79. Fixed Price Vs Cost Plus With Russ, Sky & Andy

If the client only has a budget of 500k, I don't care what sort of contract you've got. When you go over 500k, that guy stops paying, he's got no money. And guess what? You've committed to the supplier or the subcontractor. Your name is attached to that cost.

Clients get so hyper focused on your margin, but if you have a contract that just has one price and includes everything, that's a lot simpler. And here's the payment schedule Cost Plus.

Contracts they do tend to be favored by builders starting out because, you know, generally they're a bit nervous.

The truth is the only way that they can remove the risk. You as the builder do everything in your power to make that contract land within that target budget, which is a very complicated way of running a fixed price contract.

This is Professional Builder Secrets, the number one podcast to help you grow your building company safely and securely, brought to you by the association of Professional Builders. Join us every week as we talk to industry experts and your fellow professional builders on everything you need to know to generate more leads, more sales and higher margins while improving the building experience for your clients. Hello and welcome to the Professional Builder Secrets podcast, a podcast by the association of Professional Builders for building company owners, general managers, VPs and emerging leaders. Here we discuss all things running a professional building company from sales processes, financials, operations and marketing. Joining us today are Sky Stevens, Co Founder for the association of Professional Builders. Always great to have you join us. Sky.

Hey Bosco, how are you?

I'm doing well. Russ Stevens, Co Founder for the association of Professional Builders as well. Welcome Russ.

Hey Bosco, you're looking good today.

Thank you sir. And Andy Scarta, Head Coach for the association of Professional Builders, look forward to hearing you share your insights today with us and your analogies. Andy.

I'll do my best as usual.

Well, I'm really excited to talk about today's topic around fixed price and Cost plus with these two types of building contracts. Fixed Price versus Cost plus what's the difference?

A fixed price contract is exactly what it sounds like. It's a building contract that covers a set of plans and specifications that will be delivered within a fixed timeline for a pre agreed price and any changes to the design or the specifications. They will have to be agreed in writing by both the builder and the client and will be documented in a contract variation or a change order depending on where in the world you are now. A Cost plus contract. That's an agreement where the builder will simply add a margin to the invoices they incur for the labor and materials, which they then charge to the client. Now, most of the time, the builder will include their fixed costs, or at least a charge for supervision in those costs as well that they then mark up. But this is where things can get a little murky on a cost plus contract. And those cost plus contracts, they do tend to be favored by builders starting out because generally they're a bit nervous. And then as they become more experienced and confident, they tend to progress into the fixed price contracts.

Now, are we leaning towards one or the other? Which one is better?

Let's get this out the way. At abb, we only recommend our builders use fixed price building contracts. And the reason for that, if we talk about the pros, and I'm sure we can get into the cons of both a little bit later, but if we talk about the pros, especially with fixed price building contracts, you as a builder are selling on value, not price. You get to package up everything that you're going to do and deliver under one cost. Whereas if you look at cost plus, you're constantly focused on price because it's like, well, here's the cost, here's my margin and my markup that I'm adding on and here's what you pay. And so clients get so hyper focused on your margin, the margin you're making, every little markup you're adding on doesn't matter what the original cost was. It's like they feel hard done by, or it can be perceived that they're getting hard done by because you're making all this money and you're just trying to do the job. So it always leads to a conversation about price, about money. You're trying to get your margins squeezed. And ultimately with fixed price building contracts, you can achieve much higher margins. Not only that though, you can actually be as a building company, a lot more productive and much more efficient. Because when you use a fixed price contract, when you're doing that and you're producing that, you're producing a job schedule and a timeline as well. Because if you are presenting a fixed price to the clients, you're going to do a hell of a lot better in pricing, estimating, and even scheduling that project before it starts. Because you want to make that margin, you don't want any mistake to bleed into the money that you're getting. So you're going to be a lot more on top of it. And ultimately, because your schedules are a lot tighter, your estimating is a lot tighter. You are a lot more efficient as A company.

And I think to back up what sky is saying there as well, coconstruct actually did an analysis on their data where they compared fixed price versus Cost plus and they found that the fixed price projects had a 28% higher average margin than the cost plus. So I think that really says it all.

Is it a case by case basis or is there a preferred type of building contract for builders of a certain size?

No, I think as sky has touched on already, we certainly don't, you know, suggest that people vacillate between the two. We'll probably get into the pros and cons of both in a second. I don't really want to get into that here, but the truth is we are doubt that you're going to get certainly Ruska and myself to ever say to you that a Cost plus contract generally is going to deliver better results. On paper. It sounds like it should. Well, I think it sounds kind of.

Yeah, you know what I mean? I think it sounds easier.

It sounds like the client is taking all the risk. But as I'm sure we'll get into in terms of this discussion, what happens in the real world in the way that they get executed turns them into. I think the nicest way to put this is turns them into a nightmare in most cases. We've heard very, very few real reports from builders that Cost plus has actually.

Worked for them with leaving like raving clients, like raving fans. As I think the projects go longer, the clients are just paying more and more and more. And it's one of those relationships where it's like, thank God that's over, you know, like, we're done.

Yeah, let's dig a little deeper with the cons here. What is the downside to using a fixed price contract? And also, what is the downside using a Cost Plus?

Well, in terms of a fixed price, I think the risks have really been highlighted by the construction boom over the last two years and in particular the construction inflation, because when costs go up, then the builder loses. I mean, they can mitigate the risk by inserting a cost escalation clause or a rise and fall clause into the contract. And in the US 66% of builders do exactly that. But in Australia, for instance, only a third of builders are currently inserting that clause to protect themselves. And there's probably good reason why the numbers are a lot lower in places like Victoria. They're actually illegal for contracts under 500,000, regardless of what you put in the contract. So, yeah, that does prevent builders from covering their downside. And the big risk is if costs go up or if you, if you miss something in a fixed price contract, then you're potentially exposed and, you know, up for losing potentially a lot of money. Now, the risk regarding Cost Plus, I think the perception there is that they've covered off all the risk and this is probably why they are favored by new builders. But the reality, as Andy just alluded to, is a little different because these builders have still got to get these costs paid. Now, the client might be contractually bound, but that doesn't negate the arguments that take place. And Andy, I think he's probably in a better position than all of us to talk about that firsthand as to what he's seen happen. And it can and does lead to a poor experience, you know, for the client as well.

The thing that you've got to understand with these things is that with both, whether we talk fixed price or Cost plus, whether the client admits it or not, the client has a budget. Even Warren Buffett has a budget for his building project. So the reality is Cost plus sounds like it's unlimited at the top end, that whatever it costs is what the client can pay. And the problem for the builder is if the client only has a budget of 500k, I don't care what sort of contract you've got. When you go over 500k, that guy stops paying, he's got no money. And guess what, you've committed to the supplier or the subcontractor, your name is attached to that cost. It's just kind of making sure that people understand we can name these things any way we like. Clients have a fixed ceiling over which they will not or cannot go, irrespective of what type of contract you give them.

And you raised a really good point as well, because I think certainly our experience, hearing the amount of builders that have come to us that, you know, have started using Cost plus contracts, it's not a huge mark markup that they're adding. So the margins that they're adding are a lot smaller because the clients can see it. And I think there's this misconception like, oh, I don't need much, like that's all the materials paid for. This is just a margin and, and it's all good. I've already got a project management fee in there, so, like, my time's covered. It just doesn't work like that because you got to think, what's your net profitability for your whole building company? Because you've got more expenses, you know, you've Got staff, you've got offices. Even if you don't have offices, even if you don't have a whole bunch of staff, you have company expenses, you've your website, you've got different marketing materials and that all adds up. And unless you're super conscious of it, you're just paying for that at the end out of the tiny little bit of margin that you did put on that project. Whereas if you focus on fixed price building contracts and you combine it with our pricing for profit methodology, you're actually including all of that in that one price. So everything is included in that one price and clients get overwhelmed. Building a home in general is very overwhelming for so many clients. You got so many decisions to make. But if have a contract that just has one price and includes everything, that's a lot simpler. And here's the payment schedule, it's not here's new bids, here's the markup, here's like what you need to pay. Please, please, please, please, please. All the way throughout.

I had a question in regards to the clauses, you know, you mentioned that you could potentially have a clause in. And in Australia, not many builders are actually putting this to paper. Should builders talk to a legal representative who specializes in this particular field when building these contracts out?

Definitely. I think contracts general a bit of a maze. And yeah, when we speak to construction lawyers, you know, in their experience, most builders have never read their own contracts and sometimes they've even pieced them together from different stuff they've downloaded from the Internet to bring a contract together when and that just quite simply it doesn't work. And it's why a lot of builders end up falling foul of their very own contract. So 100% I would definitely. When it comes to this stuff, as much as I hate giving lawyers money, I think this is a good investment. You know, fix it once, get your contracts fixed up and get that clause professionally written because you don't want anyone being able to bypass it.

There is a preconception certainly in the Australian market that some of the building association contracts cannot be changed. So there's this misconception in builders minds that if I'm a master builder and I use a master builder's contract, I can't change a single word or clause in that contract. Ditto, HIA, etc. Etc. That is absolute horsemania. Every contract is negotiable and changeable between the parties and exactly as Russ said, in a lot of cases, all that it's going to need is to have some of those clauses adjusted and Maybe a clause or two added and now you've got a contract that you can use for the next 10 years, so it's well worth that investment.

But then you know exactly what's in your contract and you can communicate that clearly to your clients. You can over communicate it. Everyone feels fine about it. It's not this sneaky little clause that you're putting in the background. It's communicated. You're explaining, well, the benefit is this, and here's why we do it. It's. You get to explain it to both parties very, very clearly.

Yeah, yeah. With these cost escalation clauses there, there can be a bit of resistance by consumers because they have the perception, well, if I, I agree to that, then the builder can literally gives them the right to charge me whatever they want. Well, no, they still have to justify that it is a legitimate material increase in the cost of materials. But the way I present this to a client as well is that business is all about risk. So we know construction materials have risen 20% year on year for the last couple of years. Builders have got wise to that. So if they don't have a cost escalation clause, they're going to have to insert 20 to 30% to cover off that risk. So as a consumer, do you want to pay that 20 or 30% or would you rather take the risk yourself with a cost escalation clause? I know in the current climate I wouldn't expect increases to continue the way they have, but if I was exposing myself to a contract, I would definitely be pricing that in. So I think it's in the consumer's best interest to go for a builder that has that clause in their contract.

I think this is the thing that stops a lot of builders that we talk to in their tracks and go, well, then that's not a fixed price contract anymore, is it? Absolutely is. It's not a cost plus. It's still a fixed price building contract. You just have special terms, special conditions and special clauses in there. It's still fixed price. And this exactly what you were saying, Russ. This is how it's communicated. This is your fixed price. If, however XYZ were to happen, this is the contingency, this is what happens in that scenario.

Do you think the last few years have impacted a builder's decision one way or the other?

I would say definitely. If they weren't already sold 100% on the benefits of a fixed price contract to begin with. Any building company owners that we've spoken to that were on the fence, if they were doing fixed price contracts and didn't have, you know, these special clauses in place and did get stung by, you know, them having to cop the bill and just take it on the chin. Absolutely. I think it has influenced so many builders in this industry to revert and just go back to Cost plus because it's that myth that it's easier. Oh, in fact, it's better for my building company when it's just a myth. It's absolutely not. We see it time and time and time again. But I do think what's happened over the last few years has been horrific for the construction industry in so many ways. It's, you know, yeah, there have been some good stories there for sure, but it's been quite horrific and I think that has impacted a lot of builders confidence, to be honest, on how they can even go in and deliver a fixed price contract without the knowledge of inserting those special terms and special clauses and having a lawyer on your side to know that, yes, this is fixed price. This is what's going to happen in a scenario where something goes up, but going in there with confidence, so you're just reverting, going to what you think is easier and ultimately just leads you into a worse situation for your building company. And it's harder to get ahead and change and have enough retained net profit to invest back into the building company company and grow and grow safely and securely and everything that we talk about.

Bosco, when you talk about impacted, I mean, I can think of a number, a significant number of our members that have eaten those increases over the last two years because they honor their word. I've had heated exchanges with clients where I really wanted them to go back and renegotiate the contracts and they've said no, I gave people my word, I'm sticking to my word. And they've absorbed that and the client isn't even aware of it.

Well, you tell me who does that in any other industry?

Exactly. You always laugh at me because I, I draw the distinction between a professional builder and a builder. This is the difference. This is when it, when it really the rubber hits the road. Instead of trying to find sneaky ways of doing things, they sit back and they say, no, that's the price that I agreed to. I need to box clever and come up with a way that the client is not, not affected. So that word impacted in your question is. Is a huge word. I think it's had a negative impact on some people. But those people, as Rasa said, that have gone and looked at it and said, let me be transparent, let me have an open discussion with a client. And they've put in those rise and fall contracts. Obviously that's made the difference for them.

I don't see my dentist making any exceptions for for his word or my car mechanic at all. So there is a matter of principle there as well. About here's a question. What happens if you have a member come to you and they adamant about using cost plus contracts? What would you say to them?

After goodbye or before goodbye. No, that's a joke. I don't want to in this forum promote cost plus contracts purely because of the pain and the damage that I've seen them cause. But the theoretical attraction of them is they remove the risk. And the truth is the only way that they can remove the risk is if you agree on a target budget with the client and then you as the builder do everything in your power to make that contract land within that target budget, which is a very complicated way of running a fixed price contract. You can fool yourself into this is a cost plus contract by doing that, but that is the only way that it works. And we've kind of alluded to this. The horror stories in this thing are when you offer a client a cost plus contract, I think sky mentioned this earlier, they become hyper focused on the cost. So anything else that's been agreed disappears out the window. And what you find is every time you submit an invoice, you open up the opportunity for another fight. Now those of us that have been married for longer than 10 minutes, we know what fighting month after month after month can feel like. Occasionally it's not nice. And to pay for the privilege. Now we can debate that as well. We can maybe say we do pay anyway. But the point I'm trying to make here is in this cost plus world, every invoice brings about an argument and neither for the client nor the builder is that worth it? And here's the other thing. Thing. Even in a cost plus contract, your attention to detail becomes absolutely critical. If your carpenters have to redo work, there's no client in the world on a cost plus contract who's going to agree to pay twice for the same thing. So I've seen guys with what looks like cast iron cost plus contracts end up in real trouble because they had to go and do a do over on something and nobody pays them for that. And that just eats that profit right there. So we would passionately do our best to convince a client not to go down this road at all.

Influence, not it, not there's the good word. I hate when people say I need to convince them to do that. No, you're going to influence them or inspire.

There we go.

Inspire better.

All right, well, let's. Let's ask a holistic question, you know, and I guess this is a twofold question. One is, are builders struggling with pricing? And if so, why is that the case?

The best way to answer that is to maybe share an experience I had over 10 years ago now when I went to visit a builder on the Sunshine coast and knocked on his door and his wife answered the door opened up onto this massive kitchen and she invited me in. And in the corner of this kitchen, the builder was sitting there behind his desk, working on his laptop. He was working on an estimate. He said, I'll be with you in five minutes. He's got to finish this estimate. And then he called me over just to kind of show me what he was doing, because he was so proud of this estimate. And he had this price file with every single item priced, every single nut and bolt, every single thing. And he had his bill of quantities right down to. Again, to every nut and bolt. It was. This thing was a work of art because, you know, I'm a bit geeky about numbers. So I was so excited when I saw this. I could have talked to him all day. And after gushing about everything he'd done and the complex takeoff and the fact he had all these pricing there. And bear in mind, this was 10 years ago. There was no API connection to suppliers downloading the pricing. He was doing this himself. It was so, so impressive. And I said, yeah, it's just. Just amazing. Out of interest, how close is your estimate, your budget, to the actual when you finish the job? And he kind of looks up at me and he looked a bit blank and he said, what do you mean? I said, well, I'm quite excited by this time. I said, when you finish the job, you got all your invoices in. How close is it to your budget? I'm expecting like 0.1%, 0.2%. And he looks at me, he said, oh, mate, no, I don't know. And I said, well, if you don't know, then how do you know if you're making any money? And he kind of laughed and he said, oh, we never make any money. That gives you an indication there as to the answer I'm going to give you. And the answer is they don't back cost and therefore they don't learn. And back costing is the process of diligently Aligning every single invoice with a cost center and comparing it to your original budget. And if you do not do that, you will not learn about your project, about where you blew out, where you come in under, and you won't refine your budget for your next job. That is where builders struggle.

Is it possible for builders to switch strategies? You know, go from one to the other? How hard is that?

It's possible. But I will probably just say that nothing's easy in this industry. I think anyone listening to this podcast right now will agree. Okay, nothing changing anything in this industry, it's not going to be an easy feat. At the same time, nothing worth doing is easy. So of course is possible. Like, all you need to do is just get a new building contract for the next one you present. But it's so much more than that, right? Because you got to implement this all the way back into your sales process, honestly, even back into your marketing, because that's such a unique selling point, a unique value proposition that you can give your clients a fixed price building contract, have a building experience that you're absolutely going to love, and just pay one amount like it's one figure, so you can implement that into your marketing. You have to build your sales process around this, of course, because how on earth are you going to get to a fixed price? Well, there's a lot of work that it's going to take. And so what we teach our builders and, and you know, the process that we walk our members through is a detailed sales process that involves multiple steps before you even get to drawing up a proper building contract, including doing the design. I mean, we've done a previous episode on this, Bosco, haven't we, on design and build versus quoting plans. And you know what, the better business model is there. But this then bleeds into fixed price contracts. So you can be a design and build company. You can do the concept design agreement, then you can move into a preliminary building agreement which includes as part of that package, fixed price proposal creation. So you can even build out that fixed price of that building contract for your clients and then you get to present it. So yes, you can switch strategies. It's not as simple as just, you know, getting a new building contract from a lawyer. Yes, it's doing that. It's making sure you've got all the special terms in place so that you are protected, but it's making sure you can sell on that basis and you've integrated it into your whole team, into your sales process, into like, look at your quoting and your estimating and even your job scheduling because you want to be as accurate as possible. You're not going to enter into a fixed price building contract with not doing all of that homework first so you can switch strategies. Do I think it's the easiest thing? Not really. Is it worth it? Absolutely.

And I think the reality here is it doesn't make one or the other doesn't change how much attention you're going to put on your prices at the end of the day. To be honest, I think that Cost plus would probably put more pressure on you because it is going to be scrutinized every time you submit an invoice. You've got to take that into account in terms of. Are we going to switch? Well, there's advantages and disadvantages in both of them, but pricing and your attention to detail, that diligence that Russ was talking about, I think that is. There's a greater requirement of that in Cost plus than what there is in fixed price.

What's your most memorable transformation of a builder? Changing contracts from Cost plus to fixed price?

Your most memorable. Difficult to give you. Most recent, and this was a wonderful one because this was a client that we work with in Nashville, Tennessee.

Is that an accent?

There we go. I lived there for five years so I can pull it out when I need to. He in fact fell into this trap of believing that it's actually easier and it kind of makes. If you just. If you don't think it through, it makes theoretical sense that if you start a building business, start with a cost plus job because theoretically you are using your client's money and therefore you reduce the risk to yourself. But he told us the story about this particular client, got to the point as this thing unraveled and got uglier and uglier that every month he was having to debate what was and what wasn't a cost. So he's now not only debating whether or not that is an acceptable cost. It's. But hang on, we didn't agree that this was a cost in the first place. It literally got more and more painful to the point that at the end of the process, obviously he and the client were not on speaking terms at all and he made absolutely no money out of it at all. In fact, it cost him money. Money for him coming to the process, as Sky's mentioned, it's not just the contract. Obviously what we do is because we, we believe and we've proven in fact, that fixed price contract is the way to go. We've also got a system built around it that gets that to be the natural outcome of everything that a professional builder is doing. So at the end of the day, it's seeing those transformations where all of a sudden, garden. You've got a builder that hated interacting with clients. We get builders that tell us they're choosing to go to spec build now, which is another whole can of worms. But why? Because they had such bad experiences working with clients. And then we say to them, well, what were you doing? How were you working with them? Oh, on a cost plus basis. It really is a scenario of once people get to understand selling on value, not price, number one, one. Number two, making sure that they're earning decent margins on what they're doing. And then number three, setting up a professional process that walks the client through the entire process. Once they start to see that bearing fruit, they'll never go back again, ever.

Is there a scenario where a building company may offer both options to a client?

I mean, there's a scenario if I was the client given the option. I mean, let's talk about from a client's perspective, why would you not take a fixed price contract? It's a little bit like bring it back to anything else we ever talk about. You're going to buy a new car. The guy says, look, you could pay 20 grand for this car, or why don't you come back every month and we'll work out a price over the next year. Which one are you going to do? That's essentially what this is. It's a gamble on what might happen somewhere down the road versus here. You've got a fixed price and you know what you're going to pay. So, yeah, no. Dangerous. Dangerous thing to do.

Speaking of dangerous, can fixed contracts be dangerous to the financials long term, especially with the current trends that we see in the market?

Well, in terms of dangerous, you're talking about exposure there, aren't you? And we've seen builders exposed. But I think just to add on what Andy was saying earlier, we were advising builders to reprice contracts before the contract started, before construction started, because they were being delayed through no fault of their own. And when you've got a delay of nine months during the inflation that we've seen on construction costs, and then you've got to start a contract, there's no reason why you should be out of pocket. And the right thing to do at that point was reprice the contract, give the client the option to cancel and get their deposit back or proceed. And where we've seen a lot of builders Come unstuck is they didn't do that. They proceeded and then they got halfway through the contract, panicked and then tried to charge the client. And that's just not ethical at all. That was the wrong way of going about it. And it's not just small builders, a lot of big builders did that as well. So that's where it's dangerous. But yeah, like all dangers, they can be mitigated with the right process.

And I think again, going back to what sky said earlier, the way to make a fixed price contract not dangerous is to properly be set up to do your pricing correctly. If your pricing is correctly, is done correctly, your materials and labor are properly costed and controlled for everybody. There's no downside. The only danger is if you get. In fact, as I'm talking, I'm thinking about one of our favorite clients who's, who's based in Adelaide, who at a dinner shared the story where he said he used to quote four jobs and if he got a job he would go back and see what he'd left out because in his mind it was such a guesstimate anyway. The only way he could get a job was if he got something wrong. So it's really, I think the reality here is how do we take the danger out of it? Be diligent, as Russell said, make sure that you are going back at the end of every job job. Checking the budget against the actual where were you out? Why were you out? How much were you out? Course correct. Use an external takeoff agency if you're not confident in those areas, but the starting point in fact for either one. But if we're talking fixed price, the starting point is get your pricing right. Once that's right, you can then handle everything else that comes after that.

And for our listeners out there, how does the app help the listeners who are potentially not members but you know, need help with pricing, need help with contracts, need help with resources, where can they get the support that they need to help them with their businesses?

I probably say the best place to start is rather than focusing on fixed price and cost plus, we have an entire guide and checklist on how to increase your margins. So it is focused very heavily, of course, on fixed price building contracts. But it walks you through our pricing for profit methodology, which at the end of the day, cost plus versus fixed price, all you're looking at is the bottom line, which one's going to make you the most net profit. So using a fixed price contract with our pricing for profit methodology will be the best option. So you can download our whole guide on how to increase your margins by using our Pricing for Profit formula. We'll pop it in the show notes we'll put on the website so it's nice and easy to download. But of course, if you're not already a member of apb, I'd highly suggest joining so you can actually get these systems, the calculators ready to go and be involved in the forum so you can actually hear are what other building company owners from across the world, like multiple different countries, are saying who have made that switch from cost plus to fixed price. How did they do it? How long did it take? What steps did they do first? You know, what did work for them? What didn't work for them, what made them finally make the change? That community is really inspiring. And of course, if you're already a member, dive on into Facebook, go through Pricing for profit. They're going to be the most important things to do in the next couple of weeks.

Well, as the saying says, when you know better, you do better. So Russ, sky and Andy, I just wanted to thank you for your time again today and your insights and look forward to having you back here again.

Thank you.

Thanks Bosco.

Thank you for listening.

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