The Cap-Ex : Op-Ex Conundrum

 

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I had two significant calls yesterday. One was with the owner/developer of a 10M+ square foot development and the other was with a president of a multi-billion-dollar building products manufacturer. There was a single theme to both conversations: How do we start optimizing the process of designing, building, and managing buildings? We reviewed several companies in our portfolio, had a broad conversation about our mission, and discussed the lack of innovation in the built environment. We concluded that the root cause of the lack of innovation in the built environment is the cap-ex/op-ex conundrum. 

If you break it down simply, there are two broad teams involved with a building: the cap-ex team and the op-ex team. “Cap-ex” meaning capital expenses and “op-ex” meaning operational expenses.

The cap-ex team is focused on a single mission: Design and build a building that meets the customer’s requirements regarding schedule, budget, and use. These requirements are driven by a financial model that involves monetizing the use of the building. Monetization can be achieved through charging rents, treating patients, teaching students, or a number of other activities. The revenue side of the model is driven by market factors. The expense side of the equation is driven by the costs to operate the building. The mortgage, maintenance, and utilities all factor into the expense side of the equation. The mortgage is the only expense that is highly predictable; the others are modeled based on previous experience. 

So, the cap-ex team is held accountable for the budget of the total building cost (the mortgage), the schedule (when can they start monetizing), and the requirements (the features to monetize). The cap-ex team is the development team, architects, engineers, and contractors. Not one of them is accountable for the operating costs of the building. 

The op-ex team is handed the keys to the building and told “good luck.” Initially, the owner/operators are just excited to get the keys to their new shiny building because it probably wasn’t delivered exactly on time. Their objectives are to execute the monetization model. Rent the apartments, make sure patients can be seen, make sure students can be taught, etcetera. They also have to manage the operating expenses for the building: janitorial, landscape, energy, and whatever else that particular building requires. Hopefully, the building meets its operating expenses that were projected by the cap-ex team. Most likely, it does not. Why? The cap-ex team is not incentivized to meet the operating costs (other than the mortgage, since that correlates back to the total construction cost).

The result of the cap-ex/op-ex conundrum is probably best understood through an example. A decade ago, I had a massive grocery store chain as a client. We were hired to build them a predictive analytics model to determine risks in schedule, budget, and requirements. The design and construction team was not happy. Essentially, we were testing their work using software simulation. It was a very successful engagement. The follow on work was for us to explore how their stores were operating. 

I was talking to the store manager of a recently constructed building. He gave me a tour and was, of course, very proud of his shiny new store. He complained a bit about how the store was two weeks late opening and that he had to carry a large portion of his team on payroll and deal with supplier delivery changes. But, he was happy that everything worked out. 

Then he tells me that he also was delayed in receiving his new deli refrigerator. I asked him what happened. He said that the deli fridge supplied by the development team didn’t work very well and used a lot of power. He had a supplier that was letting him swap the brand new fridge for the one that he actually wanted. In the past, he would have posted it on craigslist. So I asked why the development team didn’t just buy him the fridge he wanted in the first place. He said that they told him it wasn’t in the budget. The cap-ex team’s bonus is tied to on-time and on-budget delivery of the building. They have a hard enough time meeting the schedule on projects, and using a new fridge would create additional costs and potentially impact schedule (since this special fridge may not be available immediately). This is a small example of what happens on a simple project. Now imagine on a large scale project how many short-sighted decisions are made.

The solution is simple, but far from easy. In researching for my book BIM for Building Owners and Developers (2011), I spoke to a ton of owners. The challenge of implementing any innovation project was that once they were in procurement mode for a new project, their ability to explore innovation was shut down. Between projects, they didn’t have a budget for research and development to explore new technologies and innovations. Essentially, no project = no budget. The innovation exploration must happen between projects with their entire design, build and operate ecosystems without suspicion of being “sold” a new product. Managing these “learning cycles” between the procurement cycles is the best way to solve the cap-ex/op-ex conundrum. Then we can make progress towards optimizing the process of designing, building, and managing a building.