Profit, Risk, and Overhead as it relates to rate negotiations
Profit, Risk, and Overhead as it relates to rate negotiations
(OP)
I am currently negotiating machine rates with our prime contractor and find myself at odds about an acceptable percentage for profit, risk and overhead.
Our industry (Forestry) works a little different then most in that, we sign long term agreements and guarantee a certain volume of work. The contractor is paid a unit rate ($/m3), that is derived by multiplying a machine rate ($/hr) to an negotiated production rate (m3/hr). The machine rates are based on a scheduled time (i.e. rate = (owning cost + operating costs/annual hours of use). An estimated overhead percentage (say 10%) and a profit/risk percentage (say 10%) are applied to the final negotiated unit rate. In my contractor's opinion the profit/risk value is low.
My first question is, how much risk the contractor incur when he is guaranteed a certain volume of work at a rate that reflects his minimum required annual hours of use? (i.e. If the contractor needs $X/hr to pay for his machine at say 2000 hours of annual use. The contractor has enough guaranteed work to easily make his 2000 hrs).
Next question is 1) How do profit and risk calculations compare in other industries? I know of some construction companies that would die for a contract that guarantees a volume of work over some time period. I also realize in some sectors the risk factor is high, lots of uncertainty. 2) Is a 10% profit reasonable when the risk level is low, would a value closer to 3-5 % be more reflective of a similar industry, say construction?
Our industry (Forestry) works a little different then most in that, we sign long term agreements and guarantee a certain volume of work. The contractor is paid a unit rate ($/m3), that is derived by multiplying a machine rate ($/hr) to an negotiated production rate (m3/hr). The machine rates are based on a scheduled time (i.e. rate = (owning cost + operating costs/annual hours of use). An estimated overhead percentage (say 10%) and a profit/risk percentage (say 10%) are applied to the final negotiated unit rate. In my contractor's opinion the profit/risk value is low.
My first question is, how much risk the contractor incur when he is guaranteed a certain volume of work at a rate that reflects his minimum required annual hours of use? (i.e. If the contractor needs $X/hr to pay for his machine at say 2000 hours of annual use. The contractor has enough guaranteed work to easily make his 2000 hrs).
Next question is 1) How do profit and risk calculations compare in other industries? I know of some construction companies that would die for a contract that guarantees a volume of work over some time period. I also realize in some sectors the risk factor is high, lots of uncertainty. 2) Is a 10% profit reasonable when the risk level is low, would a value closer to 3-5 % be more reflective of a similar industry, say construction?





RE: Profit, Risk, and Overhead as it relates to rate negotiations
RE: Profit, Risk, and Overhead as it relates to rate negotiations
If the site is not fully known, which they never are, these unknowns are called risks to the contractor. For example, say an inclement weather claus exists where the contractor will not be remunerated for lost time due to inclement weather. If the duration is longer than he expects, there are real costs which he incurs, and in a negotiated contract such as this, would likely come directly out of profits.
To mitigate this, the Owner must be willing to take on or share in some of the risk.Long term contracts such as yours are great to have because it provides for guaranteed work/income, but an understanding of the risks relating to the final contract price in the final analysis will determine whether it's worthwhile or not.
Overhead and profit is a number which the contractor solely requests. His operation may be different than others and therefore his overhead may be higher/lower than a other contractors. Profit is a margin with which he wants to see, which, since it is an item for negotiation, is usually a point for differing opinions.
KRS Services
www.krs-services.com
RE: Profit, Risk, and Overhead as it relates to rate negotiations
I personally would turn down the work.
RE: Profit, Risk, and Overhead as it relates to rate negotiations
I have also just received a copy of the “American” Blue Book which has the ownership costs broken down in monthly, weekly, daily and hourly categories. They have identified the increased ownership cost associated with short term work (i.e. loss in productive hours). I can see why you are probably having some difficulty understanding my situation. Unfortunately in Canada our Blue Book has only hourly rates. When I speak of long term work I should be looking at the difference in ownership costs for longer work terms and leave the percent profit and general overhead alone. It really ties your hands when you only have hourly rates to work with. I also see the American Blue Book has a Canadian rate adjustment feature, you guy think of everything.