In trying to "cut to the quick" and get to the bottom line of a contractor’s true costs in performing a cost plus construction project, and in the interest of gaining a contractor’s early insight into the cost, planning, and execution of a construction project, owners often times request proposals from select contractors based on a percentage fee and general conditions costs of a cost plus contract. There are two important factors that must be recognized and considered in evaluating such proposals. One such item is that contractors often regard certain billing items as profit centers within the budget of the project. The other is the definition of terms for general conditions, fee, and the work that determine the cost of the project can vary significantly from one contractor to another. Only when project owners evaluate the contractors on a level playing field can the contractors be evaluated equally on a financial basis, so that the other factors such as working relationships, past experience, and reputations are not over or under stated in the final analysis.
On the surface, the fact that an item is billed to an owner on a cost plus project at a rate which may or may not reflect the actual cost of the item is hard to defend, however the issue stems from common accounting methods which recognize the fact that costs vary. Legitimately, equipment depreciates un-uniformly, life cycle estimates vary, and projected costs are not always accurate. It also may or may not be a given to a contractor that an item’s costs are not represented by the billable rates. This is not necessarily un-ethical behavior on behalf of the contractor, as the value of their commodities, such as the expertise and resources of a contractor, are subject to market conditions as are any other such commodity. Only if these items are realized and evaluated can an accurate comparison between the contractors be made.
The single largest cost for management of a project is always the management’s labor costs for on site personnel such as the superintendents, project manager, engineers, and related staff. Any differences between actual and billable rates for personnel are magnified due to the significance of the labor budget in the overall project. The labor costs are typically reimbursed based on a standard billing rate for the time period the personnel are working on the job. The standard billing rate can be the actual costs of the employee to the employer including salary, taxes, and insurance, but most likely also includes indirect costs such as vacation allocation, employers portion of group health insurance, 401k, retirement account contributions, profit sharing, bonuses and vehicle allowance, etc... Some true costs are difficult to determine exactly, and the company will use a formula to determine a percentage of salary costs to be added into the actual cost calculations. Usually the formulas will reflect the most conservative of financial forecasts for items such as insurance costs, which may be subject to rebates or reductions of premiums due to the actual experience modification factor versus the presumed factor. Profit sharing may or may not be realized, as well as vacation time and bonuses. Any of these items not expended represent additional fee realized by the contractor.
Equipment costs are another area that can represent a sizeable profit center for a contractor within a cost plus project. Contractors often times set up different operating entities to manage equipment operations, which used to have significant tax benefits associated with equipment purchases and the investment tax credit in the 1980’s tax codes. When the equipment is company owned, the company is generally free to set the equipment billing rates any number of ways. Several variables are inherent in establishing the billable rate of equipment including expected rate of return and estimated useful life of the equipment, while other contractors may simply use variations of standard "Blue Book" rates. Some may use different rates internally, versus the billing rates presented to the owners, which makes the equipment rental a profit center of the project versus a profit center for one of the companies broader operations. The effect of this is to encourage site personnel to utilize company owned equipment, and requires the owner to be more cognizant of the need for specific equipment through the construction process. The fact that company owned equipment is encouraged is not necessarily a detriment to the project. Often times, company rental rates are lower than outside rental companies, depending on the shape of the equipment, and may be more available in given markets. The final disposition of equipment is also a profit center for the contractor, where the contractor keeps control of the equipment, and any salvageable value of it, for themselves, even if the equipment has been fully paid for by the project
Actual insurance costs are also difficult to determine and represent a sizeable portion of the general conditions expenses. Broad coverage general liability insurance is often distributed to the project based on the total general liability/blanket coverage costs to the company. The portion of the coverage each project bears can be distributed by any number of calculations, including total project costs, duration, or other factors. Workers compensation insurance rates are based on the contractor’s experience modification factor, which varies depending on the number and severity of the accidents incurred by the contractors operations. With the renewed emphasis many contractors have placed on job site safety, many experience modification factors, and hence insurance premiums, are being driven downward, with the savings representing additional contractor profit. In cases where insurance premiums rise, contractors are usually quick enough to modify their billing rates to account for any increase in premiums. Also, if the contractor self performs work, such as concrete operations, and has a significant payroll, even minor labor rate adjustments for benefits, such as the employer’s health benefit package can be significant in terms of final contractor costs. The addition of $1.00 per man-hour for craftsmen health benefits may appear negligible to a $20.00 per hour craft wage; the issue could well be worth hundreds of thousands of dollars on a large project.
The definition of terms is also an important subject to address, as costs represented as a general condition cost by one contractor can, and often times are, represented as a budget allowance or subcontractor cost by another. General conditions costs are those costs which are incurred to manage and superintend the work as required by the rights and responsibilities clause of the construction contract, usually as set forth by Division 1 of the Specifications. By requesting fee and general conditions proposals, it is the owner’s intention to have the stated general conditions costs inclusive of all foreseeable general conditions items, notwithstanding those costs that are incurred in the normal execution of the work. For example, it is normal and customary for the mason to remove excess material and clean up the construction debris caused by their operations, and is usually required under the primary specification section included in their contract. Often times, a contractor will include a budget line item with the masonry subcontract amount for masonry cleanup, which would be used to clean up any material that the contractor was not able to manage to have subcontractor perform themselves. The effect of this is to overstate the actual masonry portion of the project, while understating a general condition, or management cost.
A contractor may require more of a subcontractor than that required by the prime specification section of their subcontract, therefor, also minimizing general conditions costs and overstating subcontract budget items. For example, a contractor may specifically require, through bidding instructions, scope of work narratives, or subcontract language, for the subcontractor to haul away trash from the job site or otherwise pay for dump charges for the contractor’s trash bin, whereas it is intended for these hauling costs to be included within the general conditions line items in the budget. The effect of these contractor requirements also minimizes the general conditions costs while increasing the other costs of the work. A multitude of similar items also need to be reviewed, particularly hoisting and material handling requirements, task lighting, composite clean up crews, etc... so that a clear definition of general conditions costs versus costs of the work can be established during the budget process.
Another area where definition of terms is important concerns project costs, including general conditions costs and the cost of the work versus non-project costs. Non-project costs are usually defined by the prime contract, and include the costs for the contractors operations that are intended to be reimbursed through the fee portion of the project. These non-reimbursed costs often include the general and administrative (G&A) costs of the contractors operations, such as accounting, executive personal, and home office expenses. There exists the potential for potential for confusion concerning some cost items, such as the costs to administrate the warranties, that require further definition as to whether these items are regarded as general conditions reimbursable costs, or non-reimbursable general costs. It is therefor important to establish the criteria for general conditions costs and those other costs which should be included in the cost of the work for all contractors, so that uniform comparisons can be made. More important than establishing the criteria, is the subsequent management follow through to ensure that budgets and subcontracts are in conformance to the criteria, and that owner billings are accurate.
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