In the second part of a series analyzing construction contracts used by residential professionals, our team wanted to discover the financial benefits of using fixed price or open book contracts. In our first piece, we found that builders use fixed price contracts 80% of the time. In analyzing over 60,000 projects in the US from 2018 - 2020 we saw that projects with fixed price construction contracts on average had 28% higher profit margins than projects using open book contracts. This margin gap is more pronounced depending on a project’s price point but it is consistent across US regions. Additionally, average profit margins for fixed price projects have been on the rise over the last three years while open book profit margins have remained relatively flat.
A note on terminology
Fixed price contracts, also known as lump sum contracts, are when contractors and clients agree to a set price for a project. This price includes all materials, labor, and markups and is only changed if clients exceed any allowances or select upgraded materials. The other type is open book contracts, commonly known as cost-plus contracts. These contracts charge clients directly for materials and add a markup to every item during the project so the entire project is treated as an allowance and clients see their costs accumulate throughout the project.
Fixed price projects have higher average profit margins
In all project price groupings, projects that use fixed price construction contracts have higher average profit margins per project. The average profit margin gap between fixed price and open book projects varies widely across the board. In projects priced below $250K, fixed price projects had an average profit margin per project of 24.9% compared to 16.2% for open book projects. This 53.7% increase in average profit margin per project is the largest difference for any price group. Projects priced between $500K and $1M had the closest average profit margins with fixed price projects averaging 14.6% and open book projects averaging 12.7%. Notably, average profit margins per project generally decreased for both construction contract types as prices increased.
Profit margin disparity felt across the US
This average profit margin gap between the different contract types can be seen all across the US in varying degrees. The highest average profit margin per projects for both fixed price and open book contracts occur in the Northeast at 25.6% and 17.8% respectively. Average profit margins per project were 71% higher for fixed price projects than open book projects in the Midwest. This was the largest difference in any US region. On the other hand, the smallest difference in average profit margins was seen in the West with 23.6% for fixed price projects and 16.4% for open book projects.
So why use open book contracts? We asked builders who use them.
So given all of the above information we uncovered, why do home builders and remodelers still use open book construction contracts? We connected with two CoConstruct customers who use open book construction contracts to hear their perspective on the issue.
For one custom home builder based in North Carolina, the decision between contract types is less about the bottom line and more about the overall experience and interaction with the client. “Fixed price contracts create a focus on costs which could come at the expense of the client or final product. Open book eliminates that by creating a sense of shared purpose and common goals,” the North Carolina builder explained.
This builder also sees numerous client benefits from open book contracts. “Our clients like open book because it gets them closer to the action and makes them feel a part of the process. They become more educated consumers and feel like they make better choices once they have knowledge in hand and our input to supplement their process.”
For a custom home builder located in Utah that uses both open book and fixed price contracts, the decision comes down to risk and client expectations. “We do both open book and fixed and we usually make more money on fixed but with the escalation we’ve seen lately we are doing more open book. Also, on our higher dollar jobs the customer expects it to be open book and wants the flexibility of this and doesn't want to make all the decisions early on.” This builder also sees clear benefits for the builder and the client when using open book contracts. “Open book contracts guarantee profit for us and the customer knows exactly what they are paying on things so they can choose to spend more or less on items if they want.”
While on paper it may seem clear the financial benefits of fixed price contracts, residential construction professionals still see financial and non-financial benefits in open book contracts.
Fixed price margins are growing while open book margins are flat
In analyzing profit margins for fixed price projects over the past three years we noticed an upward trend in the average profit margins. This trend is noticeable across all price points though it is most pronounced in projects priced above $1M.
Conversely, over this same time period, average profit margins for open book projects have either shrunk or stayed the same across price points. The sole exception being projects priced above $1M which rose slightly from 2018 to 2020.
Where we got our numbers from
CoConstruct helps over 100,000 building professionals manage clients and trade partners, schedule work, track financials, and more. Aggregating and analyzing the data builders input into the system, CoConstruct can identify trends and highlight emerging issues in the residential construction industry. By using and sharing this information CoConstruct is doing its part to eliminate the chaos of project management and help create rewarding experiences for both home builders and clients.