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.

2 Comments Add yours

  1. Dan Jewiss says:

    Hi Luis,

    Thank you for the info about “Where do contractors hide profit?” I am on the tail end of a major remodel and I’m using a builder as a general contractor. He was recommended by my sister and her friend after doing smaller remodel jobs for each of them. Overall, I’ve had minimal issues with the job, however in the middle of this pandemic it is over budget and has taken much longer. Some of that is due to my indecision on design choices.

    My main issue is with the most recent invoices. One includes a charge of $25,000+ for cabinets, even though an earlier invoice that I paid also had a similar charge for the same. The kitchen cabinets were also done completely near the beginning of this project, so it makes sense that they were covered completely by that earlier invoice. The $25,000 is also the price I expected them to cost (material only) since I went to the lumber yard and ordered them. The GC installed these himself, so I would expect that those labor charges would have been covered in his daily labor charges.

    Unfortunately, it’s a possible double charge like this that makes me question other charges. For instance, the GC did all the painting, however he has included a specific charge for “painting” which is clearly way more than the cost of the materials. Could this also be a double charge as you described in your post, since he already charges me for daily labor (which is him and another worker)?

    He is also charging me for “waste removal.” He has his own trailer that he uses for this, so other than any charges that the dump site may charge, is it reasonable that I don’t expect him to charge me for this?

    Thanks in advance for any assistance…


    1. Luis Gile says:

      Hi Dan…I’m sorry you are having trouble with your renovation project.

      It’s difficult for me to give you any kind of specific advice or direction without a deeper dive into all of your documentation. However, from what you have written, it seems you are on the right track.

      You should not simply pay every invoice that comes your way. Ask for details and clarification on what you are paying at each step of the way.

      Remember that the Contractor may have asked for payment up-front for the cost of cabinet (because his cabinet-maker would have required it in order to secure materials) and now he may be asking for the cost of the labor for installation. A cost of $50K for kitchen cabinets does not sound out-of-line (depending on how large the kitchen is, the cabinets you selected, etc.), but this cost should not be news to you.

      You should have had a quote at the beginning that told you what each portion of the project would cost. Go back to that and compare it to the invoices you are receiving, if the numbers don’t match, question it and ask for back-up documentation. You are entitled to a detailed explanation for any numbers that are different than what was quoted, so don’t be shy about that.

      As for the cost of waste removal, you are obliged to pay for the cost of labor for collecting the waste and the cost of carting the waste away. If the GC is using his own trailer and not paying for a dumpster, you should be able to contest those costs, but don’t expect use of his trailer to be free. It should be less than the cost of a dumpster, but not zero.

      You also referred to the pricing you received as a “budget” not a “quote”. This tells me that you did not have a firm fixed price. Approaching a project with a “budget” and not a “quote” is a double edged sword. On the one hand, the contractor is not held to a specific cost, but on the other, he should justify any costs that exceed the budget. You are not in the best position with a budget, but you are not without options.

      My advice is to sit down with your GC and ask him to walk you through the costs as they are today and to help you understand where the project budget is heading. Do this in a non-confrontational way. Do not assume he is being deceitful. Assume the best intentions and take responsibility for the fact that you failed to secure a firm fixed price.

      Don’t be afraid to ask him if there are any line items in the budget where he can improve costs without compromising quality or scope. Call out items like using his trailer for carting waste as an example of ways where he should be able to reduce your costs.

      All of this needs to be contemplated in the context of Today’s market. The cost of wood has normalized, but it was at an all-time high (you might have bought your cabinets at the height of the market). Labor shortages are everywhere and just about all materials and equipment are at a premium. Keep this in mind as you sit down to review your budget and be aware of what the market conditions were when your budget was first developed.

      I wish you luck with your project and please do report back on how this gets resolved.

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