Recent studies suggest that prices for construction materials are rising at a relatively moderate pace overall, but certain materials have seen sharp price increases over the past year. Careful contractors will take steps to protect themselves against price hikes that could squeeze margins on long-term projects.
The U.S. Bureau of Labor Statistics reports that the cost of construction-related materials increased by approximately 5 percent between early 2017 and early 2018. Analysts from the Associated Builders and Contractors have suggested that contractors should expect roughly similar gains over the next year or so.
But a closer look at the numbers reveals that prices for some materials—notably softwood lumber and nonferrous wire and cable—increased at two to three times the overall rate. The long-anticipated increase in infrastructure projects could put additional upward pressure on material costs, and the possibility of new tariffs on certain imported goods could increase construction material costs even further. Meanwhile, volatile prices for diesel and other fuels add even more uncertainty to the picture.
Unexpected increases in material costs can turn an otherwise profitable project into a money-loser, especially on longer-term projects that are more susceptible to price volatility. While it is impossible to eliminate price fluctuations altogether, there are some common-sense steps you can take to help limit your risk.
The ideal way to minimize the risk of rising material costs is through a cost-plus contract. Of course, many project owners are reluctant to enter such a contract because it shifts all the risk of price increases from you to them. You might find a more receptive reaction if the cost-plus contract is coupled with a guaranteed maximum price, which lets both parties share some of the risk.
If a full cost-plus contract is not in the cards, you might be able to negotiate escalation clauses to help spread the risk. Escalation clauses specify a trigger price for certain key commodities (for example, copper pipe for a plumbing subcontractor). If prices escalate beyond that trigger, the general contractor (and ultimately the owner) agree to absorb a portion of the increase.
Such contract protections are not without their drawbacks. The accounting and documentation requirements can be burdensome because you might be required to show that escalating costs were outside of your control. You will need adequate administrative resources and a robust job cost accounting system to provide the required level of detail.
Sourcing and Supply Chain Management
Even when prices are stable, it is always important to be sure you are dealing with reliable, reputable, and informed suppliers. When shortages crop up, a supplier who has built up loyalty and is able to get you scarce materials can be a lifesaver.
In addition to following price projections from construction associations and industry publications, it’s also good practice to talk regularly with your suppliers and manufacturers about where they anticipate prices will go. In the best-case scenario, you might be able to negotiate a price guarantee during the period covered by the contract. But even if this is not possible, maintaining good relationships with suppliers is always a sound business practice.
If you have a firm contract and are confident in your continued need for certain raw materials, it can make sense to purchase critical or price-sensitive commodities in advance. Sometimes this can expose you to new problems such as cash flow issues, storage costs, and the risk of loss or theft. In addition, you could find yourself in a difficult situation if the project is halted for any reason.
Ideally, you would make a purchase commitment with your supplier but arrange for delivery at a later date. Suppliers might be reluctant to enter into such agreements, but if your supplier is willing, this could relieve you of the cost of storage and the risk of loss or damage before the materials are consumed.
Sudden price hikes can put even well-managed contractors and subcontractors at significant risk. Patient negotiating, clear communication, and careful attention to detail can help you limit your exposure.