When subcontractors bid work, it’s a balancing act between satisfying GC expectations and making a profit. All other factors being equal, the lowest bid will generally win a job. But engaging in a race to the bottom is actually a lose-lose situation for everyone involved – especially your company.
Let’s take a look at why underbidding happens, what the industry consequences are, and how you can avoid this pitfall as a contractor.
Underbidding vs. Lowest Reasonable Price
The lowest bid on a project could be a well-thought-out estimate from a contractor that falls within a few hundred or thousand dollars of other bids. In this case, the outcome is spectacular for that contractor – they were able to bid accurately enough to be in line with the GC’s plans and still get the profit margins they desire. This is an ideal situation.
A low bid only becomes problematic when it’s either so low that it raises red flags for the GC or it’s not enough to cover costs and bring in a profit for you. In that case, you might win the job, but in actuality it’s a loss.
Why Does Underbidding Happen?
There are three primary reasons a contractor might fall victim to underbidding.
1. If you don’t have a handle on your business operating costs, you might estimate simply for materials and labor and not take into account the expenses required to keep your business afloat.
2. If you’re new or inexperienced at estimating, you may have limited knowledge of the going rate in your trade and location, or the lack the history to know how long it will take your crew to complete a project.
3. If you’re stuck in a scarcity mindset and nervous about not winning enough jobs, you might be tempted to bid low out of a fear of losing.
(A contractor might also intentionally underbid, say, if you are trying to move into a new field where you have less experience or fewer connections and need to prove the quality of your work.)
Underbidding Fallout – for You and the Construction Industry
The consequences of underbidding are real and far-reaching. In the immediate future, it could mean not winning the work because the GC has done their homework and recognizes that your bid is so low that it’s unrealistic. Most GCs do their own rudimentary estimate and have a general understanding of what the job will cost. They may choose a higher-priced contractor who they trust to be more accurate and reliable.
But, there’s a chance you might win at the lowest price. What happens then?
If you haven’t accurately accounted for the expenses related to the job, you still have to complete it. Materials need to be purchased. Crews need to be paid. You could end up making no profit on the project, or even losing large quantities of money on it.
You’ll probably also find that the project is unorganized and subpar – you might be dealing with an inexperienced or problematic GC, leading to delays, change orders, and scope creep. Are you prepared to challenge it?
If you realize your mistake and go after other, more lucrative projects, dropping the ball on the low-paying job, your reputation among GCs could suffer.
Why Underbidding Is Bad Practice for the Entire Construction Industry
Too much underbidding – racing to the bottom on pricing to win jobs – would drive construction prices down, making it difficult for companies to remain competitive and stay in business. Worker pay would be cut, making the labor shortage even more of a problem, and quality would suffer.
It’s important to bid accurately and with the whole picture in mind for a successful business and a healthy industry.
How to Stop Underbidding
Instead of a mindset focused only on winning bids, take a step back and dive into what it takes to run a thriving business. You need to be able to cover all of your expenses – including those unrelated to the job at hand. And you need to be able to make a profit, whether that profit goes into your own pocket, gets reinvested in the company, or gets distributed among your employees as a bonus.
If you’re just starting out, profit margins will be slim, and construction is an industry notorious for low margins. But for a business to survive, it must take in more than it expends. So, if a job isn’t going to be at least slightly profitable for you, winning that bid is actually not a win at all.
Determine What You Need to Break Even
Before you can set profit goals, you need to have a clear picture of your break-even number. This is the amount you need to bring in to cover all of your expenses – not just for the job, but for overhead as well. Use this detailed guide for figuring up your overhead costs and break-even number.
Get a Grasp on Rates and Your Crew’s Capacity
Understanding the market and your company’s own pace and abilities is a skill that comes with time and attention to detail. Analyze any publicly available bid information so you have an idea of what specific types of projects are going for. Become obsessive about tracking time and waste on jobs you do win. Eventually you’ll be able to look back and learn from your past data. Here’s how to conduct a post-project review.
Overcome That Scarcity Mindset
It’s easy to get caught up in worry that there aren’t enough jobs to go around – after all, construction is an extremely competitive industry. But with some creative thinking, you can set yourself apart and find more jobs to consider. The Five Keys to Starting and Managing a Commercial Construction Company contains valuable information on getting your finances in order, networking, and finding projects in new, innovative ways.
Start Making a Profit
Once you understand your break-even number and you have a handle on market rates, your crew’s work pace and style, and you have the fortitude to push forward, you’re ready to increase those profit margins.
Think about how much you’re worth: what do you bring to the table that competitors don’t? Are you more reliable? Do you have special expertise? Also consider your employees: even though it might seem to eat into profits, if you’re paying good salaries and providing solid benefits and a positive work environment, you’ll be much more likely to retain good employees who show up on time, work hard, and get the job done. Can the other guys say as much?
As you win bids and begin to develop a reputation for your good work, you’ll gradually be able to charge a bit more for your services. Be sure you’re keeping detailed records so you can develop an eye for what a job will take from your particular company.
Accuracy and experience will get you where you need to go. Need help ensuring that your bids are spot on? Sign up for a free STACK account today.