Fixed Price Versus Floating

On today’s show we’re talking about how to save money by unbundling.

There’s two ways to buy a service. You can pay an hourly rate, or you can pay a fixed price. It’s attractive for a buyer to pay a fixed price from a budgeting standpoint. If you are raising capital for a project, you need to know how much something is going to cost. You can’t simply write a blank check and hope that it will all work out the way you want.

Some contracts are a guaranteed maximum price contract. In those contracts, you go through tremendous pains to make sure the scope of work is fully understood and you conduct a detailed review of the specifications to make absolutely sure that nothing has been missed. In a fixed price contract, the price is fixed, and so too is the specification. If there’s an error in the specification, you can expect to pay more to have it fixed.

It’s often the case that when items are packaged together in a fixed price contract, you end up with some of the things you want and then other things you are not that keen on. You might feel stuck because you’re buying services and products that are not to your liking, in exchange for the certainty of a fixed price contract.

I’ve seen this happen many times when dealing with construction contracts.

There are some times when a construction contract is priced too high. That’s particularly true when the contractor doesn’t know how much time something will take. They tend to quote high to protect their margin. In those cases, it’s in your best interest to pay for the work on an hourly basis instead of paying a fixed price for a package. If you still want a guaranteed maximum price contract, then the solution might be to quote a time allowance for a particular line item in the contract. Any time over and above the allowance would be charged at an hourly rate.

A simple case in point was a drywall plastering job that had three extra line items that were priced above the original scope of work. Each of the line items when bid at a fixed price came to $2,600 in extra work on top of the base contract.

When I asked the person doing the work on site how much effort it represented, he estimated about 8 hours of work. There’s no way that I would spend $2,600 for only 8 hours of work. There’s no way I would spend that much if I paid for the extra work on an hourly basis.

In that case, I went back to the manager for contractor and asked him to quote me an hourly rate for the extra work and then I gave him a blanket authorization for the extra hours.

In the end, the extra work cost me $800 instead of $2,600.

This was all with the same contractor. I don’t feel like the contractor was trying to rip me off in any way. They were estimating the job the way I would expect contractors to estimate the job.

We are often conditioned to think that fixed price contracts are the best way to go. I’m here to tell you that it’s not always the case.

Before you can realistically negotiate this with your contractors, you need the expertise in house to estimate the work and figure out what it should really cost.

Sometimes the local knowledge of the site conditions can give you an advantage over the estimator who is trying to do their work quickly and efficiently. Their goal is not always to get you the lowest price. Their goal is to get the job done, to keep their people busy, and to minimize the time lost to mobilizing staff on and off the job site.