Contractor pricing is a tough topic to cover. There is the cost of goods and labor
provided and there is the consumer budget which is not an infinite number. Customers
do not see it as their job to ensure that companies make a profit, that is your job – so
how do you make profits happen, and do you start the process with the cost of goods
and services or the homeowner’s budgets? Let’s explore.
Most American and European companies set their prices by adding up costs and then
putting a profit margin on top. And then, as soon as they have introduced the product or
service, they have to start cutting the price, have to redesign the product at enormous
expense, have to take losses—and, often, have to drop a perfectly good product or
service because it is priced incorrectly. Their argument? “We have to recover our costs
and make a profit.” But the only sound way to price is to start out with what the market is
willing to pay and design to that price specification. To start out with price and then
whittle down costs is certainly more work initially. But in the end, it is much less work
than to start out wrong and then spend loss-making years bringing costs into line.”
from The Daily Drucker: 366 Days of Insight and Motivation for Getting the Right Things
Done by Peter F. Drucker
I read this the other day, emphasis added, and it struck a chord, the concept is speaking
to manufacturing, but it can be rethought in terms of contractor pricing as well.
Most construction projects start out Design- then – Estimate; logical since how can
something be priced if there is no design to price? However, there is ALWAYS a
budget. There is a number at which the project will not go forward and clients typically
hold this number close to their chest so they do not “get ripped off”.
Obviously, the contractor pricing out the project and making a profit is not the objective
of the client – they just want the project to be built. Human nature tells us that if we
share the budget then the project will somehow reach or exceed that number, so it is
not honestly shared.
Let’s re-think the contractor pricing dilemma from Peter Drucker’s point of view; does it
not make more sense to start with a budget and then design to that number?
The question before delivering contractor pricing is “What are you willing to invest on
this project? There is a number the client has in mind. If a contractor told the client a
new kitchen would cost $500,000 the client would have a reaction; if the client told the
contractor they have $5,000 and wanted a new kitchen, the contractor would have a
reaction. There is a price, there always is, it is a matter of priorities.
Consumers need to be honest with themselves and with the contractor. The client
needs to understand how much they can spend – a “not to exceed” number. Period. No
contingencies. That is the number that should be shared with the contractor so he can
prepare the contractor pricing needed for the consumer to sign the agreement.
If you are the homeowner reading this article – you may need to invest in hiring
an Owner’s Representative who can provide unbiased advice on the scope of work,
schedule, pricing, and other administrative matters. For smaller projects find a
contractor you are willing to work with and insist on paying them for budgeting during
design, most companies will charge under $500 if no permits or architectural drawings
are needed. Other companies will charge $3k – $10k to write up a complete scope of
work and prepare architectural plans which can be used for the city to approve before
you build. This expense can be offset with a clause crediting you for all or part if they
are selected as the contractor, it’s a win-win scenario.
Now that you (or your client) have settled on what the budget is, design to that budget.
Tip: One option is to ask that the design and construction budget be 10% below your
budget so you can have some money stashed away for contingencies….. but put the
budget number on the table.
Now design, then get the contractor’s pricing; if the project is over budget – do it again.
Design – then get the contractor’s pricing. Rinse and repeat until the design and budget
meet both the client’s and the contractor’s needs. If the homeowner intends to take the
scope of work and design – and put it out to bid with other contractors it is important that
both parties (homeowner and contractor) are aware of this.
If you are a contractor and need guidance on how to communicate budgeting and
pricing with your clients, let’s schedule a 1-2-1 coaching session. Give me a call today
to get on the schedule.
If you are a homeowner and need to hire an owner’s representative to make sure your
best interests are looked after, give me a call – I am happy to collaborate as your
construction manager for major home renovations as well as custom home building
projects. You can reach me at 203-826-8096 or click the “contact us” button at the top
of this page.