Wilkinson utilized his extensive experience of more than 25 years of experience in the government contracting (GovCon) industry to explore how the COVID-19 pandemic has impacted the professional services industry and how these firms will be able to adapt to the new “work from anywhere” transition and the demands of the new cost accounting practices.
You can read Rich Wilkinson’s latest GovCon Expert article below:
Is Your Brick-and-Mortar Footprint Shrinking?
By Rich Wilkinson
The COVID-19 pandemic has changed everything. Some of those changes are transitory and provide room for us to envision one day getting “back to normal.” Other changes have the look of permanence and could well be part of a “new normal,” or at least a reality that we have to accept and plan for today.
Where employees work falls into that latter category. It is revealing that the phrase “work from home” is rapidly morphing into “work from anywhere.” This potential shift could have serious and lasting ramifications for the professional services industry.
This raises some important questions for firms in that industry, government contractors included. How long will a shrinking workforce footprint last? How do we adapt to it while it’s here? And if it is a long-term reality, how should our cost accounting practices change to reflect the changing cost of occupancy? Will it be possible to shed costs associated with underutilized facilities to gain efficiency and competitive advantage? And finally, how can we assure recovery of costs that can’t be cut?
The Relocation Trend
The title of this article notwithstanding, the question it poses has already been answered. Of course it’s shrinking. Or, at least the occupancy of that footprint is shrinking. The real questions are around the duration and permanence of the reduced facilities footprint. Trends in recruiting provide strong hints at the answers.
First, in conversations between recruiters, they consistently observe that it has become easier to fill openings, particularly those requiring scarce skill sets, now that location is no longer a factor. The point here is not that recruiting has become easier, but rather that companies enlisting recruiters are driving the trend.
If a firm is willing to fill an opening in Northern Virginia with someone from small-town Kansas or Alabama, it seems very unlikely they will try to relocate that employee when the pandemic subsides. Even if the employee is willing to relocate, the cost could be prohibitive. And forcing the issue could create yet another opening to be filled. The fact that hiring firms are driving the change, and that the cost of reversing the trend would be high, argue for a long-lasting, even permanent, change in how professional services firms operate.
Second, refilling largely empty office space will depend on (1) growth and (2) workforce dispersion. Once the pandemic subsides, firms that are growing may be able to hire locally to fill their space. Even if candidates are local and could work in your facility, the cost may be significantly higher than a “work from anywhere” employee. Recruiters increasingly are using work from anywhere as an inducement. Convenience, flexibility and not having a commute are very real considerations for candidates comparing offers. Firms that insist on filling brick-and-mortar facilities may ultimately pay a premium for talent.
Getting current employees back into the office may be even harder. Firms that pressure employees to return to the office may lose them. Worse, they may find that some employees who used to be within a reasonable commute have relocated. A look at real estate transactions reveals that small towns in states like Mississippi, South Dakota and Tennessee are seeing an influx of formerly urban professionals, many with families, and they are bringing big-city salaries with them. We will not get them back. Ever.
Lest you think this is hyperbole, indulge me as I share a personal example. I have a good friend that works for a mid-size government contractor in Alexandria, Virginia. Her commute from nearby Fairfax was less than 15 miles, yet took more than an hour on a good day. She began working from home in March 2020, and in August, she began shopping for a home in L.A. (that’s lower Alabama, not Los Angeles). In September, she sold her Fairfax home and moved her family to Andalusia, Alabama. Her main considerations were availability of high-speed internet, solid cell service and good health care.
Why such a dramatic relocation? She moved from a townhouse in Fairfax with a cost of well over $400 a square foot to a detached home on two acres in Andalusia, two blocks from the center of town, at a cost of just over $60 a square foot. She enjoys gigabit fiber internet service and world-class health care is 30 minutes away (less than when she lived in Fairfax).
Frankly, those empty desks are likely to remain so until the space is retired or repurposed.
The Urgency of Change
Empty space is an unnecessary drag on a firm’s bottom line. So why keep it if it won’t be utilized in the near term? Your competitors could already be gaining an edge by shedding space (and costs)? You can bet that firms that compete on the basis of cost or price are buying out leases, subletting space and finding other ways to ameliorate the situation.
Some companies are going completely virtual. Some have moved administrative, accounting, HR and other critical processes to the cloud and gone paperless. Some have outsourced or virtualized their IT function and converted their communications to mobile or soft phones. Meanwhile, virtual meetings have all but replaced the conference room and business travel has dwindled to virtually nothing, with little indication it will return. That’s probably not coming back either.
Empty desks aren’t the only sign of the occupancy trend. Companies going virtual no longer need to dedicate space to reception, server rooms or copy centers. In fact, just about any function currently occupying space in a facility can be virtualized in one way or another.
For government contractors, there is always the issue of allowability of the cost of idle or underutilized facilities. For guidance on the issue, FAR 31.205-17 is required reading. There will be a test later, administered by the Defense Contract Audit Agency (DCAA). Spoiler: You basically have a year to shed the cost of underutilized facilities before the costs become unallowable. Talk to your trusted compliance advisor.
Even when excess facilities costs are allowable, the Company Site/Customer Site overhead pool structure, so common in professional services, has become radically unbalanced for many firms. The allocation base of the Customer Site pool has shrunk to the point where the rate it yields is astronomically high, affecting both cost accounting for current projects and bidding rates for future work. For many firms, the complexity of maintaining separate overhead pools for work done in the company’s brick-and-mortar facility and the work done at a customer site (or home or anywhere else, for that matter) is no longer necessary. In fact, the difference in the allocated costs will probably be insignificant once occupancy costs are gone.
What to do?
Given the specter of excess capacity costs becoming unallowable, it seems clear that shedding the cost of excess space is probably top priority. For firms that started emptying the office last March or April, the one-year mark is distressingly close. You might want to get that process started in earnest.
Of course, once those costs are gone (or dramatically reduced), companies with Company Site/Customer Site overhead structures should probably consider merging those pools. It’s almost required for those companies in the process of going virtual. After all, how does a company maintain a “Company Site” overhead pool when there is no company facility? DCAA would frown on that fiction and probably require the company to convert to a single pool.
Even for companies that aren’t going completely virtual, it may not make sense to maintain two pools if one of them is below “critical mass.” It is axiomatic in the government contracting world that very small pools are extremely volatile and difficult to manage with any precision. Besides, if the remote workforce dwarfs the workforce still in a physical facility, the overhead rate of a single pool is probably not materially different from that of the old Customer Site rate.
There are deadlines firms must consider if they opt to merge two overhead pools. In general, changes to indirect cost pools must be made on a fiscal year boundary. So, if you keep your books on a calendar year, the change must be made effective Jan. 1, 2021, or wait until the following year. If your fiscal period is other than a calendar year, you have more leeway — with the important qualification that any change has to be effective at the beginning of your fiscal year. DCAA will grouse (although perhaps not too loudly given the circumstances) if you make the change a month or two late, effective back to the beginning of the fiscal year. Here again, the advice of your trusted compliance advisor will be invaluable.
The bottom line to all this is that decisions must be made. As a professional services firm, do you maintain your brick-and-mortar presence, reduce the footprint to a bare minimum, or go completely virtual? Do you engage DCAA and try to negotiate an extension of the deadline on allowability or do the best you can and hope regulators don’t challenge the costs on audit? The FAR cost principle on underutilized costs does provide flexibility in determining allowability and if any year warrants rule flexibility; it’s 2020!
Some firms may ultimately choose to keep their Company Site/Customer Site overhead pool structure for another year to see what happens. Others may merge them into a single pool to get out in front of the trend and try to make it work for them.
Amid so much uncertainty, what’s clear is that the footprint issue raises pressing questions that, given looming deadlines and competitive considerations, firms may need to address sooner rather than later.