Profit, Risk, and Overhead as it relates to rate negotiations

[foreng]

I am not sure if this the right forum for this questions, but I noted a past thread related to profit margin.

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 works a little different then most in that, we sign long term agreements with certain contractors 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 estimated historical or industry average 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 comment to him was, how much risk do you actually incur when you are guaranteed a certain volume of work at a rate that reflects a your 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).

My 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?

 

[DRC1]

If you are not in construction what industry are you in? just curious. I have worked in a wide variety of construction environments and never heard of this arangement, which does not make good or bad, just seems a little unusual.
Machine rates are often based on published rates. AED and Dataquest Blue Book are most common. These rates attempt to corralate the many variables in equipment costs. An ownership and operating rate is provided.I personally like Blue Book. Your calculation does contain a signifcant amount of risk for the contractor, as it is based on an industry average production. Production rates are effected by type of work, volume of work experience of the personel, age and size of the equipment weather and down time. The contractor must look at his rate and adjust the final cost to agree with his estimate of production.
If you want to minimize risk, consider renting the equipment and operator by the hour with a guarenteed mimnimum rental.
Margin is truely varible from one contractor and one project to another.The bigest factors are the contractors curent volume verses desired volume, thecurrent profitability of all ongoing work and the contractor's overhead and management structure. Contractors will not share this with you. This is negotiating partHow low will he go? How high will you go? It is very dificult to run an operation of any size on 3% margin. 15 to 20% is a more reasonable number. If you want to reduce cost,and you are asking for a bond, consider asking for the bond as a seperate item and not electing the option. this way the contractor demonstrates bondibility, but you save 1 1/2% +/- of the contractfor what is basically a rental.
Hope this helped Good Luck

 

[foreng]

Thanks for your advice.

I am in the forest industry (like contruction the industry are heavy to machines, unlike construction it is light on competition), and the above method of calculating rates is pretty standard. Tendering is not a common practice as the overall plan can change significantly based on market factors. The tendering process takes time to implement and requires a fairly static plan. The average production rate is actually one of the main negotiated items. We will present a production rate that we feel represents what an average operation would do. The contractor will negotiate based on what he thinks he can do looking at all the associated variables.

We will use blue book rates in certain circumstance, but
we also need to be aware of what annual hrs of use is being used to calculate the rate. We may negotiate a rate based on committing 2000 hrs of annual use to a machine. If the blue book rate is based on 1700 hrs we can save upwards or 10% on the annual rate for a specific machine. Our contracts guarantee a specified volume of work, (i.e. say 200,000 m3/year, but each work unit is around 10,000 m3 therefore we can be negotiating rates upwards of 20 times a year. The contractor in my opinion has ample opportunity to negotiate a rate that he feels is achievable.