By Nick Wright, One of three underwriting managers in Cincinnati Insurance’s large contract surety division
Whether you are a homeowner building a deck or a commercial contractor building multimillion-dollar projects, the soaring costs of construction materials is not new news. Even as lumber prices begin to retreat, what might be surprising is the length of time it might take for prices to stabilize overall or at least become more predictable.
The same could be said for the supply chain and the availability of certain products. The combination of pre-pandemic trade disputes, economic disruptions from COVID-19 and inopportune weather events in Texas have all factored into supply shortages. The trends are threatening to derail the post-pandemic recovery as project owners feel more confident about the future, but are put off by rapidly increasing prices.
Perhaps never before had the world slammed on the brakes so abruptly as when the pandemic began. It soon became acutely obvious how interwoven the global economy had become. Things we previously took for granted, like enough shipping and freight capacity, became bottlenecks. Consumer behaviors placed heavier demand on certain products. And many resources were diverted to efforts to combat COVID-19.
So, how can contractors manage through this period of economic whiplash – serving clients as well as protecting their own profitability? There may not be any easy or obvious answers to that question, but contractors should consider several angles.
DON’T GET PINCHED
This is not the first time contractors have had to navigate through periods of volatile materials prices or product shortages – it’s just an extreme example this time around. Traditionally, contractors have been slow to pass these costs on to customers either for fear of losing the contract or because the contract price had already been set.
On the other hand, no single project is worth jeopardizing your business. Consider including a provision in your bid that only guarantees pricing for a certain time, and be transparent. Share documentation of the limits that have been placed on your business by your suppliers and vendors. This helps explain the necessity – and points out the urgency – of making the “go, no-go” decision to move forward with the project. This is true risk management.
ACCELERATE THE BUYOUT
During the pandemic, owners, general contractors, subcontractors and vendors worked together managing through social distancing and other safety measures to keep the jobs going. That same collaborative approach can be leveraged to combat material price volatility. Work together to buy as much of the project materials up front as possible. The key is ensuring project owners and lenders are willing to pay for verified materials stored on and offsite. Surety bonds and other financial instruments can protect the owners’ legitimate concerns about offsite storage. Of course, storage and security costs must be considered, but pricing stability is a benefit to every stakeholder in the project.
CONTRACT LANGUAGE MATTERS
While force majeure – unforeseeable circumstances – clauses have received more attention in the past year than ever, most of the time these provisions can only allow for time extensions to complete the work. Unless specifically stated, contractors are not normally entitled to additional compensation for price increases when unforeseeable events take place.
The problem is that no one wants to hold the risk of price increases in a volatile environment. Contractors and owners would be wise to negotiate a framework that shares the risk among all parties. A transparent and well-thought-out framework in which the parties agree to a trusted price index and share the details of openly sourced materials can benefit all parties. It has to be a two-way street where the owner benefits when prices decline and the contractors limit the impacts when prices increase.
Ultimately, the safe and high-quality completion of the project is in the best interest of everyone involved with the project, and increased cooperation is the best assurance to meet that goal in an era of few certainties.
This loss control information is advisory only. The author assumes no responsibility for management or control of loss control activities. Not all exposures are identified in this article. Contact your local, independent insurance agent for coverage advice and policy service. Neither The Cincinnati Insurance Company nor its affiliates or representatives offer legal advice. Consult with your attorney about your specific situation.
If you need assistance with your contractors or construction insurance, please contact us today! Our team is waiting to provide expert guidance and advice.