Why we favour open book building contracts – even though they reduce our profit
By Ballast Point director Mat Wilk
There are generally two ways of contracting a builder. One is an open book contract, also known as a cost-plus contract, in which clients are invoiced based on the actual costs incurred, plus the agreed margin which covers overheads, profit and risk. The other is a fixed price contract, in which the builder agrees to lock in the cost of a pre-determined scope and the margin is not disclosed.
We were interested to see research emerge from construction management software company CoConstruct recently which found that projects using fixed price construction contracts had 28 per cent higher average profit margins than open book contracts. In analysing more than 60,000 completed projects, CoConstruct’s data also showed that profit margins for fixed price contracts have grown over the past three years, while open book margins have either shrunk or stayed flat.
So why – despite this – does Ballast Point promote open book contracts?
Put simply, because we strongly believe that open book contracts are fairer and lead to better outcomes. The customer is privy to project costs and can rest assured that they are getting what they are paying for. The project team can also discuss the cost implications of decisions directly and openly with the client which promotes good decisions based on return on investment.
You may be wondering what business in its right mind deliberately shuns a 28 per cent increase in profit? Well, it’s about where this additional profit comes from. This is key. Typically, the increase in profit is the result of cost cutting by the builder, but this inevitably leads to an erosion in quality. Ballast Point is a business focused on long-term sustainable growth, and we know this growth comes from improved quality and better client experiences over time. So, we are happy to forgo a higher short-term profit.
But there’s more to it than that – we take pride in our work, and to be in a position where you have to choose between profit and quality just doesn’t sit right with us.
While we believe open book contracts are fairer, there are some drawbacks clients should be aware of. Firstly, the budget is not fixed and can increase (as well as decrease). The price of materials, for example, may change over the course of the project, and decisions made by the client or design team or building team to improve the project outcome can also put pressure on the budget. Secondly, you must be confident from the outset that the people you are engaging know what they are doing. There is nothing worse than engaging incompetent builders and their incompetent tradesmen on an hourly rate, then paying them again to redo work they have botched.
At Ballast Point, we favour open book contracts because they are more transparent. They enable us to work in close partnership with the client and ultimately deliver a better all-round outcome and a better-quality build. It tends to be a more positive experience that makes our clients feel like they are part of the design and build team and enables us to talk openly about costs and make decisions based on what’s good return on investment. It also provides our clients with the flexibility to make changes without the time and cost penalty associated with a fixed price contract variation process and associated admin.
Checklist for successful open book projects:
- Adequate budget – in my opinion the most common reason for budget blowouts can be traced back to an inadequate budget to begin with. Getting an independent estimator is a good way to ensure that the budget is realistic
- Competent staff and quality sub-contractors – the productivity differential between tradespeople is truly astounding. Great workers have multi-factor improvement over the average workers, so only ever engage with high quality contractors with high quality tradespeople
- Budget tracking – giving clients the flexibility to make changes and site conditions can put pressure on the budget. Who hasn’t walked into a supermarket to pick up bread and milk and found that you’re spent $50 on incidental other things? Effective systems for tracking the budget are essential to prevent surprises
- Adequate contingency – building (and particularly renovation) doesn’t always go to plan, whether because of service upgrades or unexpected repairs. We recommend a 20 per cent contingency allowance on all projects.