There's a debate currently raging surrounding the relative merits of time and materials billing vs. fixed-price contracts.
In most respects, I think it's no contest: Fixed pricing wins hands down for lots of reasons. It holds the potential for higher margins. It provides a strong incentive to clients and remodelers alike to buy right. And it keeps clients' prying eyes away from parts of the business, like markup, that they wouldn't understand anyway.
There's a dark side to fixed-price contracts, however, and it has to do with what is perceived to be another advantage: Fixed-price contracts are easy to administrate.
What turns this advantage into a liability? Most remodelers working with fixed-price contracts pay attention to costs just long enough to price and sell the job. After that, they can apply for scheduled draws or so-called progress payments without ever taking another look at how the actual costs of construction squares with their estimate.
Paid as You Go Unfortunately, profit depends not just on what you sell the job for but on how much you spend to produce it. T&M contracts won't solve this problem — they're too open-ended — but cost-plus contracts just might. They may be time-consuming to administrate, but so is job costing. That's why most remodelers either don't do it or wait until long after the job is over to find out whether or not they made any money.
At the very least, a cost-plus contract forces you to look at actual costs, invoice by invoice, while the job is still under way. Every time you submit a statement for a payment, you have an opportunity to compare actual progress with both your budget and your schedule.
Real Time Another common complaint about cost-plus contracts is that they turn homeowners into clock-watchers. I say a little homeowner obsession over labor costs is a good thing if it gets remodelers to obsess a little bit, too —not just about every 15-minute coffee break that runs to a half-hour but over all the supervision time and set-up and clean-up time that isn't in the estimate.
Most estimators focus on labor required to get specific tasks done, and they assume that eight hours on the jobsite for a field crew are eight productive hours. Supervision is typically included as part of overhead. With no job costing, you may never discover how misguided these assumptions are, and waiting to job cost until the job is over is just too late. Cost-plus billing requires detailed time sheets and gives you an opportunity to correct productivity issues in time to save your profit.
In fact, in a cost-plus contract, supervision, set-up and clean-up time, and other non-productive labor are direct costs to the job. You'll only forget to include them once — after that they become line items in every estimate.
And when you review time sheets while preparing the progress billing, you can verify that your estimate for supervisory time was accurate.
Best Incentives It is also sometimes argued that T&M contracts provide no incentive. Unlike T&M, however, a cost-plus contract typically includes a guaranteed maximum cost that fluctuates with change orders, just like a fixed-price contract.
So if there's a cap on the cost, why not just use a fixed price? Because the cost-plus incentive is this: If you don't do the job costing, you don't get paid.
As a side benefit, cash flow progress payments cover actual expenses plus proportional overhead and profit, vs. a fixed-price draw schedule based on front-loading or an arbitrary percentage of the contract price, like 30-30-30-10.
I'm not really suggesting that everybody reading this convert from fixed-price to cost-plus. But if it were the only way to motivate you to job cost, then it's not such a farfetched idea.
The right to fixed pricing has to be earned by making job costing habitual and understanding what your real costs are.