Contractor's Overhead and Profit

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Author Message David J. Wyatt, CDT Senior Member Username: david_j_wyatt_cdt Post Number: 96 Registered: 03-2011 Posted on Wednesday, September 24, 2014 - 10:35 am:    This is probably so fundamental that these will likely seem like rookie questions, but here they are: How should the issue of a contractor's overhead and profit limits be dealt with prior to award of a contract? Should the bid form contain a line where the bidder can declare the maximum limits? Some public owners state the limits they will allow in their Instructions to Bidders, but I am dealing with a situation in which the issue was not addressed in the contract and the contractor is using high percentages on additional work. I feel that I should already know this. Any advice the 4specs faithful can offer will be appreciated. J. Peter Jordan Senior Member Username: jpjordan Post Number: 773 Registered: 05-2004 Posted on Wednesday, September 24, 2014 - 10:52 am:    Unfortunately, the answer is "whatever he can get away with." The deeper answer will require audit of the Contractor and Subcontractors to verify their rates for these items. There may be a lot of misunderstanding on both sides as to what is and what is not included. Putting something in the Contract Conditions or on the Bid Form will clarify the issue, but may not reflect accounting realities. Contractors have been dealing with this for a long time and will do whatever they can to maximize their profit. It isn't necessarily dishonest; it can be, but doesn't have to be. The Contractor with lower overhead and profit may not be the least expensive or economical. It may be that they are the ones with the most expensive (and the most qualified) labor. Wayne Yancey Senior Member Username: wayne_yancey Post Number: 692 Registered: 01-2008 Posted on Wednesday, September 24, 2014 - 11:03 am:    David, BIG OOPS? The bid form is one logical place to call for this information. One example of language is: 5 CHANGES .1 When the [Architect] [___________________] establishes that the method of valuation for Changes in the Work will be net cost plus a percentage fee in accordance with <insert article number> of the General Conditions, our percentage fee will be: (_____)% overhead and profit on the net cost of our own work; (_____)% on the cost of work done by any subcontractor. .2 On work deleted from the Contract, our credit to the Owner shall be the Architect approved net cost plus [1/2] [2/3] [____] of the overhead and profit percentage noted above. It is one more piece of information to consider when reviewing bids. Percentages may be negotiable. Scott Piper Advanced Member Username: spiper Post Number: 5 Registered: 08-2014 Posted on Wednesday, September 24, 2014 - 11:16 am:    Did the spec include any reference to AIA A201. I believe there is some legal jargon in the GCs that allow the architect to determine reasonable O&P if none has been preapproved. It may require you to rely on some CYA language in the A201 but maybe that will at least put you into a position to reach a compromise with the contractor. Scott Piper Senior Member Username: spiper Post Number: 6 Registered: 08-2014 Posted on Wednesday, September 24, 2014 - 11:22 am:    One additional word of caution. The A201 does allow for a potential additional cost for bond and insurance costs. You could end up negotiating a 1 or 2% O&P fee reduction and then have it simply show back up as bonds and insurance increases. Our specs set a limit based on a percentage and we specify that that limit includes any bonds, insurance, etc. We also specifically state that this criteria supersedes the conditions in A201 with regards to such expenses. Ronald L. Geren, FCSI, AIA, CCS, CCCA, SCIP Senior Member Username: specman Post Number: 1259 Registered: 03-2003 Posted on Wednesday, September 24, 2014 - 11:38 am:    If the project is competitively bid, then OH&P is a free-for-all--like Peter stated, "whatever they can get away with." However, the contract documents can stipulate maximum OH&P for contractors and subcontractors for contract changes after the execution of the agreement. For CMAR and other negotiated contracts based on a GMP, I recommend establishing a maximum percentage for the contract right up front...and I speak from experience. In a firm where I previously worked, we had a project that was using the CMAR delivery method, shortly after the State of Arizona allowed alternate delivery methods for state contracts. We were required to submit the documents to the CM for estimates at each of the phases. At SD, we were informed that we were over budget. We went back to the drawing boards (um, computers) and redesigned portions of the project to bring it within budget using the CM's unit prices. The DD documents went out for estimating by the CM. Surprise! The project is still over budget, although not as much. Our principal was furious. He sat down and went through the SD and DD estimates and found that the CM's fee percentage (i.e. OH&P) went up at the DD phase to compensate for the loss of fee due to the reduced construction cost. How is an architect to design if the costs are a constantly moving target? The answer: contractually limit the CM's fee percentage. Additionally, for later projects, the firm hired an independent estimator and the two estimates were always compared and reconciled before proceeding to the next phase. Ron Geren, FCSI, AIA, CCS, CCCA, SCIP www.specsandcodes.com Mark Gilligan SE, Senior Member Username: mark_gilligan Post Number: 685 Registered: 10-2007 Posted on Wednesday, September 24, 2014 - 12:27 pm:    You should ask the Client how they wish to proceed. While the architect may have insight and recommendations this is a matter where the Owner should be actively involved. Dave Metzger Senior Member Username: davemetzger Post Number: 539 Registered: 07-2001 Posted on Wednesday, September 24, 2014 - 01:47 pm:    Absolutely, Mark. While the architect can and should make recommendations, determination of specific maximum percentages for contractor OH&P is the owner's decision. We've had projects with an owner who had a complex chart with a sliding scale of percentages for OH&P for each contractor tier (contractor, subcontractor, sub-subcontractor) based on the dollar amount of the change order. But then, that owner was into micro-management. Alan Mays, AIA Senior Member Username: amays Post Number: 203 Registered: 02-2003 Posted on Wednesday, September 24, 2014 - 01:52 pm:    Then the architect should ask the client why they won't pay him with the same percentage rate instead of screwing him down on his fees! LOL! Sheldon Wolfe Senior Member Username: sheldon_wolfe Post Number: 792 Registered: 01-2003 Posted on Wednesday, September 24, 2014 - 02:10 pm:    You can try, but as Peter said, contractors have been dealing this for a long time. If you limit one thing, they'll find another place to put it. Short of an audit or a blatant lie you won't know what they really spent or where they spent it. Part of the problem is that there is no penalty for juggling the numbers. Contractors have nothing to lose; if they're successful at dodging the limits they win, and if they're caught, they lose nothing. Paul Sweet (Unregistered Guest) Unregistered guest Posted on Wednesday, September 24, 2014 - 09:01 pm:    For State work in Virginia there are limits on the OH&P for change orders. I believe it's 15% for the lowest tier, and 10% for all tiers above. For CM contracts the prequalified CMs bid on their OH&P, which includes General Conditions, home office, project management, and profit. J. Peter Jordan Senior Member Username: jpjordan Post Number: 775 Registered: 05-2004 Posted on Thursday, September 25, 2014 - 08:00 am:    Calculating overhead is not entirely an objective exercise; however, overhead costs cover the costs of doing business that cannot be reasonably allocated to a specific project. So while the cost for the pickup used by the jobsite superintendent might be allocated to that job, the luxury sedan used by the CEO will not, Companies who do more work with their own forces and own their own equipment will have a higher overhead rate. Marketing costs are definitely overhead. While too much overhead may be a sign of inefficiency, too little overhead may indicate other problems including missal location of costs (or even fraud). The overhead rate may be budgeted for a time period, but will change from one period to another. Then there are questions about how much overhead the Contractor should be permitted to charge on a Subcontractor's price (which already includes overhead) Establishing a "fair" profit is definitely subjective. This has to do with risk, but also is related to custom. Usual percentages range between 5 and 10 percent. Limiting profit to an unreasonably low percentage may drive better contractors away and will encourage more change orders. The bottom line is that this is an issue that accountants are more suited for than architects. I do like the idea of the Contractor "bidding" on these items, but you should understand that, like everything else, lower is not always better. Anne Whitacre, FCSI CCS Senior Member Username: awhitacre Post Number: 1386 Registered: 07-2002 Posted on Thursday, September 25, 2014 - 07:45 pm:    I have worked on several projects that were a variety of contract arrangements (including CMAR) and the contract arrangements between the owner and the contractor were not open for our review or discussion. I've worked on others where OH&P was part of the bid documents. the design team should have this discussion also -- clearly if there is an incentive for the contractor to propose changes, that automatically means that the architect is facing more work reviewing all of those changes. (says someone who has now spent two weeks tussling over a parapet detail. )