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 insurance companies to control the amount paid on claims. Architects picked it up, establishing a limit in their specifications of cost plus 10% on the amount the contractor could charge the home or building owner. This made the architect or designer look good to the building or home owner, helping the owner “save” 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.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.
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Risks of Cost Plus, Time and Materials Contracts
How Much Should a Contractor Charge?
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