Estimates, Bids and Proposals – Differences Among Offers in Construction
The construction industry uses three distinct terms to offer their services to customers. Estimates, bids and proposals are terms used to present a dollar value associated with construction work. For less sophisticated contractors, the terms are interchangeable. The reality is far different. Each term has an historical context and legal meaning. Thus, it is prudent for any contractor to understand the differences and use the correct term in an accurate way when offering their respective services.
This article will explain and elaborate the differences between estimates, bids and proposals. In addition, some legal issues are explained; specifically, as they relate to contract law. As a contractor, it is your responsibility to understand the respective terms and when and how to use them. This knowledge greatly reduces your risks, especially risks associated with lawsuits. It all starts with understanding the most commonly used term in the industry – estimates.
An estimate is the most broadly used term in the construction industry. However, it actually has two separate meanings. Estimates are divided into internal and external definitions. Internally, the term refers to the process of identifying the hard costs of construction. External use of the term refers to a verbal communication of how much the contractor will charge for their services. Take note, external use is a ‘VERBAL’ conveyance of value.
The following subsections explain these differences in more detail.
Estimates as an Internal Term
Internally, the term alludes to the process of calculating the financial hard costs of construction for a project. With almost every small business construction company, there is a single person assigned this responsibility. This individual is commonly called the ‘Estimator’. The estimator calculates the actual direct costs of construction to build or complete the respective task. Estimators use take-offs, worksheets and proposals from subcontractors to determine the final expected hard cost of construction.
With the known hard costs, the company adds a mark-up to determine the final price that will be delivered to the customer. This is where the confusion about the term estimate starts.
Estimates as an External Term
The core problem with the term estimate is the public’s perception of its definition. Webster’s dictionary defines an estimate as . However, for the average person, the term estimate is more in line with an exact value or calculation of the price to perform services. Some customers will allow some deviation from the quoted dollar amount; in general, many customers will allow and understand a 3% deviation from the estimated amount as the final price. The key point here is that customers interpret the term ‘estimate’ to mean an exact dollar amount to perform services including materials, labor and all other costs the contractor must absorb.
To add to the confusion, many contractors state on their websites, marketing and advertising materials that the contractor provides free estimates. Thus, contractors have allowed the term to be perceived by the public as a definitive value to perform services.
With most states, under contract law there are four key elements with the creation of a binding contract. First there is an offer, some form of a statement from the contractor stipulating they will perform services. The second key element under contract law is acceptance by the customer. In effect, whether verbally or in written format, the customer must accept the offer. A contract does not exist under these two conditions. There are still two more required elements. The third element is called consideration. This refers to the dollar value related to the exchange. The final element is called performance. This means that when either party puts some form of value in the other party’s hand, consideration is achieved. For the customer, this means some form of financial transfer to the contractor. For the contractor it means they must deliver materials or do some form of labor work at the job site.
Many states further define a contract to include mutuality, i.e. a meeting of the minds. Both parties must understand the parameters and what the contract entails. Another common requirement is a date and or timeline for the contract to exist. Overall, for the reader, there are four required elements – 1) Offer, 2) Acceptance, 3) Consideration and 4) Performance.
The conveyance of an estimate to a customer is often interpreted as an offer and consideration. This starts the process with the creation of a contract. A contract doesn’t exist yet; but this meets the technical definition of an offer along with consideration. It gets a tad more confusing because in most states, the law requires that any form of contract related to real estate MUST be in written format. Thus, if a contractor provides a written estimate, this begins the first stage of creating a written contract.
Thus, technically and legally speaking, written estimates to customers, if accepted and the customer provides some form of deposit or initial payment, is then considered a legally binding contract. It meets all four elements of a contract. An offer: ‘I’ll perform this work contingent on you paying me’; acceptance: the customer states ‘I agree’; consideration: ‘this is the set dollar value’ and finally; performance: ‘customer makes a payment’.
Obviously, the above illustration is very common with smaller forms of construction work. Think of the small contractors that perform small jobs such as building decks, sealing driveways, performing landscaping services, and even conducting traditional trade repair work. All of these are customarily done with this sub standard method of creating a contract.
However, the best construction definition for an external estimate is:
Take note of the three important elements of an external estimate.
- It is VERBALLY communicated, never in written format. Go back to the definition of a contract, especially contracts related to real estate; if in writing, there is no doubt of meeting the elements of an offer and consideration. Therefore, to prevent the creation of a contract, provide the estimate verbally.
- NONBINDING: every estimate conveyed to a customer must include the words: ‘Nonbinding’, or a statement to the effect that the company will not honor the price provided without a formal process of determining a set price with conditions and a written contract. In effect, the customer must be made aware and acknowledge the understanding that the proposed dollar value is not a legal agreement between the parties.
- An APPROXIMATE value of exchange between the parties: the verbal conveyance of dollar value should also include the words ‘approximate’ and/or ‘an initial judgement’.
So why even have external estimates? The answer is: customer expectations. Every contractor gets the common phone call asking ‘Can you give me an estimate to do such and such?’. Many contractors advertise free estimates. Thus, there must be a tool to differentiate presenting value without being formally obligated to perform the services. The answer is: provide an estimate with several levels of protection in order to alleviate the perception of a formalized arrangement.
The more professional contractors always start the conversation with the customer or client with the definition of an estimate prior to stating the price. Having the customer or client acknowledge the definition is critical to gaining an understanding between the parties. A good starting sentence is the following:
The customer must state ‘YES’ to both questions prior to providing a dollar value.
The key to an external estimate is that it is created as a nonbinding understanding between the two parties. It must be delivered verbally with at least two additional elements of 1) nonbinding, and 2) it is an approximation of value. The customer or client should acknowledge their understanding of this exchange.
This is an illustration one how one roofing contractor addresses and deals with customer requests for estimates.
Under no circumstances should a contractor provide a written estimate. This is actually called a proposal.
It is very common for customers to call contractors and ask for a written estimate. Their real purpose is to use this written document as leverage in negotiating with other contractors for a reduction in the price for the work. This is why it is so important for contractors to understand and acknowledge that estimates rendered to an external party should be conveyed verbally and include the stipulations of nonbinding and the price is an approximation. If the customer demands a written price, the contractor should state that a written price is called a proposal.
Proposals are written offers of service to a customer or client. Note the key difference between an estimate and a proposal. Estimates are verbal, proposals are written.
Prior to writing a proposal, a professional contractor will conduct an onsite walk to gain an understanding of conditions, limitations and logistics involved. Secondly, contractors generate an internal estimate of hard costs to complete the project. Finally, a written proposal is generated that includes the following sections:
- Executive Summary of the request and any stipulations made by the customer/client related to the request.
- Scope of Work is defined in a second section ensuring all aspects of construction are addressed.
- Price is identified including options.
- Terms and Conditions are documented. Common terms include the payment structure and conditions. Conditions identify the contractor’s limitations. The most common conditions are time frames and customer requirements; e.g. ‘dog must be chained’, ‘customer will allow full access to the driveway’, or ‘customer will allow contractor employees the right to use the indoor facilities’. Many proposals will include ten to twenty conditions.
- Exclusions – the proposal may stipulate that certain aspects of construction are excluded. Examples include performing engineering work, obtaining conditional use permits, or the fact the proposal is not based on union wages or night work. In effect, the exclusions clause identifies the assumptions the contractor used to calculate its hard costs of construction.
- Change Orders – this clause identifies the pricing structure related to any change orders that may occur during construction. It typically identifies the price per hour for labor and the markup on direct costs of materials.
- Standards of Performance – this clause identifies how the project is measured for completion. Most projects use a third party inspector to stipulate completion. For example, remodelers will stipulate that the issue of a ‘Certificate of Livability’ or ‘Completion’ from the local inspector is the basis of completion of the project. Other standards include milestones, units of measurement etc. to quantify percentages of completion throughout the construction process.
Note how more inclusive a proposal is over an estimate. A proposal is a one-sided presentation to a customer identifying all the critical issues, steps and factors associated with the price involved. In effect, a proposal is an offer to create a contract between the two parties related to the request of the customer/client. The customer can counter this offer by negotiating a better price, and/or change the terms/conditions clause or any other of the respective clauses of the proposal. The proposal is merely the formal offer and consideration to the customer.
Most contractors that perform services that are less than $5,000 in total value use a written estimate (again, an inappropriate form of exchange with a customer) to convey the price to the customer. On that document are often some of the above clauses; but they are conveyed in a brief format. Again, it is encouraged that all contractors at any level not use written estimates or the word ‘estimate’; proposals are far superior as an exchange with a customer. For those contractors that perform services that are a few days in duration and average upwards of $30,000; a preset (drafted form) is used with presenting a proposal. The form is a fill in blank document prepared by the ‘estimator’ and presented to the customer.
Common examples of contractors that use this presentation format include:
- Residential concrete work
- Subcontractors to General Contractors
- Flooring companies
The key is to use the appropriate term when presenting information to the customer. Proposals are the most common form of presentation to customers within the construction industry. Proposals are formal written offers to perform services and include stipulations thus ensuring mutuality of understanding between the parties. Many proposals can be easily converted to a formal contract with either a signature clause or the creation of a formal contract whereby several or all of the stipulations made in the proposal are included.
Not all customers are alike. Many customers do not know or understand construction and therefore, proposals help them to understand what is involved with their project. But for those customers that do understand what is involved such as large general contractors, governmental agencies, large organizations (hospitals, authorities, and major corporations); they don’t request proposals, they issue REQUEST FOR BIDS.
Bids in Construction
A bid is the most formal of all methods of exchange between a contractor and a customer. Unlike estimates and proposals which stipulate price and conditions to a customer for the contractor to perform services, bids start from the customer. The customer, in most cases a government entity, sets the qualification requirements, conditions, terms, scope of work, standards of care and more. The only missing piece of exchange is the price to perform services. The government issues a request to submit a price. In general, the contractor meeting all the requirements with the lowest bid is awarded the contract of construction.
The government, authorities and large corporations employ professionals to ensure all necessary construction work is completed in accordance to high standards. These professionals issue the requests; thus, making this form of exchange the most formal. Any addendums, changes or noted exchanges of information is provided to all participants thus upon final receipt of bid prices; no participant is provided an advantage over others. There is a step-by-step process used to ensure that final bids submitted are indeed non-negotiable between the parties.
Summary – Estimates, Bids and Proposals
There are three distinct tools to convey price for services in the construction industry. The lowest level is referred to as an estimate. Estimates are verbal, nonbinding judgments of prices to provide services. Estimates should never be in written format. The end goal is to provide the customer with a general idea of what it will cost to provide construction services. The objective is to get the customer to request a proposal. A proposal is a written offer with consideration to a customer to perform services. It includes identification of the scope of work, terms, conditions and of course standards of performance. In effect, it is the offer and consideration part of a contract. Most contractors include the contract for signature with the proposal.
The most formal of all tools to convey a meeting of the minds between the customer and contractor is a bid. Bids are the end result of a process that starts with a well educated and informed customer whereby the customer provides all the stipulations to complete a project. The contractor is merely providing a price to render those services. Act on Knowledge.