We’ve talked a lot about risk in past articles. However, I thought it a good idea to discuss the topic from a more general perspective – the 30,000-foot one. For instance, if your annual sales budget is $1 million and your desired net profit margin is 10 percent or $100,000, your risk IS anything that jeopardized achieving the $100,000 net profit.
The question is, “What practical steps can you take to control a reasonable amount of risk?”
The concept of risk and doubt go hand-in-hand. If you have a lot of doubt regarding a service or project, you probably have a lot of risk as well. The major areas of risk for a contractor are direct costs such as materials and field labor. Weather certainly can cause risk, but its risk is reflected in its impact on materials and labor. While subcontractors and equipment pose some risk, it is minimal compared to the other categories.
I maintain that roughly 90 percent of your risk is caused by field labor and field labor productivity. Subsequently, much of our risk management attention will be directed toward field labor.
Field labor risk management. Many estimating systems have at least two quantifiable risk management tools for labor. The first is a markup percentage applied to the crew average wage. I like to increase a crew’s average wage by 10 percent if I feel confident about its production rates. If they are working on something new with unproven production rates, I’ll add 15 and maybe 20 percent to the labor rate. These are good benchmarks for any estimator to use.
Next is a labor warrantee factor applied to installation projects to address material issues. A good starting place is to add one man-hour into your bids for every three-man crew day the job takes.
If I see some red flags at the end of the bid I like to add a contingency factor. One of my clients presented a proposal to an attorney, which the attorney agreed to. Unfortunately, my client failed to see the attorney’s vanity license plate that read, “SUE EM.” Now, that’s a red flag! Difficult homeowners or architects, limited access, time of year all can add to the contingency factor.
Materials risk management. Plant materials that die during a warrantee period, pavers that sink and irrigation systems that need to be tuned up all create legitimate costs that the contractor needs to include in a bid. Assume 5 percent of your plants will die. Companies that have tracked the costs to replace materials find such costs run 2 to 3 percent of sales. One contractor in Maine spent more than $200,000 to replace materials in 2005 lost during the previous winter. It was a bitter cold winter with minimal snow cover to protect plants. Lost plants ran almost 10 percent.
Contract considerations. “When in doubt, sub it out” is a good rule to follow. If you are unsure of your production rates, subcontract the work to contain your risk. Another adage that applies is “When in doubt, charge on a time and materials (T&M) basis.” Both strategies allow you to contain your risk. Often landscape architects on large residential projects prefer to be billed on a T&M basis. This allows for maximum creativity with minimal change orders. In such situations, one of my clients would offer a T&M contract with a qualified not-to-exceed amount.
Another clause that you should include in your contract is commonly referred to as a rock or ledge clause. If you uncover foreign materials (a ledge, stumps, sewer lines, batteries, cables, etc.) on the job site, the contract reverts to a T&M one.
Some of my clients have a clause in their contract that states if the homeowner does not have an automatic irrigation system, they will not warrantee the plant materials.
One of my favorite contracts is what I call a time and materials “over/under.” Once a price for the work is agreed on, the work is billed on a time and materials basis. If the contractor goes over budget, the homeowner only pays 50 percent of the overage. If, on the other hand, the contractor completes the job under budget, the homeowner agrees to pay half of the savings to the contractor.
Conclusion. Risk, and risk management, take many forms and apply to all levels of your business. We’ve only touched on a few ideas and techniques here. Remember, it’s your business and the more risk that you control, the more money you’ll make!
JIM HUSTON runs J.R. Huston Consulting, a green industry consulting firm. See www.jrhuston.biz; mail firstname.lastname@example.org.