In a high-risk industry like construction, it can be difficult to balance quality and revenue. Understanding how to use different pricing strategies is one of the most important factors in keeping your construction business profitable and your customers happy. But with the right pricing strategy, you can set fair rates for your projects, earn healthy revenue, and provide transparency for clients.
What makes a good construction pricing strategy?
For construction projects, having a profitable pricing strategy takes more than just adding a markup to your material and labor costs. Different pricing strategies are required to ensure both parties are happy, because every project comes with unique requirements, complexities, risks, and customer expectations. A smart pricing strategy balances profit margins with the flexibility to accommodate market conditions and risk—all while being transparent.
Common types of construction contracts
Let’s look at some common pricing strategies for construction projects, as well as their benefits and drawbacks.
Lump sum contracts
With lump sum contracts (also called fixed-price contracts), you receive a fixed amount for the entire project, including overhead costs and profit margins.
Risk responsibility: You take on the risk if the project goes over the budget or past the estimated timeline.
Benefits: A lump sum contract gives simplicity and predictability to both parties, because you and your client agree on the price and project terms before construction begins.
Potential drawbacks: Fixed-price contracts can encourage cost-cutting if the project runs into unexpected challenges and delays, making the actual project price more expensive. Also, if you complete the project faster and cheaper than anticipated, your client doesn’t receive any benefits, reimbursements, or discounts.
Cost-plus contracts
A cost-plus contract (also called a cost-reimbursement contract) is the opposite of a lump sum model. Instead of knowing exactly how much the project will cost, your clients reimburse you for expenses with an additional “plus,” which is the profit calculated as a fixed fee, a fixed percentage, or variable percentage.
Risk responsibility: Because this contract is open-ended, your client assumes the risk of cost overruns.
Benefits: Cost-plus contracts give clients transparency because you provide them a detailed expense record. They’re also more flexible because they can accommodate unexpected changes.
Potential drawbacks: Your clients must spend more time budgeting, tracking costs, and ensuring everything is accurate. They may also wind up spending more than they expected.
Guaranteed Maximum Price (GMAX)
A Guaranteed Maximum Price agreement can remedy some of the drawbacks of cost-plus contracts by establishing a maximum price for the construction project, helping control indefinite increases in the price. And if the project results in actual savings, it gets split between the customer and your construction company.
Unit price contracts
Unit price contracts give your clients cost breakdowns based on specific quantities (per square meter) or work activities (per item installed).
Risk responsibility: Both parties share the risk because the client can get inaccurate estimations. You’ll need to price everything accurately and finish the project within an agreed-upon timeline and price.
Benefits: Both parties get transparency and simplicity because they have upfront prices, making it easier for clients to compare bids from competing contractors.
Potential drawbacks: Unit pricing only sometimes captures complex site conditions, project specifications, and designs.
How to choose the right pricing strategy for your construction projects
Beyond careful project evaluation and analysis, you should take the following steps when choosing the right construction pricing strategy:
1. Lay out your project requirements in detail
Before even thinking about a pricing strategy, map out your entire project and the requirements on a micro level. For example, after identifying the project type (residential, commercial, or industrial), size, and complexity, start figuring out the specific resources, materials, labor, and specialists you’ll need to calculate expenses for different project areas.
Location, insurance and licensing, and machinery will also influence the price. Don’t forget to double-check architectural plans and engineering drawings to get additional insights into project requirements and customer expectations.
2. Estimate costs and revenue
Once you fully understand the project and labor requirements, you can start estimating and assigning costs for categories like labor, materials, equipment rental, and permits. These prices should be based on fair market rates for an accurate cost estimation.
Including a contingency budget plan for unexpected problems and expenses is also important. Don’t forget to review past projects—they can serve as valuable lessons and takeaways for upcoming jobs.
3. Work with your team
Because construction projects involve many parts and stakeholders, it’s best to work with your employees, partners, and clients to help choose the best pricing strategy and ensure the final proposal accounts for everything. Talk with your onsite team and sub-contractors (if applicable) to know the time and labor power needed for a specific project. Since they do the actual work, they can provide invaluable information about potential issues or areas that might have been overlooked.
4. Review and refine
Once you finally decide on the pricing strategy, review the final contract to make sure the numbers, profit, and timeline make sense. Run it by your legal team, stakeholders, and project managers. Having different sets of eyes review the contract can help spot problems, gaps, or areas where pricing should be changed.
Pricing construction projects accurately and strategically can help reduce overrun costs, increase profitability, and keep your customers satisfied. By choosing a pricing model that aligns with your company and project-specific goals, you can keep your customers happy, ensuring your construction business continues to grow, while building trust and credibility with your clients.
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