Where do contractors hide profit?

Although the title of this article suggests that all contractors are out to hide profits, I want to make sure reader’s don’t come away with that impression because it’s simply not true.

Running a construction company is a tough business.  Contractors like any other business are entitled to make profit.  Unfortunately, there are instances where contractors “double dip” (charges profit on top of profit) or deliberately hide profit.

In some cases these infractions, are the result of common but incorrect business practices.  Other times it may be intentional.

Either way, my goal for this article is to identify some of the potential pitfalls and call your attention to the places where this is most likely to occur.

Number One:  General Conditions

The General Conditions of Construction is one of the most common places for double dips to happen.  This is also the place where additional charges are improperly applied on construction change orders.

The key to avoiding overpayment is to make sure that you completely understand and have defined what general conditions include.  This MUST be done up front before you even request a quote.

You need to tell the contractor what costs you expect the general conditions include.  This will ensure that when you receive your quotations (hopefully you have solicited at least 4), each of the bidders have quoted their price the same way.

Number Two:  Self Performed Work

Self performed work refers to any trade work that the General Contractor performs with his own workforce (as opposed to sub-contracting the work to another company).

In residential construction many of the companies that operate as general contractors began their businesses as trade contractors.  For savvy Homeowners, this is good because it is a sign that the GC is very capable and if you understand this, it could also be an opportunity for cost savings.

Unfortunately, most Homeowners don’t know to ask and actually end up paying profit to the general contractor twice for the portions of work they self-perform.  Don’t be afraid to ask which portions of the work the GC will self-perform and make sure to ask what the profit margins are for both the GC portion of the work and the trade work.  Keep in mind that each trade contract should include profit for their respective trades and if the GC is subcontracting the trade work, the GC profit will apply as well.

If your GC is self performing a portion of the trade work, then you should be able to either negotiate a lower GC profit margin or no GC profit for the work he is self performing.

Number Three:  Rental Equipment

Construction Equipment such as bulldozers, backhoes, cranes, lifts, and dump-trucks are commonly used on construction projects.  Most of the time, trade contractors provide their own equipment and include the costs of the equipment in their price.  Other times, the GC provides the equipment.

If the GC provides equipment, he may rent equipment from an equipment rental company or provide his own.  If the GC provides his own equipment, he may apply a fee for use of the equipment.  Invariably, these costs are passed along to the Owner as equipment rental costs.

Costs for GC owned equipment should be treated the same as self performed work.  Don’t be afraid to ask who will be providing equipment for your project.  If the GC will be providing some of his own equipment, ask him to quote you his rates and make sure you understand how he will be applying profit to those rates.

Number 4:  Change Orders

It may seem pretty obvious that change orders are a great place for profits to be hidden, but you may not know how profit is hidden in change orders and how to avoid overpaying.

The most common way that GC’s overcharge on change orders, is to add general condition costs to every change order.  If you have properly defined what is included in the general conditions costs, then you should be able to discern when a change order should include general condition costs and when it should not.

To ensure that you are not overpaying for change orders, make sure you negotiate change order rates as part of your overall price negotiations.  Ask for change order rates as a percentage mark-up.  These rate can be applied to change orders by multiplying the cost of work on the change by the percentage markup to establish the GC’s profit.

Also, if you know in advance that a certain portion of the scope is subject to change,  the best way to avoid overpaying for a change is to solicit alternate pricing.  Alternate pricing can be used to price alternative solutions for almost any part of the scope of work.  By soliciting this cost up front during the bid you are ensuring that you have competitive pricing for this alternative scope.

The various cost elements that make up the cost of a construction project can be very complex.  There are multiple layers of contractors and lots of moving parts to track.  Being clear and deliberate about every cost element is the best way to ensure that you are getting a fair price.  Be fair to your General Contractor.  He should not be expected to eat costs or perform work you are not willing to pay for.  Keep in mind that he is running a business and he is entitled to earn a fair profit on everything he does.  Conversely, you are entitled to know and to negotiate just how much of a profit you are willing to pay.  Address all of these issues early on and you will have a much more successful project.

Are you struggling with your negotiations?  Do you think you have overpaid on a portion of work?  Tell me about your project.

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