Why Underquoting Hurts Everyone 1

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Monday, November 2nd, 2015
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I have lost count of the number of times I see contractor trying to do a $90,000 job for $75,000.

Such underquoting is not limited to small jobs, either; it’s no different than the builder who tenders $6 million for a job that everyone knows can’t be done for less than $7.3 million. This problem has at its heart the wrong motivations, and then catastrophic consequences. The causes and effects here are so interrelated, it is far easier to understand them by looking at them separately. This is what I see first-hand from the adjudication applications we have done over the years:

The race to the bottom

Sadly, the industry is almost entirely price-driven. No one is prepared to look for value anymore, only price. Contractors and builders who offer more experience, faster progress, more resources, and less defects are almost immediately swept aside by another contender offering cost savings of two per cent. This has given rise to a race to the bottom where the only game in town is who can do it cheaper. This is a huge source of pressure on tenderers and inevitably drives prices below cost, or else cuts away at net margins that are so thin the project goes into loss at the first unapproved variation. Then it’s all downhill from there.

False focus on cash flow only

Given the above, many contractors decide that it is worth underquoting just to get the cash flow from the work. In these cases, the project is a loss even if you get the entire agreed contract price. But when did you last get paid the entire contract price? It is likely that the loss will actually be far bigger than you expect, and while you’ve got some cash flow in the short term, the day will come when you’ll need to cover that loss.

I once spoke with a builder who had so much work on he failed to realise what his underquoting was costing him until his accountant told him he was facing a $700,000 loss for that year. He had nothing to claim because he had been paid his contract price, but it wasn’t enough to cover the work and was miles away from break-even.

Back-charging your way to profit

Imagine a case where one party in the contract chain has realised that their contract price is nowhere near enough. Now they look for reasons to back charge their down-line contractors to scrape some of their losses back. Disputes break out down the chain because then the subcontractors start doing the same to their sub-subcontractors. Sadder still is the fact that many tenderers will underquote on the assumption that they will recover some margin through concocted back charges. That is, underquoting actually becomes part of the business model.

Retentions vanish

Of course, another form of margin recovery is the vanishing retention. From the subcontractor’s point of view, the underquoted job gets even worse when that 2.5 or five per cent doesn’t get paid either. And related to the point above, their head contractor may be arguing for back charges that wipe out the retentions, or make other arguments to avoid paying them. As is well-known, insolvency is the biggest retention stealer in town. The fact is that the search for margin caused by underquoting puts great pressure on the retention money that often does not get paid to the contractor who is himself already in loss.

Insolvency

So much has been said and written about this that I don’t need to reiterate it here. Anyone in the business will know the ways in which all of the above leads to insolvency. I simply observe that to me it looks like the construction business has morphed into a ‘minimise your losses’ game rather than a ‘maximise your profit’ one. That does not help anybody.

What does it all mean?

Perhaps it is naïve of me, but I think that contractors and builders need to be selling their value, not just their price. So many other industries are able to show clients the value they get by paying a bit more, but this seems lost in the construction world. Despite the many assets your business may have, none of it comes onto the client’s radar as something worth paying for. That is no good for an industry where experience, a good track record, and taking extra time and spending a bit more can deliver a far superior job.

Recently in the media, much has been said about how almost every block of units built in recent years is rife with defects. To me that is one of the symptoms of this problem. These blocks were most likely under-quoted, everyone down the contracting chain absorbed a massive loss, and the owners can’t get the builder back to fix them because it went into liquidation. This smacks of an unsustainable industry.

Surely everyone needs to do a lot better, and take notice of billionaire American investor Warren Buffet, who famously said “price is what you pay, value is what you get.” Next time you submit a tender or review one, give that some thought.

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  1. Peter

    So True. For a vast majority, being busier trumps being wealthier.