labor cost (whether selling hours on a time-and-materials or lump-sum basis)—provide only minimal profits for firms. They also reinforce client perceptions that engineering, architecture, and design services are simply commodities to be purchased on the basis of lowest cost. The insufficient returns generated by these pricing methods starve firms of the resources they need to grow and foster a survival mentality in which many professionals are unwilling or unable to apply their unique expertise, dedication, and vision to the complex challenges that confront clients, communities, and society.
The common theme in these challenges and, perhaps the key to addressing them, is the civil engineer’s compensation and the manner in which it is determined. Almost all firms utilize time-based compensation and have done so for years. Essentially, the client pays for the engineer’s time with a markup for overheads and profit. While automation over the last forty years has dramatically reduced the amount of time required to perform most traditional engineering tasks, virtually all of these savings have been passed on to the client. No wonder then that profit margins, multipliers, and salaries in constant dollars are the same or less today than they were forty years ago. Now many in ASCE are suggesting that we need to rethink time-based compensation and urge the profession to move toward a concept called value-based compensation (VBC). With the backing of ASCE, could movement toward VBC help address the challenges described above? Is time-based billing, like fee bidding, a practice that ASCE should take steps to change?
Lessons learned in addressing fee bidding
In 1987 ASCE adopted Policy Statement (PS) 304, “Qualifications Based Selection of Professional Engineers,” stating that it “believes that the selection of professional engineers as prime consultants and subconsultants should result from competition based on the qualifications best suited to complete the work successfully.” The federal government and most states now require some form of qualifications-based selection (QBS). The rationale that supported adoption of PS 304 concluded:
Design costs represent a very small proportion, probably less than 1%, of the costs that will be incurred over the life of a project. Fee bidding is an imprudent policy to follow because it forces the engineer to forego detailed analysis of the problem and the search for innovative solutions, or even the comparison of obvious alternatives. In the short run the client may save a few dollars on engineering costs, but in the long run such myopia can carry a huge price tag. In other words, looking at the short-term picture the client may save a small amount on ‘up front’ design costs by taking bids on the engineering portion of his project, but the cost of construction and the long-term costs of operation and maintenance will undoubtedly be substantially higher than they would have been had a first-class job of design been done initially. More time-consuming designs that would pay for themselves many times over will have to be forgotten.
It has been nearly twenty years since ASCE adopted PS 304 and other QBS requirements were enacted. Have these changes been effective in diminishing the practice of fee bidding? At best, one would say they have only been modestly effective and some might say they’ve seen no difference. In newspapers every day one can still see headlines stating, “County Hires Designer for RV Park—Three Companies Bid on the Design Contract.” In 2000 ASCE conducted a survey of consulting firms to provide data for the 2003 revision of Manual 45, How To Work Effectively with Consulting Engineers—Getting the Best Project At the Right Price (ASCE 2003). The survey provided information on nearly 1,000 civil engineering projects throughout the country, including whether they were awarded on the basis of QBS or bidding. The comparison of the number of projects procured by each method is shown in Table 1. The data show that nearly 20 percent of service as the prime consultant was awarded on the basis of a bid and almost 40 percent of service as a subconsultant. The percentage of projects awarded on the basis of a bid generally increased as the cost of the project increased. It is likely that the actual percentage of jobs awarded on the basis of bids is actually higher than reflected in the survey due to the reluctance of some respondents to report on bidding.Table 1. Survey Results: Projects Awarded on the Basis of QBS versus Bid
| Form of service/size of project | QBS | Bid |
|---|---|---|
| Service as prime consultant | 471 | 102 |
| Service as subconsultant | 137 | 92 |
| All service: projects $100K–$500K | 192 | 54 |
| All service: projects $500K–$1M | 157 | 27 |
| All service: projects $1M–$10M | 171 | 67 |
| All service: projects over $10M | 88 | 46 |
Have ASCE’s efforts to advance PS 304 and other QBS legislation been a failure in terms of eliminating the practice of fee bidding? More likely, they have served to illustrate a certain reality that some level of fee bidding, even with its potential pitfalls, is always going to exist in today’s business and political environment. Certainly the level of engineering expertise and judgment required on the thousands of projects completed each year covers a vast spectrum—from small jobs at nearly the technician level on one end to massive projects with huge unknowns where the ultimate success, the investment of millions of public dollars, and public safety rest clearly in the engineer’s hands on the other. Maybe it is time for the profession to recognize that some jobs may be suitable for bidding while others may not. If the proper steps are taken when fee bidding is utilized and the client is appropriately advised (Parks and McBride 1987), the outcome can be acceptable. Obviously, as demonstrated by the survey data, fee bidding continues to occur, particularly in professional-to-professional engagements.
Even in the rationale supporting adoption of PS 304 in 1987, ASCE concluded:
Some public officials and administrators find it politically expedient to insist on bidding engineering contracts—after all, who can be opposed to competition when taxpayers’ dollars are involved? It is more difficult for a public official to try to educate the public and the media about the hidden costs and dangers of trying to obtain an engineer by competitive bid. Yet the reality is that quality engineering can no more be obtained by competitive bid than can quality legal advice or medical treatment.
One of the reasons that engineering services are perceived as a commodity is that, in general, people do not understand what engineers do. The computational aspect of engineering has been oversold such that there is a loss of appreciation for the engineering thought process. The new age of design, drafting, and graphic software is leading the public, our clients, and even some practitioners to believe that engineering can be done by the computer with the engineer simply inputting data. Besides stifling creativity, eliminating checks and balances, and generally applying conservative design coefficients, such an approach often minimizes the engineer’s exercise of judgment. For most projects in the spectrum of complexity, such an approach is clearly improper and does a disservice to the public. Again, however, the reality may be that some projects at the simple end of the spectrum fall into the commodity category, which makes them candidates for both fee bidding and straightforward, time-based compensation methods.
If we can accept that there are projects at the commodity end of the scale, we must also acknowledge the projects at the opposite end. These are the projects that truly embrace the art of civil engineering, where both the selection of performance standards and design standards require the exercise of judgment, as either choice implicitly selects a probability that the project will fail if subjected to some level of natural system stress (e.g., flood flows, drought, earthquake, etc.). David Pye, as quoted by Henry Petroski in his book To Engineer is Human (1985), defines this engineering challenge quite clearly:
[A]ll designs for use are arbitrary. The designer or his client has to choose in what degree and where there shall be failure. Thus the shape of all things is the product of arbitrary choice. If you vary the terms of your compromise—say more speed, more heat, less safety, more discomfort, lower first cost—then you vary the shape of the thing designed. It is quite impossible for any design to be the logical outcome of the requirements, simply because the requirements being in conflict, their logical outcome is an impossibility.
If we look at engineering projects at the complex end of the spectrum, bidding for services often precludes the engineer’s exercise of creativity and professional judgment, the examination of appropriate levels of risk, and the possibility of greatly reduced project life-cycle cost. However, being able to perform these remarkably valuable aspects of the engineering effort as a result of QBS, yet charging only for the time they require, makes little sense either. Most importantly, it fails to recognize that certain aspects or activities in the engineering/design process have different values or worth to the client. These values are often not proportionate to the time (cost) spent and are usually much greater.
Value-based compensation as the solution
In May of 1996 Elbert C. Ray, P.E., made a presentation to the Council of American Structural Engineers concerning value-based compensation (VBC) (Council of American Structural Engineers 1997). Ray’s basic premise is as follows:
[T]here are or may be certain aspects of structural engineering that fall beyond the normal scope of services that can have a very significant effect on the client’s planning and investment decisions. There are certain specific services, which will vary from project to project, that can provide information to the client that may be of value far in excess of the fees that might normally be charged for those services.
The concept is applicable to all disciplines of civil engineering. Ray went on to state:
[V]alue is defined as “relative worth.” VBC refers to compensation that is established on the basis of the relative worth of the service to the client (purchaser of the service). It is a concept through which engineers are compensated on the basis of the increased value, or savings, which their services contribute to a project.…[S]ome services are more “valuable” than others, particularly when such services are provided prior to beginning what is referred to as basic services. VBC means that an engineer is rewarded for originality, added value, or increased risk associated with his professional services. It is not for every project or client, and the engineer will not receive any additional compensation unless he negotiates and identifies such work, up front, in his/her proposal.
The greatest influence that an engineer can have on the ultimate success of a project will occur at the earliest stages of planning, when the broadest decisions are being made. Examples of structural engineering services that can provide value to the client far in excess of the fees that might normally be charged for those services include building site location, orientation, and massing; decreased construction time; arrangement of building functions; foundation systems; and fixed costs versus long-term costs. Consider just the attention given to life-cycle costs. Engineered facilities or projects have ongoing operation, maintenance, replacement, and retirement costs after construction is complete. Such things as durability, energy consumption, ease of use and convenience, reliability and redundancy, serviceability, flexibility for adaptation to changed future needs, operational staffing, ease of refurbishment, and functionality can all be dealt with to minimize life-cycle costs at the early planning stages and within the design phase. Many times engineers give away such services as part of normal design services. However, through QBS and participation in these early stages, the client, the public, and the engineer can benefit greatly.
ASCE’s Structural Engineering Institute, together with CASE and NCSEA conducted a workshop in 2000 entitled “Taking Control–A Workshop on Value-based Compensation” (Structural Engineering Institute 2000). This workshop defined the problem as follows:
The evolution of the process for the selection and retention of structural engineering services has created an environment that intensifies price competition, compresses profitability, and compromises quality. New project delivery processes have exacerbated this situation. The implementation of practices for value-based services and compensation will lead to improved selection and retention processes, improved profitability, and improved project quality.
Causes of the problem identified by the workshop attendees included a willingness to accept low fees, a failure to say “no,” erosion of the traditional design/bid/build system, a willingness to compete for fees, societal obsession with low price, and lack of negotiation and marketing skills. Although the attendees could easily see how VBC could address the problem, their ability to foresee implementation was less clear.
Bringing about change
While many may agree that VBC sounds good in theory, just like QBS, most would suggest that implementation presents a real roadblock. Flavell et al. (2005) suggest that our clients and the populous in general need to be educated to the fact that civil engineers interface between social infrastructure and the vagaries and power of nature; that we visualize the entire project in three dimensions and figure out all the components that are required for the project and fit it to the site that is intended to receive it. We transfer that 3D visualization onto paper in the form of drawings and specifications, or contract documents. These documents allow the entire project to be built and put into service. It is the engineer that creates these documents—not the computer.
DesignIntelligence believes that firms’ leaders must help their executives and senior managers overcome deeply held mental models that support the current economic model of practice. Some professionals actively resist new pricing strategies, believing that what looks like an excessive markup on direct labor costs is somehow unethical or unfair to their clients. Leaders must help their staff understand the imperative of the new business model and see how higher profitability can lead to higher professional standards.
Ray (Council of American Engineers 1997) believes VBC can be marketed in two ways: “[O]ne is to package and receive compensation for additional, up front services that we are giving away in the normal course of design. In identifying those ‘value services,’ it will be found that they will normally be outside of the usual basic services.…A second method is for engineers to take a leadership role on projects and deal directly with the client.” In the end he believes it comes down to a question of the multiplier—for traditional, low-risk work the firm may accept a relatively low markup, but for high-risk or innovative work the markup should be higher.
Clearly, these approaches to implementing greater use of VBC are good. However, they generally rely on educational activities on the part of practitioners and one very large assumption—that a more informed public equates to an evolution of VBC. The reality that has lead to limited success in the implementation of QBS suggests that this assumption may not be totally correct. Education and development of policy statements will be required, but will need to be combined with stronger actions like the activities that facilitated the limited adoption of QBS two decades ago. At the federal level, proposed additions to the 1972 Brooks Law (P.L. 92-582) may be a start. Model compensation guidelines for state and local governments could be developed and incorporated in ASCE’s Manual 45 (ASCE 2003). Education and implementation at state and local levels could be encouraged by grass-roots efforts of facilitators employed by local engineering associations as was done to promote QBS.
Taking our lead from the medical profession
ASCE could follow the lead of the medical profession in fostering VBC. The parallels between the two professions have grown closer as civil engineering moves toward a longer basic education and increased specialization (certification). Just as engineering fees are being increasingly controlled by politics, perception, and auditors, the medical profession was being challenged in the 1960s by the Medicare program to better substantiate its costs of services and, therefore, its compensation practices. The medical profession conceived a system of fees based upon relative value that assigned a numeric unit value to every procedure (ASA 2004). Initially there was huge debate over the proposed system within the profession. While many saw merit in it, most worried that it would be interpreted as a violation of the antitrust laws, some continued to favor time-based units, and others favored “usual, customary, and reasonable,” or UCR fees.
The debate in the medical profession continued through the 1960s and into the 1970s. Different specialties within medicine began to develop their own relative value guides (RVGs). Emphasis was always placed on the fact that the RVG was a guide rather than an official fee schedule. However, in 1975 most societies’ RVGs came under broad attack by the Federal Trade Commission, which alleged that they represented conspiracies to fix the prices for medical services. All but the American Society of Anesthesiologists (ASA) agreed in consent orders to cease publication of their RVGs. The Justice Department brought suit against the ASA, alleging violations of the price-fixing prohibitions of the Sherman Antitrust Act. After a six-day trial, New York District Court Judge Kevin T. Duffy issued his forty-page decision, which concluded that the RVG did not violate antitrust laws. The legality of the RVG had been dramatically established in the practice of medicine. In December 1989, President George H. Bush signed the Omnibus Budget Reconciliation Act establishing a physician payment schedule based on a resource-based relative value scale (RBRVS). In 1992 Medicare began basing payments for physicians’ services on the RBRVS.
In the RBRVS system, payments for services are determined by the resource costs needed to provide them (“RBRVS” 2006). The cost of providing each service is divided into three components: physician work, practice expense, and professional liability insurance. Payments are calculated by multiplying the combined costs of a service by a conversion factor and are also adjusted for geographical differences in resource costs. The factors used to determine the physician work include the time it takes to perform the service, the technical shill and physical effort, the required mental effort and judgment, and stress due to the potential risk to the patient. One could easily envision a similar system for civil engineering applied either to different types of projects, different aspects of the design process for all projects, or a combination of both. Initially the system could be a guide to be used at the discretion of the engineer. ASCE is currently implementing a program of certification in specialty areas, which affords an ideal opportunity to move toward a different method of establishing compensation.
Summary and conclusions
The civil engineering profession is at crossroads—it faces a number of challenges and sees the need to make a number of changes while lacking professional support with adequate funding to do so. The original rationale that supported adoption of QBS also supports the use of VBC. It is time to recognize that any particular civil engineering project falls somewhere on a spectrum of required engineering expertise. A project’s position in this spectrum should determine in large part whether fee bidding versus QBS and time-based versus value-based compensation methods are most appropriate. The case can be made that civil engineer’s overreliance on time-based methods for establishing compensation for services may be detrimental to the profession. Time-based fee structures do not recognize that the value of time invested in certain aspects of a project can provide far greater value to the client and the public than other aspects of the work. The client’s high return on investment in these high-value services justifies VBC for them. At this point in our history we can choose to charge what is “usual, customary and reasonable,” and see our profession continue to decline or we can move toward charging what our services are worth. There are steps that the profession can take to advance the concept of VBC.
References
ASCE. (2003). “How to work effectively with consulting engineers—Getting the best project at the right price.” Manual and Report No. 45, ASCE, Reston, Va.
American Society of Anesthesiologists (ASA). (2004). “ASA relative value guide (RVG): A defining moment in fair pricing of medical services.” ASA, ⟨http://www.asahq.org/Newsletters/2004/09_04/ogunnaike.html⟩ (accessed June 2006).
Council of American Structural Engineers. (1997). Commentary on value-based compensation for structural engineers, Council of American Structural Engineers, Washington, D.C.
Flavell, E. L., Begbie, H., and Flowers, S. G., (2005). “Civil engineering: A changing profession.” Unpublished white paper prepared for ASCE Committee on Business Practices, August 10.
Fanning, W. F., (1997). “Time-based billing must end.” Eng. News-Rec., 239 (18), 57.
Parks, G. A., and McBride, R. R., (1987). “Competitive bidding for engineering services.” J. Prof. Issues Eng., 113 (1), 66–76.
Petroski, H., (1985). To engineer is human, St. Martins Press, New York.
“RBRVS: Resource-based relative value scale,” (2006). American Medical Association, January 25, ⟨http://www.ama-assn.org/ama/pub/category/2292.html⟩ (accessed June 2006).
“Redesign your profits: Value-based fee structure,” (2005). DesignIntelligence, July 26, ⟨http://www.di.net/article.php?article-id=454⟩ (accessed June 2006).
Strogoff, M., (1997). “Let’s value our services more.” Eng. News-Rec., 239 (18), 57.
Structural Engineering Institute. (2000). “Taking control—A workshop on value-based compensation.” American Society of Civil Engineers workshop. Stone Mountain, Georgia, July 8, ⟨http://www.ncsea.com/downloads/compensationworkshopnotes.doc⟩ (accessed June 2006).
“Wanted: Civil engineers.” (2005). Civ. Eng. (N.Y.) 75 (7), 46-49.
Biographies
Gary A. Parks is Redmond regional manager, Bonneville Power Administration in Redmond, Oregon.
Information & Authors
Information
Published In
Leadership and Management in Engineering
Volume 6 • Issue 4 • October 2006
Pages: 144 - 149
Copyright
© 2006 ASCE.
History
Published online: Oct 1, 2006
Published in print: Oct 2006
ASCE Technical Topics:
- Bids
- Business management
- Construction engineering
- Construction management
- Contracts and subcontracts
- Education
- Employee compensation and benefits
- Employment
- Engineering education
- Engineering profession
- Fees
- Financial management
- Organizations
- Personnel management
- Practice and Profession
- Professional practice
- Professional societies
- Project management
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