The following list are some (but not all) of the major reasons that a contractor in a construction related business should not do Cost Plus or Time & Material contracts or billing to their customers.
There are two major reasons contractors use Cost Plus or Time & Material Contracts:
- Difficulty estimating jobs.
- Not knowing how to establish a sales price.
The book, "Markup & Profit, A Contractor's Guide" was written to help contractors know how to price their jobs to cover their overhead expenses and make a reasonable profit. Learn more about it here.
This list applies to all general contractors and most of the specialty contractors in this business. The exception to this would be using Time and Material billing for service work such as electrical, plumbing or HVAC service calls.
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There is no universal definition of Cost Plus or Time & Material Contracts or billing, thus creating confusion and misunderstandings almost immediately in any contract. Attorneys practicing law in the same town will often have different definitions of what is a Cost Plus or Time and Material Contract.
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Lenders will not lend on Cost Plus or Time & Material jobs unless there is a not to exceed clause. When the job goes beyond the not to exceed clause, you must have written authorization to do that work (signed, dated and completely priced out change work order) or your customer is not obligated to pay you for the work.
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Some states now have laws that specifically prohibit the use of Cost Plus contracts.
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Based on discussions with attorneys, and our work as an arbitrator, Cost Plus or Time & Material jobs generate lawsuits at a rate of 2 or 3 to 1 and arbitrations at 9 to 1 over fixed figure contracts. There is ample evidence that the rate of lawsuits on Cost Plus or Time & Material is probably closer to 3 out of 4 over fixed figure contracts. T & M jobs have slightly lower numbers but are still much higher than fixed figure contracts.
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Cost Plus or Time & Material contracts are an easy way out of doing detailed project study and estimating. This increases the chances that the original "estimate" for work to be done will be low to very low. You risk accusation of violation of the GOOD FAITH & FAIR DEALING law for "Low Balling" estimates. "Low-balling" estimates can also lead to a fight over money when the real costs start coming in and accumulating on the project and the customer is requested to pay more for the job than the original estimate. Fixed figure contracts give you less chance for surprises on jobs. A good estimator will never have surprises on a given job if they do their job correctly.
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For your own protection, you must keep an accurate day to day log of all labor, materials, sub-contract and other fees or costs on the job to be able to verify your actual expenses to date. If you do not, depending on your contract, you may not be able to collect for undocumented expenses, regardless of what kind of or how much work has been done.
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Doing Cost Plus or Time & Material jobs requires that you have in your possession every document from the job that has incurred a cost. This includes all time cards, invoices, or any other papers related to the project. If you lose any item, you may not be paid for it.
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Owner's believe that Cost Plus or Time & Material jobs will cost them less money to build their job. Therefore they expect you to charge them less money for the work that you do. ( i.e., less than your normal overhead and profit). In most cases, Owners believe that you should only make:
- Remodeling = 10% Overhead and 5% to 10% Profit
- New Home Construction = 10% Overhead and Profit
- Specialty Construction = 6% to 10% Overhead and 5% to 10% Profit
This makes it extremely difficult for you to use your established markup on that job, especially when you have to show them your invoices at the normally required meetings to review the job progress and expenses to that date.
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Cost Plus or Time & Material jobs require at least two and often three times as many meetings with the customer to review job progress, billings, invoices, labor, etc. Who pays for the meeting time and the extra administration time to prep all documents for labor and invoices from subs and suppliers?
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Who draws the plans and gets the permits on a Cost Plus or Time & Material job? If a mistake is made on the plans, who pays for the time it takes to redraw the plans, and who pays to tear out the mistake and rebuild it?
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Who pays for the Engineering if the Owner forgets to include it on the plans that they provide, and who pays for your down time while you wait for these revisions?
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Who makes up the material lists for jobs with Cost Plus or Time & Material contracts that are needed before the job starts? If you do, how do you get paid and how much?
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What happens when the Owner is to supply some of the materials and they forget to buy a certain item or don't know what materials to bring to the job site? Who pays to go get the forgotten items? What happens if it takes the owner two or three days (or longer) to get the needed materials to the job site? What do you and your crews do in the meantime and who pays for that down time?
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Owners are far more prone to want to furnish some or all of the materials for their jobs when using a Cost Plus or Time & Material contract. The Contractor is expected to guarantee those materials when installed, not to mention losing the markup on those materials. Who pays for the time to replace defective materials supplied by the owner?
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Owner goes to your supplier (with your permission) charges materials for the job to your account, and then refuses to pay for them claiming those costs are your responsibility. What happens if you send the owner to a certain supplier you normally use for materials, they purchase the materials, and then later claim that they could have purchased the same materials at another location at a better price? You gave them the higher priced supplier to go to, so you are responsible for the difference in cost.
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Will the Owner be willing to pay for your travel time to and from your office for meetings or discussions on problems that might arise on the job, or from the job site to your suppliers and back to the job site for material pickup that either they or you forgot?
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Owner expects you to be fully productive on their jobs for 8 hours a day. They will be looking over your shoulder constantly. You will seldom if ever get the job done as quickly as they are expecting you to do it. Will they be willing to pay for your State's mandated morning and afternoon breaks for your employees? Will they be willing to pay for smoke breaks, coffee breaks, cell phone time? Will they be willing to pay for you or one of your employees to escort an inspector through the job and answer all the inspectors questions? Who pays for the labor and materials to do the changes?
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Suppose Engineering on a portion of the job gets by the plans examiner, the inspector catches the problem, and the job has to shut down until the engineering is complete and new plans drawn and ready to use. Who pays for the new plans & delays? Who pays for tearing out the wrong structural work completed and the materials that are ruined due to tear out? Who pays for the additional labor needed to correct the problem? Who pays for the down time for you and your crew, driving time, re-start up time?
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Cost Plus or Time & Material reviews show the Owner what you are paying for materials. This will increase the probability of complaints from the customer that they could have bought the same item elsewhere for less money. It also leads to customer believing they only have to pay the amount that they could have bought the materials for.
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If you make a mistake on a Cost Plus or Time & Material job, who pays for it? Do you donate your time or is the customer willing to pay for it? Who pays for ruined materials? Who pays to go get the new materials and the cost of the vehicle expense to do the pickup?
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Because of the perception that on Cost Plus or Time & Material contracts the Owner is required to pay for absolutely everything, many contractors do not write out change work orders and have the Owner sign them, falsely believing that they (the contractor) will be paid for all the work that they may do on that job.
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Contractor must be far more diligent in policing employees so that they are productive on the job at all times, with no miscellaneous discussions or activities on or about anything other than the job they are working on. Again, this pertains to starting and quitting times, smoke breaks, coffee breaks, cell phone time.
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Owners do their homework, put their job out for "Bids" @ Cost Plus or Time & Material plus 6%, 7% or 8% maximum markup. They tell you if you don't want to bid that way, don't enter a bid. They also tell you that "You're not going to make your normal markup on my job!", i.e. take it or leave it.
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Very difficult to "compete" for commercial jobs because larger construction companies will take these jobs at cost, to build presence with corporations that allocate the multi-million dollar projects on assignment basis because of favorable past performance.
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And here is the big one that catches so many using Cost Plus or Time and Material contracts. They take items that are considered overhead and stuff those costs into their job cost section. Then when the fight starts (as it often does), a sharp expert witness that examins the contract will find the overhead items listed under job costs and the contractor will be charged with "double dipping" the job. This immediately paints the contractor as dishonest and they will lose this court battle.
We are sure with a little research, we could double this list concerning Cost Plus or Time & Material Contracts. Suffice is to say that the reasons listed should be enough of a warning to most people in this business to avoid Cost Plus or Time & Material contracts or billing.
" . . . thought I'd write to offer affirmation that your philosophies toward residential construction company sales and management as well as customer management really work.
Since attending one of your seminars and reading your book several years back, we have been basing all of our design/build practice on firm price contracts. All of our pricing is done with estimating software. We automatically build our OHP factor in-nothing is "stick-priced". This process has saved us hundreds of hours both in office and wrangling with clients (and the added stress that goes with that), and has probably added years to our lives.
Your system is by far the easiest way to run a residential remodeling company. I just wish I could convince more of my competition in our Central Mass. market to read your book-there'd be a lot less education of the client-base between T&M and fixed/firm price contract pricing."
Boylston, Massachusetts
