Successful contractors understand their costs before they bid. They understand the factors that drive cost and how to manage them. They understand how to identify and mitigate risk, when and how to apply contingencies, and what they will make at each stage of the job.
To Bid or Not to Bid? That Is the Question!
One of the keys to making money in this business is learning which opportunities to avoid and having the discipline to say “no!” Too often, contractors are tempted to chase every opportunity that comes their way. Winning a project that is a poor fit for your company is not a win at all. It generally results in cost overrun, crew and management frustration, and ultimately, lower customer satisfaction. A formal bid screening process can help you avoid those results. A “bid screen” is a flow chart showing bidding activities and decision points. Your bid screen should reflect your company’s business strategy, including specific criteria related to target customers and projects. It should be periodically reviewed and updated based on lessons learned. When designed and used effectively, the bid screen allows you to quickly weed out the “dogs” and focus your resources on opportunities that best fit your company’s strengths and direction. Before submitting that next bid, take the time to do your homework. It can go a long way towards avoiding major headaches in the future.
Developing the Bid
You don’t have to be Albert Einstein to understand the science behind effective bidding. Recognizing and managing the key drivers of cost, and having a healthy dose of common sense, is typically sufficient. Start by developing a clear understanding of your organization’s labor and overhead cost structure and cost behavior:
Labor Cost – This is fairly straightforward. Develop average hourly labor rates for each category of labor employed. These labor rates should include not only the base wage, but fringe benefits and payroll-related taxes and insurance. Be sure to factor in the impact of non-productive time (breaks, delay time, transportation time, etc.).
Overhead Cost – Many contractors struggle determining the appropriate treatment of overhead costs. Different activities require the use of resources (people and equipment) that carry different overhead costs. For example, activities requiring the use of heavy equipment versus strictly labor obviously consume different amounts of overhead. If your company utilizes heavy/expensive equipment, develop average hourly rates for these resources (perhaps by major category), similar to the development of labor rates. Hourly rates for equipment should include not only the initial capital investment (or replacement cost) spread over the useful life of the asset, but the cost of maintenance, fuel/supplies, insurance, etc. Again, be sure to factor in the impact of nonproductive time.
Some elements of overhead, such as supervision, office space, accounting, and general management, will need to be allocated to labor, equipment, and other categories. Apply some common sense here. Think about how each major element of general overhead is consumed. For example, the number of subcontractors and the specific characteristics of each can drive significant management oversight. Therefore, a reasonable allocation for management oversight should be added to each subcontractor quote.
Common Cost Drivers – Effective bidding requires the contactor to recognize the key drivers of cost. In addition to labor hours and equipment hours, key cost drivers include:
- Number and Characteristics of Subcontractors – As discussed earlier, subcontractors must be managed. Given that some subcontractors are less reliable than others in terms of timeliness, dependability, and quality of work, the level of management time required to manage risk and ensure customer satisfaction can vary significantly from one contractor to the next and from one project to the next.
- Change Orders – Most contractors underestimate the true cost of performing change orders. Change orders often result in a ripple effect of replanning and rescheduling, as well as a loss of efficiency on the job site.
- Non-Standard Items – Use of nonstandard materials or items can result in a significant increase in labor and management time, as well as material waste, than when using standard items.
- Project Timeline – Compressed timelines that don’t allow for sufficient contingencies to cover weather delays, problems with material deliveries, crew/subcontractor scheduling conflicts, etc. can result in significant overtime, expediting charges and/or late penalties.
- Site Challenges – The specifics of the site (terrain, accessibility, other structures, drainage, soil type, etc.) can impact the efficiency with which crews can get in and out and complete their work.
- Customer Characteristics – Let’s face it, some customers are much more challenging to do business with than others. Some may require significant hand-holding, are particularly fussy, and/or may be slow paying. Know your customer and whether or not they fit your profile of a target customer. If they don’t, you are typically better off walking away. If they do, factor the level of customer service required into your bid.
- Economic Factors – The basic rules of supply and demand must be considered. Though a booming local economy typically means a quality contractor can charge a premium for their services, it also means that the supply of subcontract labor and other resources is likely to be tight. If so, hiring and retaining competent resources may prove to be more difficult.
The presence of these common cost drivers requires the contractor to increase contingencies to be sure they are not left holding the bag! Track these drivers for each job so that over time you build a database of proprietary intelligence regarding their impact that can be applied to future bids.
Once all the key cost drivers have been accounted for and an initial bid has been developed, some creativity can go a long way toward improving your chances of winning a desirable job. Work with your crew, subcontractors, and customer to manage these cost drivers. Sometimes slight changes to timelines, materials, layout, etc., can result in significant cost savings. Without identifying and managing key drivers, contractors are flying blind and leaving to chance whether or not they make money on a particular job. Remember, if you lose $75,000 on a bid, you will need to sell $500,000 of new work to earn that write-off back (assuming a 15 percent gross margin).
Although you don’t need to be Einstein to understand the science of bidding, it doesn’t hurt to be part accountant, part psychologist, part economist, and even part meteorologist!