When starting a construction project, contractors review many factors to meet the desired profitability. But to make sure the numbers add up at the end of the day, it all begins with proper bidding.

In construction, everything is bid or estimated out. Pricing strategy is based on the cost of materials, labor and margin. If contractors bid aggressively, then margins end up thinner. Room for error is minimal, and bidding is competitive regardless of the market.

Consider an example of a project bid at $1.5 million. That $1.5 million is probably going to cost $600,000-$800,000 in materials and labor, which is calculated by totaling person hours, contractors, materials, permits and all direct costs. Then, the appropriate amount margin is added to cover the overhead, insurance, salary, staff, supervision, etc.

Job costs come down to how the actual hours of the subcontractors and the materials are accurately executed against the original estimate. So, if the bid was accurate and is executed accordingly, it should generate the gross margin and profit anticipated as well.

Profit margin can be lost, however, due to unknown factors. For example, a project is estimated to take 90 days to complete. By mapping out the project for 90 days, the production crews and subcontractors should be one-third completed with the project after 30 days. In addition, nearly one-third of the hourly labor budget or subcontractor’s budget will have been spent at this juncture. If, by the 60-day mark, 90% of the budget has already been spent on hours, and contractors and are only 60% complete, they are over budget. This is either caused by incorrect bidding or mismanagement.

In order to fix an issue like this, the project must first be bid correctly, then mapped out to achieve that bid.

Kyle Ballew, partner at Live Forward Ventures, says that the best way to stay on budget and obtain correct bids on projects comes down to the details.
“The more detail you have upfront, we have found, the less cost overruns and delays to the schedule. That also affects profitability, and we have fewer surprises with the detail up front and the bidding process we use,” he says.

When it comes to staying on budget, having a plan for the project from beginning to end—and being able to execute that vision on a financially accurate level—starts before the project begins.

“It starts way before the bidding process,” Ballew says. “When we are in the design phase, we have profitability and labor costs in mind from day one. By the time we get to our bidding process we have a ‘ballpark’ of what we’re going to see back because of the cost per square foot, as well as the type of materials we are using, and we try to seek that out before we finish our design so we aren’t on the backend trying to get numbers down.”

The communication and the details are the most important part that I’ve experienced in development,” Ballew says. “There are all sorts of general contractors and bidding processes out there, but you can never provide enough detail.”

Contingencies

Most contractors will put contingencies into a bid, and it will impact the price of the project. That’s always the needle to thread. How much in the way of contingencies should be added into a project to safeguard the future? Those contingencies will protect against profitability, but can also keep contractors from winning the project at all. So how can the best of both worlds be achieved?

The best way to bid a project is to bid the actual hours, the actual materials, the actual contractors, the actual equipment costs and margin to make a respectable profit, which is where the planning takes effect—because the project is already built on paper.

Contingencies are put into bidding contracts because, inevitably, things happen on a project. For example, contract language was missed or overlooked in the initial bid, economic conditions changed, or inclement weather occurred. By placing contingencies, contractors are prepared for these situations, but execution is critical to stay on budget and meet the margins of the project.

Regardless of a contractor’s confidence in a bid, contingencies should be added to provide a larger margin and allow for potential risk.

Fixed Price

Most construction projects are set at a fixed price; contractors bid labor and materials with a margin to arrive at that fixed price. It’s up to the contractor to ensure costs are correct and that they execute correctly so they can make a profit.

A fixed price can be risky for contractors. For example; if a contractor is bidding on a $1 million project and they want to walk away with a 25% gross margin, they will have spent 75% in costs of materials and labor and will leave with $250,000 in gross margin to cover operating overhead, insurances, project management salaries, vehicles, etc.

The risk for contractors is that, instead of picking up the expected margin, their 25% investment only comes in at 20%.

The key to get the maximum, bottom-line profitability on a construction project is to make sure the bid is done correctly and accurately. Creating the plan on paper and mapping out the project before the ground is even broken has the largest effect on the profitability of any project. Once these items are finished accurately, then execution is all that matters.