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.
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.
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.
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.
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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.