Understanding the Variables of Successful Bidding -- Part One

For many construction business owners, the process of bidding for projects has always been a fairly straightforward equation that involves some math, some guesswork and often a stubborn adherence to "the way we've always done it."

Back in the go-go days when times were flush and work flowed, these formulas seemed to work well enough. Jobs came in, crews remained busy and there were profits to show for it at the end of the day.

Over the last several years, however, the industry's prolonged downturn has forced closer examination of these business practices.   Competition for work has been the fiercest in a generation. Business owners have struggled to find new opportunities to fill their project pipelines. And when bids are lost, those in charge of estimating jobs may wonder why the old methods no longer seem to be working.

Successful bidding comes down to a clear understanding of a few important variables – costs (both fixed and variable), overhead and a company's true break-even point. In this first installment of a two-part series, we'll examine the concept of "mixed costs" and their role in producing more accurate bids.

Traditionally, "cost" has been defined as the sum total of fixed and variable expenses required to complete a project. But a third kind of expense, called a "mixed cost," is one that is neither totally fixed nor totally variable. This hybrid category is not simply a matter of semantics, but rather a key component in a contractor's overhead – a component that, once understood and mastered, can help you win more of the jobs that are worth winning.

In an ideal world of purely fixed and variable costs, profits are made once you pass your break-even point. Table 1 shows two sales scenarios. Materials and direct labor are variable costs because they vary proportionally to the jobs or sales in hand. Indirect labor and other overhead are fixed costs because they are incurred no matter how slow or busy you are throughout the year.

Table 1

When comparing the two sales scenarios, note that the percentage of variable costs to sales remains the same, while the dollar values of fixed costs to sales also remain the same. Clearly, the $2 million sales scenario highlights the advantage of these fixed costs. With sales significantly above break-even, a profit is produced that is equal to the contribution to overhead (your sales minus your variable costs) of 45% (100% less 55%), once you go above your break-even sales level of $1M ($450,000 equals 45% of the sales above break-even).

Table 2 shows a more real-world picture where mixed costs come into play. Here, we have re-categorized 50% of the owner's theoretical $100,000 salary from indirect to direct labor, to account for the fact that half of his time is actually spent in the field managing the work of specific projects.

Table 2