Some thoughts on what to do when material prices are spiking

[rockstar.esq]

For those who aren't following the markets, it might come as a surprise to learn that some material prices are rising at an alarming rate.  Common commodities that have barely any price changes for years at a time, are currently doubling and tripling in as many months.  PVC pricing is through the roof.  This has triggered a lot of panic-buying which has made materials scarce, which only compounds the problem.

Contracts are typically written based on the assumption that materials pricing will be "locked in" upon signing.  Indeed there are lots of risk-averse companies that will place a material order for everything they need immediately.  Other firms will make strategic purchases when markets appear low, so as to maximize their profitability.

Sadly, the bulk of contractors tend to hold off on buying materials until they're actually needed, hoping that the market shifts will even everything out sufficiently to make the books balance.  Some of these contractors will not be granted any additional funds to cover the price hikes, which is going to hurt.  

I'd like to address this challenge from two perspectives, what to do about ongoing work, and what to do about securing work in the future.

Starting with ongoing work, it's obviously critical to take stock of your situation.  Nothing less than honesty will do here.  If you've got a problem, define how big a problem that is.  Take the opportunity here to learn from your mistakes by accurately defining what the mistake was.  Keep in mind that some contracts will require quality assurance processes/bureaucracy before the contractor is given approval to place an order.  This means that you may have been under contract according to the terms of your bid, but not actually permitted to place a material order until such time as the market increases took effect.  One lesson that should leap out here, is that it's good policy to do a material pricing check at every contractual inflection point.  Let's say your proposal was good for 30 days.  If the client calls to accept the project on day 31, check the material pricing before you accept.  Now, let's say you get a "notice to proceed" letter because the client needs time to process the contract stuff.  Do a material pricing check.  If things are trending upwards, you might find yourself in an untenable position before your contract is ready.  Communicating early and often will give everyone the best opportunity to make smart moves.

Along that same line, it's significant to note that market volatility can work in both directions.  If the project will run for a long time, there may be a case to be made for a "wait and see" approach.  Material prices often decline just after the seasonal rushes.  One of the most common logic mistakes I see in this business is when entrepreneurs consider the price hike on a project against the contract value for that project.  This leads them to overlooking some significant facts.

For simplicity's sake, let's say that material is half the project cost, and labor is the other half.  Now I wrote cost, not contract value, because we haven't added for overhead or profit yet.  Keeping things simple, let's say overhead equals 10% of cost, and profit equals 5% of cost plus overhead.

OK, now for the first of many things that people routinely screw up.  Working from 100% of  contract value, what percent is left when you remove the overhead and profit?  See, a lot of people would respond with 85% because 100% - 10% -5% equals 85%.  That's wrong.  Starting from 100, we must back out profit.  100/1.05 = 95.24, now we back out overhead 95.24/1.1 = 86.58%.  Divide that in two and it's now obvious that material is worth 43.29% of your contract value.

Lots o' math there.  What's my point?  Let's say your contract is for $100K, and material prices for that job have spiked by $10K.  Many knuckleheads will focus on the job getting 10% more expensive.  They're not wrong, they're just looking at it as though they're not the one actually doing the job. 

Keeping all my percentages from the original example, we know that material was worth 43.29% of the contract, which means the material budget went from $43,290 to $53,290.  That's a 23.1% material price hike.  This difference in perception is important because the scope of work didn't change.  Comparing the change against the contract total spreads the material price difference across material, labor, overhead, and profit.    That conceals the real truth of what's going on.

Now let's say you're in a situation where nobody will help to cover that difference.  Where does that money come from?  See material, labor, and overhead are all costs attributed to the job which hasn't changed.  You're still going to have to pay for all of that.  The only thing left is profit.  Now let's consider profit in the bigger picture.  

Revenue is the sum total of all the sales for a year.  At 5% profit, there's a 21 to 1 ratio between revenue and profit assuming everything goes to plan.  Let's say you have to pay that $10K out of your profit.  At a 21  to 1 ratio, you'll need to complete $210K worth of revenue to earn that back.

Staying with the simple theme, let's say that most of your work is at that $100K contract level.  Getting stuck paying for that $10K material price hike is equal to all profit from two+ jobs.  

Circling back, can you see why "the price went up 10% over contract value on this job" sounds very different from "this 23.1% material price hike will cost us all of the profit on this job, all the profit on the next job, and 10% of the profit on the one after that, assuming there will be any work to pursue, now that prices have spiked."

Moving onto securing future work, we can build on the lessons regarding ongoing work, to make better decisions in pursuit of securing new prospects.  Right off the bat, anyone who was left "holding the bag" on material price increases is likely to be in bad financial shape.  "Make it up on the next one" bidding tactics don't work unless the market is booming for whatever you sell.  Competitive markets encountering price hikes will typically lead to a decline in demand.  

This often means that there will be less work to go around, with an ever increasing number of competitors operating on the brink of survival.  Desperation is a poor posture against the lowest common denominators operating in readily accessible markets.  The key to survival, is to find quiet market sectors where your business is viable.  This is easier said than done.  But bear in mind that you've got more time to find a solution before you've made a mistake, than after.  Many firms would be better off by "hibernating" than to do business at a loss.  Where that's not possible, adapt to what is going on.  Honesty is huge here.  I've been in plenty of situations where the only paying work I could find was with dullards and scoundrels.  Demanding cash up front, and putting everything on the record, kept us solvent while we made our way through difficult times.  Dishonesty is a huge warning sign that is best heeded.  Most contractors don't go under because of a job they lost, they go under because of a job they won.  

[White Nomad]

This is some very valuable advice.

I haven't been directly affected by the increase of steel prices, however there have been steel shortages in a few local hardware stores.

[Frosty]

Hardware stores are POOR places to buy steel. You can buy a full 20' stick at a steel supply for about the same as a 4' piece of the same steel at the lowest priced hardware store around. 

Buy hardware at hardware stores, buy steel at steel suppliers. Hmmmm? 

Frosty The Lucky.

[Goods]

At my local supplier I paid right at $2US/lb. Seems high when I consider my previous purchases, but at the big box stores you won’t get near that price or near the same selection! (But, I did get their last stick of 1” by 1/8” thick angle iron and they had no idea when they would get more in.)

David

[ThomasPowers]

I'll have to see if the scrapyard has raised their price yet...

[Frosty]

Going to take a load in it's gone up enough?

Frosty The Lucky.

[ThomasPowers]

Well I've bought over 1000 pounds since lockdown trying to keep them afloat.  So I plan to taper down till I use some of it and clear out my yard some as well.

[Old Crew]

I purchase quite a bit of 3 construction materials : structural steel, galvanized steel coil and fire treated plywood.  Everything was gone up exponentially .

For instance In mid January I bid a job for a contractor that we do a lot of work for. At bid date we were under contract with them on 2 similar jobs. The jobs were light gauge steel trusses which we manufacture and install with fire treated ply wood decking. At the time plywood was on the rise, I tried to convince them to sign the contract and we would order the material to lock in the price. We would have billed them a stored material draw when we received the material, both the steel coil and the plywood.

In early March we rebid the job and again on May 3rd. They signed our contracts on May 5th. In January the cost our cost of galvanized steel coil was 54 cents per pound, in march it was 63 cents and in May 74 cents per pound. The 5/8 fire treated plywood was 56$ per sheet in January, 63$ in March and $72.30 in May. Currently the same plywood is 97$ per sheet and the steel coil is currently 1.12 per pound.

Structural steel beams and shapes were about 39 to 40 cents and are currently 65 to 70 cents per pound but structural sheet or plate is at $1.05  Tube steel was at around 64 cents a pound and is now $1.27 per pound.

The price increases will at some point get to a point where it limits growth . I doubt that things will slow down much in the area where I live though. Recently I read an article that stated that the county that I live in is the fastest growing in the US. I live 35 miles north west of Austin Tx

[Irondragon Forge ClayWorks]

I have been thinking about replacing our old aluminum storm door for about a year now. I had priced a nice insulated one back then. It was $349 US dollars. Since then it has gravitated to the top of my honey do list, so I priced the same door this week. Sticker shock doesn't adequately describe the feeling at $879 US dollars. I think we can live with the old door for sometime to come.

[rockstar.esq]

On 6/25/2021 at 4:28 PM, Old Crew said:

Recently I read an article that stated that the county that I live in is the fastest growing in the US. I live 35 miles north west of Austin Tx

It has been my experience that every metro area  in the U.S. has a recent article claiming or predicting the fastest growth.  Bad news is only ever reported in hindsight, usually within the confines of a prediction that things will improve.  

Out here, they level a farm to slap up depression-era style housing blocks and self-storage facilities following every foreclosure wave. We're supposed to believe we're seeing "growth", in a situation where none of the young working couples can afford to buy a home, or have kids.  

I read recently that there is a huge investment group that's buying some enormous percentage of homes on the market.  They're not renting them out, so as to keep the home prices high.  

My bet is we're past the point where meaningful construction growth has slowed out here.  Three months from now I'll expect to see trade journals predicting fourth quarter growth percentages that read like they're higher than the losses they'll only admit to then.  But if you "do the math" on the figures presented, you'll see stuff like a 50% loss followed by a predicted 75% gain, which leaves you 12.5% below your starting point if they're right (and they never are).  

[JHCC]

Since I moved away from NYC in 2008, there has been a huge amount of construction of "luxury" apartments, a significant percentage of which were bought as investment properties (and quite possibly as money-laundering opportunities by the Russian mob) and have never been occupied. Meanwhile, commercial rents for retail spaces have skyrocketed, mom-and-pop stores can't afford the rent and close, and landlords prefer to keep the spaces vacant in the hope of finding a corporate tenant who can afford the space. Apart from the loss of individual character in many neighborhoods, this means that it gets harder and harder to get the things one actually needs to live, such as groceries, picture hangars, duct tape, and shoe repair.

[rockstar.esq]

JHCC,

I'm not sure about NYC, but there was a code revision about fifteen years back that allowed "Stumpys" which are sometimes called "Five over ones".  They're commonly a type of mixed use development where the first floor is commercial, with five floors of apartments above.   However there are plenty of them that are purely residential.

The main change was that only the first floor had to be built to commercial standards, however the top five floors are all residential-style wood framing which is much cheaper to build.

Developers pushed hard for unified designs so that they didn't have to hire new design teams every time.  Most of these projects are repeated patterns of symmetrical transpositions like shifting an aesthetic feature from left to right, or rotating the floor plans on a site.  Stuff that can be done by a CAD professional without any need to pay a costly Architect or Engineer.

Aesthetic features were intentionally limited and made into modular blocks so that a simple material specification change is all it would take to get zoning approval.  Out here, there are noteworthy Architects penning public letters disparaging these developments on aesthetic grounds.  However, these self-same professionals are famous for designs which are equally bleak, repetitive, and rectilinear.  In my first-hand experience, the only difference between econo-block, and luxury bloc, is how much is spent on overpriced minimalist trim.  Absolutely outrageous sums are spent on low-quality "luxury" light fixtures which are indistinguishable from the cheap stuff put in housing projects.  I've seen more than one European art-house manufacturing firm that is clearly selling rebranded Asian import stuff at 20x the price.  

Tourism to cities with pre-WWII architecture is always higher than post-war which strongly suggests that the overwhelming majority of people prefer classical architecture to modernism, minimalism, or brutalism.  It's been my experience that the overwhelming majority of Architects hold the opposite opinion.  They've largely succeeded in convincing young people that a 70 year old aesthetic famously applied to the most hated low-income housing developments in world history is "modern" and "luxurious".  

Nope, it's cold, hard, loud, bleak, and intentionally dysfunctional.  There's no room for your stuff, your spouse, or your kids, which sells vacations and storage units, while reducing the need for building schools.