Homeowners are often unsure of how to respond when they receive a quote to replace their central air conditioner. The quote is often a black box — in fact, it may literally be a single dollar amount, which takes into account (and hides!) the cost of the load calculation, the air conditioner itself, repairs or replacement of ductwork, labor and warranty costs and an unspecified profit margin.
To negotiate effectively in these circumstances, you need more information — often information that the contractor is reluctant to give you. This article opens that black box, and helps you understand how contractors develop their quotes.
How do Contractors Come up with their Price Quote?
Though there is some consistency between how contractors prepare bids, each contractor goes through their own process. Some rely on software and guides to help them accurately determine what to charge while others have methods based on past experience and rules of thumb to determine equipment cost, materials and labor. The following should provide some insight as to how contractors prepare bids, figure costs, labor and add their markup to the project and equipment.
We spoke with Bob Jackson, a heating contractor from Chesapeake, VA about how he creates bids. Here is the system he uses:
STEP-1 Talk with the Homeowner
Jackson says he likes to have a fairly comprehensive discussion with the homeowner to understand what they’re looking for in a new air conditioner. For example, rather than simply providing a drop-in replacement for the old system, he tries to understand if the new system can solve problems that the old one didn’t. Do they want it to be on the high end of efficiency with lots of bells and whistles or simply heat and cool the house?
“The better educated the homeowner is on what it is they are asking for, then the better decisions they will make for themselves and the better my ability to create an accurate bid,” he says.
STEP-2 Create an Estimate of Materials & Labor
While there are guides such as RS Means to help contractors quickly create bids, Jackson says he does not rely on them. Instead he relies on past experience to create an accurate estimate of what he thinks the job will cost to complete.
This is not simply making a hypothesis, he says. Instead, he creates an estimate that is aligned with specific cost coding that he performs during previous jobs. For example, he creates a code for each component of the job, such as installing ductwork of a specific size and length, and then as the work is performed the workers break their timecards down to list each cost code and how long they worked on each. He can also incorporate the cost for materials with these codes, which gives him a fairly precise sense of how long it will take to install a system as well as the relative cost for materials.
“I can keep my bids current with what it takes the guys to actually install a piece of equipment,” he says. “I can also get as detailed with the cost codes as I want.”
STEP-3 Include Any Additional Variables
Beyond the cost of materials and labor, Jackson has to add in any subcontractor costs, tax on materials, vehicle charge (this is a percentage based on his hourly rate and covers the cost of running and stocking his vehicle), overhead (generally 23 percent of the total job), and his warranty cost in case he has to return to perform more work under warranty (this is three percent of the total cost).
When these figures are added the sum represents the total cost for him to break even on the job.
STEP-4 Calculating the Profit Margin
According to Jackson there are two methods for assessing what the profit margin for a job should be: flat rate pricing structures and hourly pricing structures. He prefers the latter.
Flat rate pricing is similar to going to a mechanic with the rates for brake jobs and so on listed on a price board. This is what it costs and the profit is built in. In the automotive world this may make sense for some jobs, but when talking about installing an AC system, he says, flat rate structures use labor rates and pricing markups designed to hit a 60 percent gross profit. This is a lot of money.
In order to hit a 60 percent gross profit it is pretty much the equivalent of about $180 to $225 per hour, says Jackson, which will not be acceptable to most homeowners.
What the contractors do that use such a pricing system, he adds, is charge a diagnostic fee. “This is pretty much a bait-and-hook to get you to say yes to a reasonable cost for them to tell you what is wrong with the system,” he says. “From that point, they are going to give you the flat rate pricing structure, which has an exorbitant labor rate built into it.”
By contrast, a fairer structure is one where the contractor figures what the cost per hour is to do the job and then folds that into his total break even amount. Generally, he says, the cost of labor should be in the $70 per hour range.
Jackson then adds what he believes is a reasonable profit margin to the job, which is about 20 percent. “However, my actual profit compared to my projected profit depends on how well I perform and that nothing goes wrong,” he says. “If I do better on labor, then I may make a little extra, but if I go over I make less.”
STEP-5 Equipment Markup
This isn’t really a step in Jackson’s process, but discussing equipment markup is important.
Buck Taylor, VP of HVAC design firm Roltay Energy Services, believes homeowners shouldn’t worry too much about the markup. He argues that the cost of the markup is relatively small relative to the importance of getting the job done right. Price-sensitive homeowners may disagree.
According to Jackson, as a general rule of thumb it is important to know that the more expensive the material, the lower the markup. For example, a fuse that may cost $3.50 at Lowes or Home Depot may be marked up 100 percent or more because there are costs associated with procuring the part and keeping the truck stocked.
However, when talking about a compressor that costs hundreds of dollars, a contractor simply will not mark that up 100 percent. Generally, large equipment will be marked up around 10 to 15 percent, but could be quite a bit more depending on the contractor.
Does the Equipment Affect the Cost of Installation?
Other than labor, the cost of the equipment is the biggest expense of installing a new AC system. The cost of the equipment is primarily determined by how efficient it is, as measured by its SEER (Seasonal Energy Efficiency Ratio).
According to Chandler Von Schraeder, of the U.S. Environmental Protection Agency’s Energy Star program, the base price of equipment is governed by the efficiency of the system you decide to install. “If you are going for a high-end SEER of 16 or above, then you are going to pay a lot more for the equipment,” he says, “but it will come with a better warranty and will also be a more complex installation.”
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Some contractors may even increase their markup percentage or up their overall bid price based on the efficiency and quality of the equipment the homeowner wants to install, says Jackson. For example, a contractor may increase his equipment markup percentage for an AC system with a higher SEER. And this is true even though the steps and labor to install that equipment are largely the same as for any other AC system, adds Jackson.
“I don’t see the difference between a 13 SEER installation with a programmable thermostat and a top- of-the-line 16 plus SEER,” he says. “The programming is just about the same, 5 minutes, and all the installation steps are the same.”
The only difference, notes Jackson, is that a super high-efficiency system will use communicating thermostats, which require cabling between them similar to CAT 5 wiring. “But in my humble opinion, it is no more than an hour’s difference between super high efficiency systems and the lowest efficiency system.
Other areas where the overall cost for the installation could increase, adds Taylor, is if there is work that has to be done beyond installing the equipment, such as expanding the space in the home where some of it goes. This may require new framing, drywall, wiring, etc.
Additional aspects of the job that could increase the cost of installing an AC system include:
- The cost of workers compensation and other employment laws in your state
- Scope of work, which refers to simply replacing an outside unit or having to redesign and replace the entire system
- Zoning and control strategies, such as creating cooling zones for a set of rooms or just one zone for the whole house.
Should I Bypass the Contractor to Purchase Equipment?
One of the most hotly-debated topics in the HVAC industry is the issue of companies selling HVAC equipment direct to consumers.
The traditional method for purchasing equipment is a three tiered system: manufacturers first sell the equipment to a distributor/ wholesaler. The distributor, in turn, sells the equipment to a contractor, who finally sells the equipment to the homeowner. At each step in this process a markup is added, which increases the eventual cost of the equipment.
It is safe to say that manufacturers, distributors and contractors prefer homeowners stick with this tradition. “I wouldn’t advise people to go out and get the equipment themselves because you will more than likely lose your manufacturer’s warranty on the equipment,” says Taylor. “Even guys that are doing jobs on the side are leery of letting a homeowner purchase the equipment directly due to the potential of violating the warranty and all it takes is one piece of failed equipment and you won’t have the manufacturer’s warranty behind you.”
Other arguments against purchasing the equipment directly include:
Homeowners may pay more
Because contractors represent repeat business they receive favorable pricing. Larger contractors also have added leverage and can extract even more concessions from manufacturers. The same is true at the distributor level: contractors will get a better price because they represent consistent and repeat business. As Wendy Welton, RA, President of Art Form Architecture in Portsmouth, New Hampshire, says, “A good contractor will do a better job of getting you a better price because a distributor or manufacturer will never give a homeowner as good a price in a direct sale than the contractor will receive. Also, preserving the time tested chain benefits the homeowner because if something goes wrong, the contractor is the person who is responsible to ensuring the homeowner is protected.”
Of course, the flip side to this argument is that while homeowners won’t get a volume discount, they also won’t pay the contractor’s markup.
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Limited direct-to-consumer market
Because of the issues surrounding warranties, proper handling and installation, etc., many manufacturers won’t sell equipment directly to a homeowner. There is a relatively small market of distributors that sell to consumers, says Taylor.
However, while the above represents one side of the debate, there are a number of direct to consumer retailers, overwhelmingly online, that believe they offer consumers a very valid option for purchasing equipment. “Contractors hate companies like ours because we cut into their business,” says a customer sales support representative at an online outlet who wished to remain anonymous because she believed her employer would not like her speaking to the media. “However, this is something we are allowed to do, sell to the public, so that is what we are doing. We are just as legitimate a business as a contractor and it should be up to the homeowner to decide for themselves what the best route is for them to buy their equipment.”
In response to contractors’ concerns that homeowners risk losing the manufacturer’s warranty, she says, “For us to honor the warranty we would have to be sure the customer had the equipment installed by a licensed HVAC contractor. To prove this they would need an invoice from the contractor with the company’s information, license number and so on. Basically, the warranty is from our company so we deal with the manufacturer and the customer deals with us.”
This issue with the warranty seems to be fairly consistent with other direct to consumer companies.
For example, Sam Wyant, Sales Manager for Alpine Home Air, says that his company honors the manufacturer’s warranty in a similar fashion and requires the homeowner to show proof that a qualified contractor performed a final inspection and startup of the system.
The one area where neither company offers a warranty is on the labor. That is up to the contractor to provide and honor. However, they do sell much of the equipment necessary for the install such as lines, thermostats, and so on. Anything else is up to the contractor to provide.
The advantage to purchasing equipment directly, says our anonymous sales support representative, is the cost, which depending on the equipment can be $2,000 to $3,000 less expensive. “For some customers, depending on their budget and what they are looking for they may want to work through a contractor and have a warranty on labor and equipment while for others they are trying to save some money by cutting down on the cost of equipment and have a contractor only handle the installation at a reasonable price.”
She goes on to add, “However, when they call us, the customer is already looking for an alternative. That goes without saying because they have gone online and they are already going to find companies that are selling equipment and they are going to see who has the best deal.”
Wyant adds that his company often can offer a wider selection of products than a contractor normally can offer, they provide lifetime trouble shooting support to help customers if something goes wrong, customer education on the systems, and support in properly sizing the equipment.
Will the Price Increase Based on the Value of My Home?
Though most of what goes into preparing a bid is objective information, one can’t help but wonder if there are any subjective aspects of the home or homeowner that may affect the markup of equipment or the profit margin. For example, if you live in an expensive home or appear to live a wealthier lifestyle, will the contractor try to squeeze a few more dollars from you?
Jackson says that he does not adjust a bid based on whether he believes the homeowner is wealthy or not, but he acknowledges that some contractors do.
“The fact is that some contractors are going to charge you more based on where you live and how flashy of a lifestyle you have,” says Jackson, “and some contractors will charge you based on the SEER rating of the equipment you want.”
How Common Is It to “Revise” a Bid?
Lastly, there is nothing more frustrating than to receive a number of bids and select a contractor only to have him come back to you and say he has to raise his price because of unforeseen complications.
According to the sources for this story it is rare for a contractor to revise a bid after they have won the job and begun work; though some do. As part of your due diligence this might be a good question to ask a contractor’s references or keep an eye out for in online customer ratings as it may be a sign of a less than reputable contractor.
What is common, however, is for a bid and contract to include “exclusions.” These are specific things that the contractor will not do. For example, if a homeowner already has wiring running up a chase, then adding a new line would be excluded if the homeowner does not want it replaced. “These are exclusions on items that we are not going to do for the price the homeowner has agreed to pay for the scope of work,” says Jackson.
Perhaps the best advice we received while researching this story is to make sure you don’t end up seeking a contractor to replace an AC system in an emergency situation. The fact is that it takes time to do your research to find contractors to request bids from, research their bids and learn all that you need to know about AC system replacements.
The best advice is to periodically consider the age of your system and ask a technician during regular maintenance how the system looks.
Also think about how comfortable you feel for the price you are paying in utilities. For example, do you find yourself turning the AC down to where it is marginally comfortable on a hot day because you are paying a lot in utilities? If so, this may mean your system is not functioning at peak efficiency, which could indicate improper installation, that it is aging, or that some aspect of it needs to be fixed or replaced.
These systems are significant investments, so be sure you have the time to make a good, well- researched choice.