Choosing Your Pricing Strategy

When prospects call your design/build company and tell you they are thinking about hiring a custom builder, this conversation is the unofficial start of the sales process. The prospect will have many specific questions while he evaluates you and your company. Simultaneously you are asking questions to determine if your company is able to meet their primary objectives.

Consumers today seek quality, service and value, and most recognize that one company can be the best in only two of these three areas while striving to be excellent in the third. I have elected to prioritize, and strive toward, giving my clients the best service while seeking to achieve the best value by using a pricing strategy. Some builders give clients the best value possible while allowing for profitability. How your design/build firm addresses this conundrum probably is revealed in the pricing strategy you implement.

Four basic types of pricing strategies exist for building a custom residential project. These include: fixed bid with allowances; fix bid with specifications defined; cost-plus with a fixed fee; and cost-plus a percentage. We will address these one at a time.

Fixed bid with allowances
This is the most traditional method for bidding a custom project. The builder’s proposal gives the client a fixed price for the total project and provides stated allowances for phases that typically are customized, such as kitchen cabinets and tile selections. If the allowances prove sufficient for the client to complete each allowance phase, the final project cost for the client will match the original bid amount. This pricing strategy allows the builder maximum pricing flexibility, i.e., increased profit potential, when asked to complete a change order or when the client’s selections exceed the contractual allowances.

The builder also has the opportunity to bid the job with as high a profit margin as the market will bear. If actual labor and material costs for the job come in lower than originally budgeted, the savings drops to the builder’s bottom line. Conversely, if actual costs are higher than budgeted, this will decrease the builder’s profit margin. The builder does not reveal his bottom line to the client when using this pricing strategy.

Fixed bid with specifications
The primary difference between this strategy and fixed bid with allowances is allowances are eliminated and replaced with predefined products and specs for all phases. In the builder’s proposal, products are detailed and the client is left to choose only colors. If the client is satisfied with the builder’s specifications, the total cost will match the accepted bid. However, any client deviation from the builder’s specifications is handled by a change order and the builder’s pricing is restricted only by his desire to be fair and reasonable. Again, the builder does not reveal his bottom line to the client when using this strategy.

Cost-plus with a fixed fee
More precisely, this strategy is called “cost-plus with a fixed fee and all specifications and scope of work clearly defined.” As the name suggests, it requires the builder to open his books and limit his profit margin while predefining all specifications and the overall scope of the project. From the builder’s perspective, it’s imperative the project be carefully and thoroughly predefined before the builder can commit to a fixed fee.

One particular successful high-end luxury builder colleague fell into exactly such a trap. He was building a 10,000-sq.-ft. home and agreed to a fixed fee for construction management. The client then made significant additions to the project, specifically a pool, pool house and extensive landscaping. The builder asked for additional fees but had difficulty maintaining a good relationship because the client had assumed the fee agreed to entitled him to grow the project indefinitely. Even a smaller change, like adding a cherry-paneled library when only wainscoting was in the specifications, requires additional management, supervision and responsibility on the builder’s behalf. In 22 years of building custom and spec homes, never has one been completed exactly as originally planned. Therefore, it is difficult to create a win-win agreement for a fixed fee.