August 1, 2016

Financial incentives, expensive problems, and slaying deadlines

At 3:42 am on Sunday, April 29, 2007, a tank truck carrying 8,600 gallons of gasoline overturned on a large freeway interchange in San Francisco. The intense heat from the subsequent fuel spill and fire weakened the steel structure of the roadway above, collapsing it onto the lower connector.

Immediately after the accident, the California Department of Transportation (Caltrans) estimated that it would take months to rebuild and cost at least $10 million.

C. C. Myers, Inc. (a contractor with a proven track record of rebuilding damaged freeways) submitted a winning bid of $876,075 to repair the damage.

The bid was estimated to cover only one-third of the cost of the work, but the firm counted on making up the shortfall with an incentive of $200,000 per day if the work was completed before June 27, 2007.

On the evening of Thursday, May 24, the connector re-opened. C. C. Myers beat the deadline by over a month and earned a $5 million bonus for early completion. The entire reconstruction project was completed only 26 days after the original accident.

NOTABLE NOTES

The buyer (Caltrans) estimated the rebuild would cost $10M and take months (therefore, the perceived value was at least $10M)
The seller (C. C. Myers) submitted a bid for about 1/10 of the buyers projected cost (fixed price was set at roughly 1/10 of known value)
The seller was a recognized expert at handling the client’s expensive problem (specialization begets trust)
Both parties agreed to a financial incentive that would align their interests (seller demonstrated extreme confidence by shouldering the client’s risk)
The client spent about half of projected costs AND work was completed in about half the expected timeframe (when was the last time these two things happened with a highway project in your area?)

POP QUIZ

Please hit reply and answer the following questions inline:

What do you think it would it have done to the seller’s chances of landing the work if they had submitted an estimate for $5M instead a fixed quote of about $1M?
What effect do you imagine it has on the seller’s organization to submit bids in a way that rewards them for rapid delivery?
If you were a high ranking official at a state transportation agency faced with an overpass collapse, who would be the first company you’d call after hearing this story?

MORAL

Specialize in solving expensive problems
Align financial incentives by offering value-based fixed bids
Dramatically increase your profits by slaying deadlines

Yours,

—J

P.S. For the record, I recognize that I’m stretching the analogy a bit - an emergency highway reconstruction project isn’t the same thing as a software project. Still, there’s a lot to learn here. If you’re not sure how to apply these lessons to your biz, check out https://expensiveproblem.com

P.P.S. Hat tip to my colleague David Trejo for sharing the highway collapse story (btw, no one was injured except the driver of the gas truck who suffered only second degree burns on his hands)