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When you see a rapid increase in material costs over a short time frame, quoting a firm fixed price on a job can be a problem if your contract doesn’t allow for cost increases.

Michael Stone: Dealing with Rapidly Increasing Material Costs

A note came in last week asking about how to handle those material cost increases. The writer started by letting us know how he’s improved his business:

“Hey Guys,

Review – Really appreciate your work. After reading Markup & Profit last year I changed to your more realistic markup method. I still have a long way to go in changing my business practices but that one change has had a huge positive impact on my business. It weeds out the low profit jobs which finally allows me some time to work on the business. It’s also forcing me to improve my sales & presentation skills (with the help of your Profitable Sales book). Small, working contractors like me can’t afford low profit work – we only get about 3,000 hours a year to make a living (working at getting that to 2,080!). Thanks!”

We love hearing from someone who’s made changes to the way they do business and is reaping the benefits. I liked his point about avoiding low profit work because there are only so many hours a year available to make a profit. I wish I’d thought of it.

He went on:

“Idea for an upcoming Wednesday topic (maybe you’ve already written on this?) – The lumber issue. My two go to lumber yards are only holding pricing for a week or two. The one is raising their price weekly. At first it was just lumber now it’s other related items that were previously stable (composite decking, railings etc.). I signed up a $7,394 porch replacement job in January & the parts have gone up almost $500 since then. I’m going to buy the lumber for this project to stop the bleeding. How are guys pricing lumber intensive projects these days? An escalator clause in the contract relating to a national lumber index, then it goes up or down at purchase time? Put it on an allowance? Trying to figure out how to quote jobs with lumber/parts that may not be purchased for 2 – 6 months. I’m debating passing on the additions right now & sticking to kitchens & baths.”

You don’t have to walk away from profitable jobs if you protect yourself. The easiest is a material escalation clause in your contract. We have language in our Fast Track Proposal Writer software that addresses cost increases that occur when a job isn’t started within a given time frame.

I reached out to a few friends for their input, and Bob Williams of Star Construction Company shared language which includes a clause for any significant material cost increase. I think it’s appropriate to include that clause as well:

Owner understands and agrees that this Contract price has been figured at current local costs of labor, materials, sub or specialty contractor and other costs. If, during the performance of this contract, the price of materials significantly increases through no fault of #CONTRACTOR#, or if this job cannot be started within #NUMBER# days from the date thereon for whatever reasonable reason, #CONTRACTOR# at his option shall be entitled to a change order increasing the contract price to include any such increases incurred.

Another option is to use allowances in your contract. We explained material and installed allowance amounts in this article, and we went into them in depth in one of our Business-Building Discussions last year. Quick definition: Allowances are a dollar amount that you include in a construction contract for a particular item.

While allowances are usually given for selections that haven’t been made before the contract is written, such as carpeting or countertops, allowances can also be used to cover items you consider most at risk for a significant cost increase. Your contract needs a clear definition of what an allowance is and how it’s handled:

When a MATERIAL ALLOWANCE or an INSTALLED ALLOWANCE AMOUNT is specified in this agreement, the following will apply:

If the cost of materials exceeds the MATERIAL ALLOWANCE AMOUNT, then that amount will be added to the next progress payment or final payment. If the amount is less than the MATERIAL ALLOWANCE AMOUNT, then that amount will be subtracted from the final amount of the Contract.

If the cost of the INSTALLED ALLOWANCE AMOUNT exceeds the amount specified, then that amount will be added to the next progress payment or final payment. If the amount is less than the INSTALLED ALLOWANCE AMOUNT, then that amount will be subtracted from the final amount of the Contract.

With that definition, include the allowances where you’re at highest risk. For example:

#CONTRACTOR# has a MATERIAL ALLOWANCE AMOUNT of $5,750 for framing materials.

#CONTRACTOR# has a MATERIAL ALLOWANCE AMOUNT of $3,250 for composite deck materials.

If there is a cost increase and you need more than the allowance given, write a change work order for the difference. Don’t wait until the end of the job to do this, do it now.

You don’t want too many allowances because you’re essentially itemizing the project, leaving yourself open to questions. Keep in mind that you might need to document your original allowance amount and show invoices for the actual materials. So don’t just throw out an allowance amount; make sure you can back it up with a quote.

Subcontractors can also be subject to cost increases. You should be getting quotes for any major subcontractor work, and if your subs experience an unexpected cost increase they should be able to document it. You could include subcontractor quotes as an installed allowance amount or let the material escalation clause cover any possible increases from your specialty contractors.

As a reminder, put a time limit on any proposals you present. I’d make it a maximum of three days; if the proposal isn’t signed in that time (after a proposal is signed it becomes a contract), the price can be adjusted. You don’t want to hear from a client who has been holding a proposal for six months that they decided to sign it and are ready to start, especially if significant material cost increases have occurred in that time.

Our Fast Track Proposal Writer software has over 1200 paragraphs of contract language that can be used to write your contracts. You can and should customize the language to meet your needs, creating a template for most contracts that allows you to quickly write a detailed contract that protects you and your client from many of the issues that can cost you money or your reputation. We have an article on what the importance of written contracts here.

We have an active private Facebook group where this and many other topics have been discussed. We’re doing our best to limit membership to construction-related business owners or principal employees with the goal of making it a safe place to discuss questions or issues in your business. If you aren’t part of the group, apply to join here and you’ll be accepted if we can confirm your qualifications.

One last comment: We aren’t attorneys and can’t give legal advice. We don’t know the laws and regulations where you do business. So, edit or adjust this language for use in your own business as you wish, and be sure to have your attorney read and approve this and any other contractual language you use, whether you find it in our software, in our newsletters or on our website. (This contract language is copyrighted and not to be posted on any other website.)

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