Wednesday, October 25, 2006

Time & Materials vs. Fixed Price Contracts

Most of the home improvement contracts that I see are fixed price contracts. Homeowners ask for proposals and then choose a competitive bidder. Contractors must price jobs carefully. They should charge enough to cover costs and build in a percentage of profit, but they don't want to charge so much that they lose out on jobs. This forces contractors to build in a cushion for possible changes in prices of materials and/or labor. If contractors do not put a provision in the contract for increased prices, or make their proposals time-limited, they may put themselves in an unfortunate position where they barely break even.

It is understandable that fixed price contracts may not offer the cheapest possible alternative for homeowners or contractors. For that reason, there seems to be an increase in the use of time and materials contracts. The arrangement for these contracts is that the contractor gets paid on a weekly or biweekly basis either in advance, or as each phase is completed. There is an hourly rate for labor, and there can be a certain percentage added to the materials and labor for profit. At first glance, this type of contract can be advantageous for both parties. Homeowners are not paying for that extra "cushion" that contractors build into fixed price contracts, and contractors are ensured that they will make their fair profit.

However, this arrangment shifts the risk of pricing completely from the contractor to the homeowner. In this kind of contract, the homeowner is at the contractor's mercy, unless there are some kinds of checks and balances for the types of materials used and the actual time spent. In addition, the homeowner should make sure that there is a cap on the amount of the contract, or he or she could be giving the contractor a blank check.

Whereas fixed price contracts place the total risk for the profitability of the job on the contractor, a time and materials arrangement shifts the risk to the homeowner. Neither alternative is optimal. As with all contracts, the best arrangement is one in which there is as much detail addressed as possible. As long as the scope of the project is clear, the types of materials or allowances for items are spelled out, possible increases in prices are accounted for, and expectations are discussed, the parties can work out a contract that is fair for both sides.

Sunday, October 01, 2006

The Contractor Who Shoots Himself in the Foot

I recently met with a new contractor client who was in financial trouble. He reported that his jobs were not profitable, that he bent over backwards to please clients, and his prices were generally lower than other bids. This contractor seemed to do an excellent job for his clients, but he was not doing well for himself or his business.

Contracting is a business. Not all skilled craftsmen are business people and vice versa. As with any business, one has to recognize one's own strengths and weaknesses. Hiring a business manager, or taking a business class may greatly improve one's profitability.

A friend who is a contractor says that she takes her cost and adds ten percent. She knows the price of her labor and materials and ensures her profit. If changes are requested, she requires written change orders. I can't emphasize this enough. You have a right to make a profit, and you do not have to bend over backwards and satisfy every demand of the client. For example, I have a contractor client who brought the homeowner to the quarry to pick stones for a fireplace personally, and then when the stones were delivered she decided she didn't like them, and he paid to replace them himself! This is a big mistake. The homeowner will start to make more and more demands, and the job will turn into a loss.

The key to profitability is to start with a good contract where there has been a true "meeting of the minds." If the contractor's policies are spelled out in advance, and allowances are clearly laid out, then both parties will know when an item falls under the category of a change order. The homeowner will not be surprised by unexpected bills, and the contractor will make a fair profit.

It is not necessarily the lowest bid that will get the contractor the job. Homeowners are looking for reliability, personability and good references and skills. In fact, they may be more impressed if you charge more because they may believe you are a higher level professional.

So, take a look at your business practices and see if you are truly profiting from your jobs. If not, it may be worthwhile to consult with someone to revamp your proposals and contracts.

Mediating Construction Disputes

Construction contracts frequently have mediation clauses, but few people understand what these mean, and whether they are useful. Mediation has a number of definitions, including assisted negotiation, but its most important features include a third-party neutral whose job it is to help parties identify the issues, generate options, and develop an agreement that comes from the parties themselves. Mediation is usually voluntary, and there is frequently an agreement signed stating that it is a confidential process.

The advantages of mediation are numerous. When parties are in the midst of a dispute, the communication between them has often broken down. There is a great deal of emotion, and people need to vent. When people are involved in a dispute, and are angry, it is very hard for them to think rationally. Mediation is an opportunity to turn back the clock, and gives each side the chance to really listen to and hear the other's version of the story.

Feeling listened to and understood often helps to diffuse the emotional part of a dispute, and both sides become more able to consider what their true concerns are and they can start working on addressing them. Once the key issues are identified, through brainstorming the parties can frequently come up with a mutually acceptable resolution to the problem.

As a mediator, I have seen the mediation process work over and over when parties come in believing that they will never resolve their dispute. There really is a magical aspect to the process. Even if the parties do not settle at the time, the information provided often helps to resolve the disagreement down the road.

Parties should not become involved in mediation if they are firmly entrenched in their positions, because it can add additional expense to the dispute resolution process. People have to try to approach the process with an open mind. If it is viewed as mandated by the contract and therefore a waste of time, then the parties really will be wasting their money.

I am a firm believer in mediation, because mediated settlements are usually complied with much more than judgments. Parties buy into the process and become invested in their agreements because they have a hand in drafting them. Rather than submitting to the rulings of a judge or jury, the mediated resolution to a dispute frequently repairs the relationship and provides a more secure footing for completing the project.