by Michael Stone
We often hear of home or building owners claiming that contractors overcharged them for work being done on fixed figure (lump sum) contracts. The claim is usually that the "construction industry standard" is Cost plus 10%.
Let's be clear here, there is no such industry standard. There never has been and there never will be. If you have read our book "Markup and Profit; A Contractor's Guide", you know that few contractors can operate a business and breakeven at cost plus 10%, let alone make a profit. The idea that a contractor can survive at a low markup defies the mathematics of basic business and common sense.
Our belief is that this "industry standard" of cost plus 10% was created by architects. At some point, an architect put a limit in their specifications of cost plus 10% on the amount the contractor could charge the home or building owner. The reason for the limit was to help the architect or designer look good to the building or home owner. In short, they helped "save" the owner some money.
That grand idea was passed along to other architects, and first thing you know it is cropping up all over the country.
I have talked with several contractors about this and some have been badly burned by these specifications.
Even worse is the recent ploy of putting specs into a job that limit change orders to COST ONLY. No overhead and profit margins are allowed. The contractor is somehow supposed to extract any money they need for overhead and profit from the original contract amount.
How do you combat this nonsense? Here is my best advice:
Don't take any jobs where someone else tries to tell you how much you can charge for your work. (This includes architects, engineers, owners, government entities, insurance companies or commercial companies.) Your price is your decision alone. If all contractors would stick to this rule, this nonsense would go away because companies that try and dictate what contractors can charge simply couldn't get their jobs built.
If anyone claims you are overcharging, tell them to put together their own estimate, in writing, on what the costs are, and what they feel are adequate overhead and profit margins for a construction company to build that job. In many cases you will find that they will drop the claim because they are throwing nonsense at you to see if it will stick. If they do in fact put together numbers for you, it should be very easy to find what they've missed. They will not have adequate numbers in their "estimate" to cover overhead for any company, and the same would hold for profit. A quick check of most government required fees for contractors in the form of licenses, bonds, insurance, etc., that are heaped on us will exceed the 10% figure alone.
If you run into an architect or designer that puts these limits in a plan, tell them, in a nice way, to draw plans and stay out of the business of telling you what you can or should charge for your work. Plain and simple, they do not know. By the way, the architects and designers that are putting these Cost or Cost + 10% figures on their specs are charging their customers far more than cost plus 10%.
If you have a case where you are not sure how to handle the claim, send me an e-mail and we can talk about it. If we need to talk on the phone, we can decide that after you have sent along the facts of your case.
And remember to read the specs on every job before you decide to get involved. It's the small print that carries the surprises.
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Bill at Grand-Dads Toolbox replied on 07/13/10:
One thing that is interesting to note and remember with regard to architects is that most of them have NEVER done the work that their designs dictate the contractor to perform.
So let's see, they spent a whole lot of time in air-conditioned environments learning to draw pictures of buildings that are allegedly constructable by qualified yet albeit underpaid contractors. I don't recall anything in the architect's job description that qualifies them to set prices for anything a contractor would do.
Maybe I'm jaded because I work for a living, and have had occasion to deal with MANY high-priced yet flawed architecturally engineered projects.
Chad replied on 09/23/10:
I understand the sceme of what you are saying but but have to respectfully disagree somewhat. We have run cost + x% projects before and they can be a useful tool for things like difficult remodels or simply where your just trying to keep cost down for the client. It is my strong understanding that the "COST" portion of cost+ includes ALL operational expenses including your overhead mark-up. The trick is knowing EXACTLY what that % is and it has been my professional exerience that most don't even have a clue (Almost always the ones who get burned). We run service, commercial, and low volt departments and they all have differing OH points that are established at the years beginning using data from the previous year and budget forcasting for our revenues in the year to come. These are monitored quarterly through the year and adjusted accordingly if needed. COST is EVERYTHING associated with the project from accounting to postage to permits to gas for the vehicle to the vehicle to labor and so on. The "+" is simply the profit you make and has nothing to do with ANY expense, and considering remodels especially, knowing that I'm not only 100% going to cover ALL of my cost but also get ALL 100% of my profit is very insuring when we enter into contract in those types of situations. In addition, Cost+ can even reduce admin expense by reducing the cost for estimation of a project. This is almost always carried by the bidding firm as an extended offie expense and is considered overhead for normal projects. By creating a Cost+ agreement you have reduced your operating expense and overhead for that project inmany cases by thousands of dollars. My point isn't to hammer what you are trying to say (We hardly do these types of projects anyway). I jsut think to scoff at a dependable tool to make money with this artical's information may be a little mis-guided. The main point really is know your "COST" if your going to do business that way our you will get burnt.
Michael Stone replied on 09/27/10:
Chad - I appreciate your comments, but you are operating on dangerous ground. If you had to defend your definition of "cost" to include overhead in court, you'd lose.
I also have to comment on "simply trying to keep cost down for the client". The cost of the project is determined by the design, and if it costs too much, the problem is the design or the selections, it isn't the pricing method you use. You are in business to provide a service and make a profit doing it. If your focus is saving money for the customer at your expense, you won't last long.