To fee or not to fee…

Fee or profit, is the amount you stand to gain for taking on the risk of the contracted value of the work.  Most contractors competitively bid using a percentage for fee.  In the cases of a negotiated agreement, the contractor may elect to bid a fixed fee for a set duration.  Any extension beyond that duration has a weekly rate.  This can alleviate client concerns regarding changes because the General Contractor has no monetary stake in change orders that won’t extend the job.

Profit is not optional for a business to succeed.  Winning an unprofitable job may well consume resources that prevent taking on a more profitable prospect.  This is called “opportunity cost” and it’s terrifically important to consider when a client is looking for  help on a low-budget project.  “Helping” that client costs much more than just the profit.

To fee or not to fee...

Experience shows these clients are more likely to require extra revisions, extensive pricing breakouts, and as a rule, they pay very slowly.  Charity organizations that must “pass the hat” in order to pay an invoice are great examples of this.

Unpopular can be profitable

As counter-intuitive as it may sound, very few people are analytical about what makes work profitable.  Often in construction, the focus is on the difficulty of a project.  As a result ground up or new construction project is viewed as more profitable than a remodel.  While it’s true that there is a greater degree of uncertainty in remodeling, it’s not the only factor to consider.  Basic rules of supply and demand play a role.  When there is more supply than demand, prices must fall.  More contractors pursuing ground ups leads to greater competition and lower profit margins.

Balancing act

From the earlier article on overhead we’ve shown that overhead is driven by project duration, pay delay, inflation, and office commitment to that job.  Put another way, if a job is too small the overhead costs are too high to make that firm competitive on those bids.  If the job is too large, the company risks all other contracted work becoming “non-profit” while they scramble to keep up.  Companies obsessed with landing the big job are especially vulnerable to biting off more than they can chew.

To fee or not to fee...

Efficiency of scale is how economists describe institutions that must reach a certain size in order to make their product marketable.  This is especially true of General Contracting.

Many entrepreneurs fail to recognize that contracting is about assuming risk.  An estimator’s job is to reduce risk.  The test of an estimators nerves is to balance the risk and the profit while keeping a keen eye on what the market will bear. Some estimators are very intolerant of risk to the detriment of their vocation.  It’s a fine line to be sure but every good estimator must reach a point where they are comfortable with uncertainty.

Most contracts require retainage which is  traditionally 10% of contract value held as surety until the job is done.  Most competitive markets keep profit percentages below 10%.  When the retainage is greater than the profit, the contractor must complete the job to cover bare costs which is why it’s done.   This relates to a surprising difference of opinion on what should and should not have the fee applied.  Simply stated, any direct project cost to include overhead should have the fee applied.  Permits and taxes are typically calculated on the sum-total  including overhead and profit.  Bonding agencies typically provide a formula for calculating their fees.  Be advised that they calculate their fees based on the sum total of everything included in your contract total.  Since bonding fees are job costs, you’ll need them included in that total.  Look for future posts with some excel formulas to help solve this problem.

Beware of moving parts that eat your profit

When bidding it’s very common to encounter requirements to provide allowances, alternates, and unit costs to the client.  This information can and likely will be used to influence owner decisions on anything from scope of work, to change order pricing.  In the case of publicly funded work, it’s very common for there to be several alternates which the decision makers use to maximize their allotted funding.  Speaking very generally, you should add overhead and profit to all additive alternates, and unit costs.  With deductive alternates you should keep the overhead and profit from the base bid.  The rationale for this is simple.  Deductive alternates typically don’t always affect the schedule duration. That means that your overhead costs aren’t likely to go down.

Since additive alternates can be viewed as a separate and smaller bid, it makes more sense to bid them accordingly. The overall project duration isn’t typically extended with additive alternates which means there’s greater workload on every scheduled day if they’re accepted.  Making every portion of work “pay its own way”, ensures that you won’t come up short.

Unit costs and allowances should be treated like cost accounts rather than jobs.  Keep in mind that you need to be OK with the client adding or subtracting using this price.  With an allowance, it’s important to know that the client will expect unused allowance money returned.  It is not uncommon for costly undefined items to be carried as an allowance.  Be aware that clients and design teams view allowances differently.  It’s embarrassing for an allowance to come up short once the design team weighs in.

To fee or not to fee...

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Alternates can drive permit costs as well

One commonly overlooked issue with alternates is how they influence the permit fees, taxes, and bonding rates.  In some cases it’s going to be negligible, in others it could be massive.  From the permit counter’s perspective the project costs whatever your contract’s written for.  They’re not concerned with how the client asked for the pricing.  Be advised that some cities conduct audits on contractors and any penalties they assess will come out of your profits.  Some cities have a policy to conduct an audit within six months of final inspection for every project they permit.

Alternates can define awards

Let’s suppose that a bid had five alternates.  When all the bids were read and tallied, your bid was low for all possible combinations but one which sadly, is the combination the client selected.  It’s terribly frustrating to be low on five out of six prices, and still lose the job!

Reading the tea leaves of bid results will be a future post but let’s take a moment on a few details about the last example.  If a competitor was higher than you were on the base bid and four out of the five alternates.  It stands to reason that there’s something significantly different with that last alternate.

Strategy may look like error to the opposition

Lots of estimators would assume there must have been a mistake. There may be another explanation.  If that bidder knew which alternates would be accepted, they could determine the overall profitability of the job and make the strategic move to bid that alternate “for free”.

Knowledge is power

It’s easy to get into the mindset that everything in an estimate must be about uniform and consistent accounting.  Remember that estimating get’s you the working knowledge to reduce risk, but bidding is about winning a job.  Many fastidious estimators lose bids because they don’t have a strategy to win.  It’s critical to get your head up to see the big picture.

 

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© Anton Takken 2014 all rights reserved

About Anton Takken

I chose to focus on estimating for a few reasons. Chief among them was that it's a position that's hard to fill in most companies. Job security and advancement is easier as a result. Unique to this job is a higher vantage point over the company and its place in the market. Bids are generally over in a few weeks which keeps things from getting boring. The reasons few of my colleagues pursue estimating comes down to a few misconceptions. The first is that it's the builders version of accounting - perceived as a lonely and quiet life among the charts and plans. The second is that it's not engaged in the construction process. Lots of the appeal of the construction industry is the sense that individual effort brought a plan into reality. The teamwork and camaraderie present among tradesman seems conspicuously absent at the estimators desk. Finally, I think the last reason is that it's daunting to be responsible for setting the price of something that's never been done. The good news for folks in estimating is that it's much more social than advertised. An estimator's phone is constantly ringing. Taking the opportunity to build relationships with the bidders creates a positive atmosphere and encourages everyone to do their best. It can be too much of a good thing which is why it's common to arrive at their voicemail when you're calling with a question. A strong rapport with the bidders can be invaluable. Subcontractors have much more exposure to what's going on in the market and they're often eager to share their knowledge. Learning from these experts is a priceless opportunity that's often overlooked. More on this in a bit. I decided to start this blog because I noticed that estimating has applications in many arenas. Over the last few years I've helped estimate in fields ranging from software development to blacksmithing! The more I thought about it, the more I realized that it's not about knowing what everything costs, it's about knowing how to figure that out. I believe the very first step to knowledge is to seek it, the second is to retain it, and the third is to pass it on. I hope to share some insights into how estimating is done and hopefully have some fun doing it. My experience is mostly commercial construction, but I'll try to make everything as generally applicable as I can. There are many aspects of business that all markets share yet it's remarkable that one of the most consistent is the failure to recognize that estimating is the very first step to a successful project. So if you're frustrated that work isn't profitable, or exasperated that there's never enough time to get the job done, this blog will be worth your time. Feel free to email me at: estimatorsplaybook@gmail.com View all posts by Anton Takken

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