Pros and Cons of Fixed Price and Cost Plus Bids

Some Pro's And Con's of Contractor Billing Methods: Fixed Priced Bids Versus Cost Plus Agreements

 

 

            As a landlord, you may hire contractors frequently to work on your property. One of the most important early steps in the transaction is knowing how the contractor will be billing you.

 

            There are two main ways the service work will be priced and billed are: (1) through a Cost Plus Estimate or (2) with a Fixed Price Bid.

           

 

There are pros and cons of each. The fixed bid is common and you may know it best (they bid and ideally complete the work for that amount).  Less known is the Cost Plus arrangement.  In either case, be sure you have a very clear and specific "scope of work" agreed on so you and the contractor both know exactly what will be performed and what materials will be used.

 

We can't cover every aspect of contractor agreements and practices, but we can offer an overview of these two common arrangements. Landlords can decide which might work best in a given situation.

             

            Cost Plus (Estimate) Pros and Cons

            First, let's cover the potentially less understood cost plus or time and material contract for services. This form should not actually be that mysterious for the average landlord or consumer. We see it all the time in professional services: doctors, lawyers and many professionals bill this way. They charge you for all their hourly services and every item (down to the paper clip or bandage) all marked up and itemized in the final bill. This is the norm in our society for white-collar work. However, it is sometimes less readily accepted in the blue-collar context. That said, this is often a billing and contract method popular in the trades. Why? It protects contractors by ensuring they'll earn an hourly wage, cover materials and overhead costs while still turning a profit.

            Your first impression may be that the arrangement could be a recipe for disaster. Your interests and the contractors are no longer aligned. The longer the job takes and the more expensive it becomes, the more the contractor stands to gains (and the landlord to lose). You may feel you are, in effect, writing blank checks and the proper incentives for efficiency aren't in place. This can be true in some cases. However, in other cases, the cost plus arrangement could work for both parties, offering less risk for the contractor and lower costs for the owner.

            For example, in a case where a contractor makes a high fixed bid on a job and it goes flawlessly, the contractor could make out very well, and the owner may have been better served with a cost plus arrangement that only paid for the actual time and materials expended.

            The cost plus arrangement generally means more detailed and (ideally) transparent billing. You could be charged for many of the behind scenes items we sometimes forget: time in mobilizing and staging materials, incidental supplied and clean up. Good contractors can match receipts and timesheets with your bill.

            Another area where cost plus arrangements can favor landlords would be in the quality of work performed. Think about incentives for "cutting corners" or doing lesser quality work. Unfortunately, with the flat bid, every dollar saved on the project is a dollar in the contractor's pocket. This can offer incentives for behavior that is not in a landlord's interest. Over the long term, quality work is far cheaper than shoddy, rushed work. But think carefully about when cost plus arrangement can work well and when it can't.

           

            Guidelines for when cost plus arrangements work:

1.     Trust in Place. Be sure to have a good, long term working relationship with the contractor. A high level of trust can prevent abuse in the cost plus arrangement.

2.     Pick a Busy Bee. Be sure your contractor is busy. With a full schedule, a busy contractor will need get your job done on time in order to serve other clients. There is less risk that unnecessary time will be sent at your site (a real risk in the cost plus scenario) when the contractor has to move on to the next jobs as soon as possible. The contractor's own calendar serves as the incentive for efficiency.

3.     The Known Unknown. The cost plus arrangement is perhaps the only honest way to approach unforeseen or concealed aspects of a job. For example, provisions for rot repair within walls or hidden under shingles is almost always done on cost-plus basis. It can also be the best route for exploratory or diagnostic work to find leaks, sources of moisture problems or anything that involves underground work. Trying a fixed price bid with unforeseen circumstances is a guessing game, and both the client and contractor are likely to be disappointed, so cost plus works better.

4.     Cost Cutting Possibilities: There may be charges you can keep off the bill altogether in a cost plus arrangement. Remember, it a system for billing for the time and materials actually expended. Think about how you can reduce the contractor's time and materials. You might facilitate the job by buying some materials, pre-selecting exact finishes and colors, and working with tenants for access. Also, think about creating a scope of work that allows you to do the final painting, cleaning and other tasks that could reduce hourly charges on your bill.

5.     Clear Agreement: Again, perhaps the best protection in the cost plus agreement is a clear scope of work to avoid add-ons, overcharges, and extras.

6.     Negotiate a "not to exceed" clause. Strongly consider inserting a "not to exceed" clause in the cost plus agreement (with an agreed mechanism for approving amounts over this cap). This is a "just in case" protection for you that could cap the total amount billed. Of course, don't be surprised if your total just happens to reach that level.

7.     Transparent billing and strong bookkeeping are a must. This should show all the people on the job, the materials, and subcontractor's fees as week. Competency in billing will be key in the cost plus arrangement because, well, you are paying for everyone and everything, so the more detail the better.

8.     Red Flags: Conversely there are many red flags that may prompt you to avoid a cost plus arrangement.  If you don't know the contractor well and don't have a good working relationship, it may be poor choice. Also, if you can't be around to monitor progress, this may also make the cost plus arrangement less advantageous. The type of work could also be key. If you can foresee many time consuming issues, excessive downtime or possible delays, you could be paying for people standing around.

 

Fixed Price (Bid) Pro's and Con's

            The most familiar working arrangement is the flat or fixed bid (also called a stipulated sum). There are clear pros and cons. The biggest positive is certainty. You and the contractor are on the same page as far as price is concerned. You are both in alignment on getting the job done as quickly and efficiently as possible. It is also easy to administer and requires less accounting and billing detail.

            There are some risks people often do not consider with a fixed price bid. For example, a landlord could actually overpay for a job. A project might cost less on a time and materials basis. So consider which is the best format.

            If a landlord does work to streamline the project like cleaning up, hauling trash, covering floors and walls, and being onsite to direct tenant traffic, it will not reduce your bill (but may aid tenant satisfaction).

            The interests of the contactor and client can also diverge in the fixed price bid system, just as they can in the cost plus arrangement. The faster the work, the cheaper the labor and material, and the less detail the better. So precision and quality could suffer.  Of course, this also highlights the importance of the bidding process and contractor selection.

            The right contractor and the right agreement can make either a fixed price or a cost plus agreement work. Often, contractors may favor one or the other method, so savvy landlords will be aware of how each works.