THIS ARTICLE FIRST APPEARED IN THE JULY/AUGUST 2018 EDITION of INPROCUREMENT MAGAZINE.
In previous articles, we discussed the difference between a contractor’s overhead and profit. We also acknowledged the pressure construction firms are under and reflected on how many of the largest firms are realizing narrow profits or even failing.
With that in mind, I wanted to discuss how self-performing contractors realize value for themselves and how Owners can also benefit.
When I use the phrase “self-performance” I am referring to General Contractors(GC) who use their own employees to perform trade work.
It’s well known that general contractors have direct control over fee and general conditions. We also know that most of the monies paid to general contractors are a form of reimbursement that flows through the general contractor down to trade contractors.
Some general contractors have the ability to operate both as a general contractor and as trade contractors. These companies have the ability to perform specific trade work without contracting other companies.
Perhaps your initial reaction to this kind of arrangement is negative. You may consider it a conflict of interest, or perhaps you worry this kind of arrangement could create a revenue stream outside of your control.
The truth is that self-performance does create additional revenue streams for the general contractor and you do need to address this, but the benefit to both the contractor and the owner can be quite good.
Trade contractor revenue
To understand this better, let’s consider the way a trade contractor makes money.
Trade contractors have the same overhead expenses as any other contractor. They have costs associated with offices and home office staff that must be recovered. They also need to pay for salaries of the workmen in the field. Trade contractors also have expenses associated with materials and equipment. Of course, all of those expense are all subject to profit.
This all holds true whether your GC is self-performing or not. These costs are included in every trade contract.
When an Owner pays an invoice, he is in fact paying for compounding profit. This means the GC adds profit to the costs of his trade contracts. Trade contracts already include the profits of the trade contractors, so you are therefore paying for profit on top of profit.
This can be a gut-wrenching realization, especially if we were to look more deeply at how overhead and profit is added by suppliers, distributors, and manufacturers of the products used on your project. The fact is that everyone in the construction supply chain is entitled to making profit and recover overhead expenses for their business. We just have to pay it!
Let’s consider an example of a general contractor building an addition where he plans to self-perform carpentry work.
A typical carpenter may add 15% profit to his expenses. The GC might also add 10% profit to all the trade work. If the cost of the carpenter’s materials and labor were £10,000, and he adds 15% profit, that would add £1,500, making the cost quoted to the GC £11,500. The GC would then add his 10% or an additional £1,150. This means the GC would present the Owner with an invoice of £12,650.
In this example, the total profits paid by the Owner add up to £2,650 or 26.5% of the cost of the carpenter’s materials and labor.
If we know the GC plans to self-perform the carpentry work himself and we openly discuss this with him, we may be able to negotiate his margins and perhaps improve the percentage of profit added at each stage.
Let’s say that we are able to negotiate with the contractor to reduce the profit for the carpentry work from 15% to 10% and for work he self-performs, we agree that as general contractor he will only add 5% instead of 10%.
This simple negotiation reduces the amount paid by the Owner from £12,650 to £11,550.
For the GC, self-performing the work increases his profit from £1,150 to £1,550 a 35% increase, but for the owner his price is reduced 8.6%.
This is an example of how a smart GC can secure additional profit for his company and a savvy Owner can save big money.
I should also note that in addition to cost savings, there are potential schedule and operational benefits when a GC self-performs trade work. The scope of this discussion is really about cost, so I won’t go any further on that.
So, I hope this simple example has demonstrated the potential benefit both parties can realize from awarding work to a self-performing GC. The numbers I used in my example, are quite small, but imagine how much more value can be realized when project costs are much higher.
The only way to know when a GC plans to self-perform work is to ask the question. Have an open discussion and demonstrate to the GC that you understand and respect his need to earn a fair rate and he just may be open to discussing his margins with you.
Be sure to do this before you make an award decision. After you award the work, your leverage and ability to negotiate will be gone, but if you do this right, you both will win.
What about you? Have you worked with a self-performing GC? Did you negotiate his margins? What benefits did you realize? Tell me your stories.
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