When starting a contracting business, gaining work is the top priority. Projects will be priced based upon the knowledge you have. Adjustments to the price you estimate will be made if you do not secure work based upon the prices you submit. Usually, this deciding you can do something quicker or substitute an alternative product and the “race to the bottom begins”. The spiral leads to cheaper prices being submitted and the only person who suffers is the owner, who finds that they could be earning more working for someone else.
Recognising that you need help is the first step in breaking the cycle, but help is difficult to find. The approach to solving the problem taken by disciplines such as an accountant, marketing person or estimator / QS will be different. The reason being is that those disciplines all contribute to the build-up of the break-even price, but only you can decide how much profit to add. The decision of how much to mark-up the break-even estimate by is called “settling a tender” or “adjudicating a tender”. Research shows that turning estimates into winning tenders is often done intuitively by a director who is most experienced about the work and experienced in the segment of the market.
Over ten 10 years of settling tenders a method was developed which reduced the intuitive adjustment to the very minimum. Using the method mark-up was maximised, thus optimising profit on each project. The method entails; selecting who to work for by matching your businesses capabilities to the most suitable segment of the market, ensuring that your accounts are structured to give accurate information about overheads and then benchmarking markup against wins and losses.
The components of the estimate up to break even are derived from marketing strategy (the best markets to be in usually worked out by a marketing person experienced in the sector), the cost estimate of the project, worked out by a QS or estimator and the overheads to add, given to you by an accountant. The estimate is turned into a tender by adding the profit, which the owner or director does. The profit mark up is done more easily if estimates are all built up the same way and are consistent.
Selection of who to bid for.
For educated serial procurers the selection of bidders is fundamental to ensuring that they will get their project delivered in the optimum way, for the optimum price. Procurers who select their tender lists and make them attractive to a limited number of bidders is the exact opposite to those who will accept a bid from anyone and then take a chance on the lowest price. Those who accept multiple unknown bidders encourage the “race to the bottom” and invariably blame the contractors when it goes wrong leaving a bad taste for everyone. Where a procurer selects a supplier and the type of work fits with the supplier’s business strategy the outcome is invariably better.
Contractors who make a conscious decision as to which projects to tender using a bid-no-bid process immediately give themselves an advantage. They will be bidding projects which are real, and where the other bidders have been selected as being equally capable companies so the pricing approach will be similar.
Estimating the cost of the works.
The concept of equally capable businesses should eliminate priced differences for the delivery of a project, as all bidders will estimate the price for the delivery at about the same amount. The supervision levels will be similar, their accreditations equal to other bidders to meet the preselection criteria and their materiel & labour costs similar, as these are usually ascertained from market testing. The similarity in pricing at this stage holds true unless one of the bidders has an innovative solution, makes an error in the pricing or has been selected in error. Therefore, if delivery costs are similar, it means that the only difference on price will be what is added for overheads and profit.
Adding OH&P.
From their accounts a contractor can calculate the mark-up required to break even leaving just the mark-up on profit as discretionary. For the procurer, if overheads and profit are the differentiator as quality has been addressed in the preselection, then the prices should come in relatively close to each other, giving confidence that the project can be delivered for the price. The contractors know that the combined overheads and profit figure is the differentiator so realise that the profit they can add is dependent upon their overheads. The higher their overheads the lower the profit, otherwise they will be above the market.
By benchmarking project wins and losses against the calculated overheads plus an adjusted fixed profit the market can be found as to what will secure a win. Knowing what the amount to add to secure a project does not mean that this is the figure you necessarily use. Knowing how busy your competitors are, when the project is likely to start in relation to your resources coming free, what risks there are in going forward and the specific contract conditions, should all be considered when the final adjustment is made.
The important thing is that the price tendered is one that will be profitable for you, and you will have bid as high as the market will bear. Most tenders are lost on price, when work is scarce, and a business has no systems it could be that only 10% of work is won. By targeting work and following the benchmarking system described above the strike rate can improve to nearer 50% with the confidence the project can be delivered profitably. Projects which are priced and have the maximum profit built into them that the market will bear, leads to a contractor having no loss-making projects and becoming a profitable contractor.
If you want to be confident about your pricing and find out about a method to benchmark your mark-up so you can improve your strike rate and profit levels, then please contact me, Peter.Searle@ba4cs.co.uk .
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