Tariff Negotiation for Contractors

Gierke: [Tariffs] are perhaps not the biggest risk contractors are facing, but they’ve certainly created the largest amount of uncertainty in their businesses.

FMI put out a whitepaper that instructed contractors to be ready for conservatively 5% to 7% price increases this year. And I thought that was conservative at the time.

The Construction Industry Roundtable Report—which is about 130 CEOs and executives of architectural engineering firms and large commercial contractors that was conducted in April and May—that survey they came back and said respondents expect their pricing for materials to increase anywhere from 5% to 10%.

That 5% to 10%, that is typically the entire net income of a contracting business, that's everything… if prices go up 5% to 10% and contractors do nothing, that's the difference between, frankly, making something or making nothing or even losing money. So, the moral of the story is: pick good projects and execute them profitably and protect yourself against this pricing risk.

CONTRACTOR: In some of the writing you’ve done on the FMI site, you drew parallels between the situation we're in now and the disruptions the industry went through back during the pandemic. What are some lessons to take from the pandemic?

Gierke: I haven't mentioned overall supply chain disruption yet—the extended time that it takes to get materials—that's often an even larger impact to our projects and to our business… remember those vendor letters [during the pandemic] that your equipment was going to be 10 weeks late, or it was going to be 26 weeks late, or 60 weeks. I expect that if this tariff uncertainty continues, we're going to start seeing the same thing again as manufacturers draw down their inventories and then wait to restock.

What most contractors learned during COVID was that buying early is really important. How quickly can I get my project bought out? How quickly can I buy everything, lock in pricing, lock in deliveries? Because the earlier the better.

Contractors also learned to work with the customer to lock in design choices, and so that drove a lot of conversations upstream. Customers were being asked to issue letters of intent to buy materials early, even before we knew what the entire scope of the project would look like… What size of building are we really going to build? What's the mechanical system that we're going to install? We have to make those decisions earlier and then we can't change them.

It's the same with contracts. Contracts are meant to drive discussions around risk and how risk will be shared… Contractors modified force majeure clauses and inserted clauses around cost sharing or price sharing for material price escalation. Clauses around time-impacted materials and price-impacted materials, but all of that was really meant to drive a conversation about where the risk lies and how that risk was being handled.

All these lessons really revolve around communication—communication upstream with customers, with your vendors, with designers, with your field, with your project managers. Communicate early and often.

Something else to keep in mind, the average plumbing and mechanical contractor makes about 5% net a year. Pre-COVID, that number was closer to 4%. So, something happened during COVID. Those contractors that adapted to the risks, who took on those risks, who mitigated those risks, actually became more profitable—and that's net of things like the PPP (Paycheck Protection Program) funding that was available during that time, or employee retention credit for those firms that qualified.

For contractors who can solve this problem, they'll come out ahead.

CONTRACTOR: What are the most important things a contractor needs to communicate that a typical customer might not understand?

Gierke: One is the cost increases that have already hit various types of contractors—33% since COVID for plumbing and HVAC. Customers don't really realize that the cost of building their projects has gone up by at least that much.

According to the Bureau of Labor Statistics, the cost of building a school project, a healthcare project, a manufacturing facility, a warehouse has gone up anywhere from 33% to 45% since COVID, and that's a hard number to wrap your head around.

Customers don't realize that price increases happened, and that's already in the past, that's baked in. So what we’re talking about, in 2025, the 5%, 10% more (depending on the mix of materials and what you're building), that's on top of that. For customers who aren't, say, repeat buyers of construction, who aren't in the marketplace all the time, which I think is most customers, they're going to get a little bit of sticker shock, so we have to prep them for that.

Because those costs, at the end of the day, are their project costs. They're not the contractor’s costs… those are the customer’s cost to bear. That's a tough conversation.

Contractors are expected to know everything about what's going on in the construction materials market, and supply chains, and delivery—but that's not our business. Our business is building great projects for our customers. We are not experts in the futures market for various commodities.

The second thing that I don't think customers realize is just how much these price increases are coupled with material delays, shipping delays or extended lead times.

So, customers really do have to participate and make decisions earlier about what it is that's going to be the design basis of their project… We need them to make decisions earlier so we can get that stuff here, sooner, in order to build their projects on the schedule that they want.