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Cost-plus, a clients question

Sam_Fromartz's picture

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We are renovating a townhouse in Washington DC for six-figures-plus and have settled on a contractor whose work we really like. We used an architect, a budget and got a preliminary estimate from the builder that was in line with our expectations. I have a couple of questions about his cost-plus contract, however.

He wants:
1. $20,000 up front for labor/materials that comes out of the back end when the project is done. (I assume this is so he doesn't have to chase us for the final bill).

2. 20 percent for his fee paid with the biweekly invoices of labor and materials. Subs are working on fixed-contract basis.

My issues:

1. Can there be retainage on his fee in a cost-plus contract so that he has an incentive to finish the job?

2. How can one build in a budget process so we make sure the budget is in line as the project progresses. (I don't want to be hit with a surprise cost overrun).

3. Can we build in an incentive for him to come in within the estimated budget or are we just shooting ourselves in the foot. ie, corners will be cut to make the incentive.

Any thoughts you folks have on this would be welcome.

Thank you,
Sam

(post #163878, reply #1 of 58)

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Well this is a remodel. The fact is that for a serious remodel you never really know what the job is until demo is done. A lot is hidden by the walls. So, I would kiss good bye any hope of coming in on budget. You should expect cost overruns for unexpected problems you encounter. If this were new construction you could tie down the bucks. Don't even try for a remodel at least until the walls are open.

What you should expect is a schedule of costs and a negotiation method for figuring out what to do and how much it is going to cost when the problems come up. You should also look at the contractor's business record as well as the quality of work. Most are pretty good. But, like anything else, the unethical or inept can create a nightmare.

Just reread your post. Washington DC? Seems to me from what I've read a low 6 figure remodel, depending on where it is, may not be much. I mean a $100,000 remodel in lots of places is merely cosmetic. So, how about describing about what you are having done?

(post #163878, reply #2 of 58)

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Sam,
He wants:
1.A down payment is ordinary and expected,as you should finance your project,not your contractor.This allows the contractor to fund the project and place orders for materials and down payments to the subs as necessary.Normally,I would then present the invoices against this balance,accounting for it in the project,and continuing to use it to fund the ongoing project.See #2...

2.20% is fairly common-refering to #1,this is now the money that the contractor has earned,and gets to pocket;the 20% down is still funding the project.

Your Issues:
1.A retainage on his fee in effect means that your contractor is not making a profit during the course of your project and will not realize a profit until the end.There are several ways to provide for incentive on the contractors' part:One is with a cost plus fixed fee arrangement,you might ask him about this possibility;Another is to offer to split the difference with him if he comes in under budget and on time.(This assumes change orders to be seperate from the budget).

2.Keep an eye on the invoices;ask your contractor(Who has a reputation as an ethical builder,I hope) how you are doing in terms of budget.Can't think of anything better at this point.

3.See #1 above-If the contractor builds to your architects specifications,there should be no corners cut in any event.

Making sure your contractor is someone you can trust is very important always,and even more so in a contract of this nature.Maybe you would feel better taking firm bids...?A whole 'nother can o' worms...

Hope this helps..

JW Heck,JW Heck Building Company

(post #163878, reply #3 of 58)

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Mr. Fromartx, both Fred and Jim posted important concerns.

It's crutial that you verify the integrity of your contractor. Also, as the others mentioned, I cannot emphasize enough that not one, and I mean not one, contract ever came in at the contract price. The larger the dollar amount and the more details of the remodeling involved, the more Change Orders will be initiated, both by the items exposed during the process and the changes you will want as you see things develop. Plus, your building dept. may mandate changes once the demo is done.

I never ask for labor monies up front, but do for any and all materials, plus those deposits our subs may require. That's pretty much standard.

I've never understood the purpose of retainage in residential projects. Certainly, as the work is being done, and the project progresses, one can see if something is being done wrong, plus you have the building inspection approvals of all phases, plus you have pay out phases. Usually, of those who asked about retainage, their reasoning was just to assure things were done correctly and to assuage their anxieties. I said sure, then from my perspective, since I've not taken a credit report on you to verify your capability, or intent, to pay, how about giving me a 50% deposit so relieve my own anxieties? See, in large remodels, in effect, during the process of remodeling I'm extending credit to the client.

Remember, this is a partnership for a specific purpose and for a specific duration. The contract fit and "procedures" must be fair to both "partners." And no ambiguities.

Finally, as I tell our clients, we do not have the luxury of an R&D Dept as factories, not their ability to refine and test market their "proto-types". Nor the ideal environment of a factory setting. We must bring our man power, equipment and materials to your home, and build out "proto-type" under your watch full eye and under what are really conditions under duress. And we have only one shot at it while trying to make our own 5% - 10% net profit. Try building a $100,000 custom designed car under those conditons. So be prepared for Change Orders. They are a normal part of the process of building proto-types in this un-natural environment as manufacturing per se.

One more thing. I've never seen a set of architectural plans yet for a remodeling project that "didn't" have errors or items that were missed or not accounted for. Whoops! Another Change Order.

(post #163878, reply #4 of 58)

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James, this sounds interesting but I'm not sure what it means:

"There are several ways to provide for incentive on the contractors' part: One is with a cost plus fixed fee arrangement, you might ask him about this possibility" (you mean his fee is fixed rather than a percentage?)

"Another is to offer to split the difference with him if he comes in under budget and on time.(This assumes change orders to be seperate from the budget)." (You mean if the job costs $10,000 less than expected he gets $5,000?)

I think the point I hear most is about ethics and trust. And on that score all I have is his former clients and my architect who has worked with him before. I feel he is honest and trustworthy.

As for cost overruns, I've heard the point about you never know what's behind the walls -- and I can understand that, which is why we agreed to cost plus. I figured that in a fixed bid, the unknowns would be tacked into the contract as a generous percentage in any case.

Fred, As for the job, it's a townhouse with two room areas on each floor: dining room/kitchen on ground floor, living room on 2nd floor separated by a fireplace structure in the middle; two bedrooms on top floor with bathroom between them. Its about 1,800 sf.

The job:
Ground floor: new kitchen, remove 1/2 of a bearing wall to open up kitchen to dining room. Replace glass wood doors to yard. New small powder room in brick shed attached to house. Window between shed and house turns into a doorway. New storage beneeth stairs.

Second floor: 3 glass/steel pocket doors to close off 1/2 of living room (hard to explain without a drawing). Add tile shower area to half-bath where a washer/dryer is. Move washer dryer to third floor.

Third floor: redo existing 6x6' bathroom: new tiles, tub, vanity. Wall off new space for washer dryer stack.

Refinish old pine floors in top two floors, paint whole house. Refinish teak tile floor in dining room. Lay slate floor in kitchen.

(post #163878, reply #5 of 58)

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Sam,
Fred makes the most important point in his first sentence. Remodeling is the big unknown.
This fact can be fun or terrifing. The only way to make it fun is to realize changes are going to happen.
Most of those changes, if everything is designed reasonably well, will come from you. It's fun (or it should be) to see your project develop and have the ability to change your mind.
Fred's, James' and Sonney's points try to address this reality. If you have things your way, Your builder will have to keep everything to the letter of the specs.
The way he has it set up, your allowed to change your mind.
As for a bonus, Everyone I've every done one of these deals for is broke at the end. Offer me a bonus, I'll take it, but I won't count on it.
Luck

(post #163878, reply #6 of 58)

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Sam,

"There are several ways to provide for incentive on the contractors' part: One is with a cost plus fixed fee arrangement, you might ask him about this possibility" (you mean his fee is fixed rather than a percentage?)
Exactly.The idea here is that you are purchasing the contractors' services for a fixed price.This price is normally determined to be a percentage of the budget,the contractor will estimate the time necessary to complete the project,and charges you a fee for using his company for that time,and no more.He will be trying to recover his profit and overhead for the time that his resources are tied up on your project.The incentive here is that after making this agreement,the more efficiently and quickly he can complete the project and free up his resources,the more net profit he makes.He is rewarded for efficiency and actually is penalized if the project takes much longer than estimated,as his "plus" is fixed.The client pays for all construction costs as normal,same accountability,the fee is prorated along the project.As soon as the fee is gone,the contractor wants to be done.Now the client knows that the contractor is not dragging out the job,no gain in it for him.

"Another is to offer to split the difference with him if he comes in under budget and on time.(This assumes change orders to be seperate from the budget)." (You mean if the job costs $10,000 less than expected he gets $5,000?)
Again,the contractor is awarded for efficiency.If your primary concern is one of cost control,and if you were agreeable to paying the budget estimate to begin with,wouldn't you feel it was fair to reward your contractor $5,000.00 if he saved you $5,000.00?(To use your $10,000.00 example)The only way he can accomplish this would be with a sustained effort to be efficient.The incentive.

All of this again does not include change orders.In both arrangements,change orders would include additional fee,and in the second arrangement would also include additional time to complete.More work=more fee and more time.

Remodeling can be very stressful for all involved,and these two arrangements give the most flexability to the owner,as well as the fairest compensation to the builder.You should get what you pay for,and he should get paid for what he does.

I have used these types of contracts for many years,as I feel they are the most equitable that we have available.You are correct in observing that a fixed bid would have to allow for every contingency,and you might end up paying for more than you get. From the contractor's standpoint,the work is too hard to risk not making a profit.

Luck,

James

(post #163878, reply #7 of 58)

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Sam

What you have with your contractor is a cost plus a percentage of costs contract. The greater the cost, the greater the fee.

A cost plus fixed fee contract provides a set fee. No matter how high the costs the fee remains the same.

Avoid the advice on setting a certain budget and splitting the difference with the contractor if costs are under that budget amount. Such a situation only leads to the contractor thinking of himself and how he can screw you and those who furnish labor and materials.

(post #163878, reply #8 of 58)

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Remodeling. Plan on 20-30% higher costs than planned on! Safe way...either set a budget, and if possible....set 20-30% of that in an accessable account....or scale back the project by 20-30% and put the moneys left over into an accessable account. Unforeseen conditions, code updates, and most of all...client change orders, updates, and may-as-wells will create this 20-30%.
Alot of it being 20 or 30% will be the age and construction of the original building...and how much the original building is disturbed. The rest, if your contractor did his job....will come from the customer changing and/or adding to the scope of work. Jeff

(post #163878, reply #9 of 58)

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Sam

From your post, there are three components to your project. First, the contractor is getting 20 per cent of the cost of labor and materials. Second, the subcontractors are not getting a percentage of the cost of labor and materials, but rather a fixed fee. And third, you have the cost of labor and materials.

If your subcontractors had operated on a 20 per cent of the cost of labor and materials like your contractor, then 40 per cent of your budget would have been contractor fees and 60 per cent for labor and materials. That seems high to me. You want to put most of your funds into good materials and quality labor.

Make sure that the workmen employed by the subcontractors and the material suppliers employed by the subcontractors turn in proper invoices for the labor and materials supplied by them. The 20 per cent you are paying your contractor is based on those amounts. The fixed fees to the subcontractors are separate and the contractor is not entitled to a percentage of those fees since they are not labor and materials.

(post #163878, reply #10 of 58)

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Thanks for the info. You've gotten some pretty good advise on the contract side of it. But, consider this. You are making both cosmetic and basic structural changes to the town house. That means that it must be brought up to current code in the process, at least I think that is true throughout the continent. So, you really don't know how big the job is until you get the place opened up and are able to inspect it.

So, why not do it this way? Break the contract into two phases. First phase is the demo and inspection phase. Contractor does this either on a Fixed Cost, or a Fixed Fee Plus Cost basis. You agree on a schedule of charges for the actual remodel.

Second phase is the remodel. You, your architect and the contractor agree on what needs to be done. You apply the schedule of charges to the Schedule of Tasks and go for it. Payment schedules are always a tough bone. They are because everyone wants to hang on to their money or get the money sooner. I'm comfortable with anything that guarantees to the contractor that you are, in fact, able to pay the bill. No decent contractor wants to take the chance on getting stiffed in the end. Nor, does he want to starve while the job is going on.

So, why not pay for phase one in two lumps, beginning and end. For phase two pay materials as purchased and the fee in three lumps, 20% up front, 30% half way and then the end. Subs are to be paid as the costs are incurred based on presented bills.

This gives you control, gives you a chance to quit if the job is too big, gives the contractor his money and makes sure subs are paid on time.

Now, it is your turn to see if you can keep the right attitude about the big adventure!

(post #163878, reply #11 of 58)

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Thanks all for your thoughtful advice. I will let you know what we decide in the next week but off the bat I think the fixed fee idea makes a lot of sense.

Fred, I negleted to mention the house was renovated in 1972, nearly gutted, so many of the systems as far as we are aware are to code. There are of course some unkowns behind the walls in terms of some duct work. We were also permitted by the city on the architectural plans already.

Again, thanks to this group for all the advice -
Sam

(post #163878, reply #12 of 58)

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You can open walls now and end many mysteries...I am always asking to do this...

near the stream,

aj

I would be wary of unlimited unknowns...

(post #163878, reply #13 of 58)

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Ditto, AJ.
You can save yourself alot of grief and misunderstandings.

Billy

(post #163878, reply #14 of 58)

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Sam, I have negotiated one "cost plus, not to exceed" contract. I basically figured my budget and then doubled it. We then agreed to split the underage.

There wasn't any and I was thankful that I doulbled the cost going it.

The idea basically trumps the original idea of getting the homeowner to pay for everything, like they should. But the homeowner tends to get too scared to enter into a cost plus contract even though their can be substantial savings because of them. After all, you must be aware that contractors assume the worst on fixed bids and pocket the difference between the worst and best scenarios.

Try asking for a cost plus not to exceed contract. You might spend a little more but the peace of mind might be just what you need.

blue

(post #163878, reply #15 of 58)

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This is a little late, most likely.

In a a contract what both parties agree to, is what you have. The hard part is being fair to both parties. The contraact writer usually protects themselves the most.

The thread doesn't explain much, but how can the specialty subs bid fixed price? Bids after everything opened up and the work can be defined? Therfore unknown, so cost plus?

Watch the plus percentage fee profits. The more it costs, including the GC's mistakes, there's profit.

Working cost plus is an art form, particulaely for the buyer. Knowing what info to ask for and knowing what isn't significant is somrthing only experience can help you with. You can mire yourself in data or you can skip over important stuff.

Cost plus - buyer risk
Fixed price - seller risk

Cost plus can be the most cost effective way to do a job.

Lots of variables

If your paying biweekly you shouldn't need a big deposit because you're probably making payments before the GC is billed.

Lots of variables

Many assumptions on the statements. Lots depends on GC's business methods.

(post #163878, reply #16 of 58)

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I like AJ's idea about ripping the walls open before starting. I have made similar suggestions myself.

Clients understandably want a fixed cost on a project. Generally that is what a bid represents. The number one reason why it escalates? The client.

Fact is, customers never want less than the specified amount of work once the job starts. Further, customers will make changes even to the smallest job, its inevitable. I get the old can we put a door there?, often, and then I got to frame it, trim it, paint it, etc. That costs money, and you're paying.

Personally, from a contractor's perspective, little good can come from cost plus contracts at least for me. I cannot bill labor high enough or make my margins. Clients tend to watch the clock more on these jobs. I tend to drive my guys harder.

Having said all that I am doing a cost plus job this year, but there are special circumstances. Oh yeah and I did a big one last year. In the end, terms in any agreement have to be negotiable by both parties. Contract negotiation, not contract ramming it down someone's throat.

Hey Ted, 40 percent in contractors fees and overhead sounds right to me. Aren't the subs entitled? Shoot the gov't gets more than that and they can't do anything right.

(post #163878, reply #17 of 58)

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What's the point in doing a cost plus not to exceed? Just do a fixed cost and make it so high that it covers every possible thing and then the contract prices is yours even if all goes well. A not to exceed contract just never made sense to me.

I can handle a cost plus contract, and do them all the time.

Louis

(post #163878, reply #18 of 58)

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I do 90 percent of my work on a time and material basis(labor plus materials I 20%). I believe that it gives my clients the best value, and also control of their money. In this age of big bow stores, I try to sell my service, since most of my clients think that they can get materials cheaper than me. I also think that a time and material contract eliminates some of the animosity that happens on a fixed fee contract. I believe that we end up playing on the same team, so to speak, instead of being adversaries. It is not the perfect match for everyone, but works well for me. I can also get very close with my ball park figures to start, but all my clients make too many changes to hold me to those prices.

(post #163878, reply #19 of 58)

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david .. et al...

cost plus only works for us as contractors if we have correctly identified our COSTS..

what does the 20% represent ? is that your company's profit ?

if it is overhead and profit.. you'll go broke..

in a true cost plus contract.. the cost will include all of your overhead associated with the time span of teh the contract..

for example: if you have 1800 hours of billable production time in a year... and the contract you are doing takes 25% of your work schedule for that year... then the job has to carry 215% of your overhead...

including your production hours... ( what ever they are)... plus LABOR BURDEN.. plus overhead.. usually means that you have to charge $30 to $45 per hour for your labor rate...

at those levels... the customer starts to balk when your crew takes a coffee break..... or anything else tehy think is non-productive....

when public contracts go to "force account" or cost plus... every paper clip, phone call, fax machine, niut and bolt is part of the cost...

is it part of yours?

(post #163878, reply #20 of 58)

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In my world there is a defference between a time & materials and cost plus. While the result in a good relationship/experience is the same, when things go sour there is a world of difference.

(post #163878, reply #21 of 58)

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When I have done a cost + fixed it is based on a certain estimated amount. If the customer should up the scope of the project, I have it written in the contract that the "plus" will increase proportionaly. That way I am not doing all the extra work for no profit.
That is why I believe that the cost + % is a better way to go. From the contractor's point of view, there is no possiblity of losing money if you are using a properly calculated profit. From the customers view, they are getting exactly what they pay for, not bulking up the cost for unforseens as done in fixed price contracts. Cost + % requires trust on the part of the customer, and that can only be earned with a good past history. It makes the contractor totally accountable for what happens. And, the best parts of it is that less overhead time going into the contract is required by contractor, as precision to the nth degree is not required, allowing for the estimating to go quicker, as well as the fact that change orders are not needed. If a decision is made for a chabge by customer, I will give them an approximate cost and begin the work.
the percentages I use are 15% for near or over 100K jobs, 20% for over 40 k, 25% for over 15K, and only a fixed cost for anything under 15K.
More muddle for the mind.

Jim B

(post #163878, reply #22 of 58)

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bobl... i don't care what you call it....
does T&M include all of your costs or not.. if it doesn't ... you're subsidizing your customer...

(post #163878, reply #23 of 58)

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Louis, I did one cost plus, not to exceed.

I wasn't willing to do a set fee. He wasn't willing to do an open ended contract. We were talking about a $5,000 half bath remodel. Theortetically, that half bath could end up in the million dollar range with an open-ended contract.

We agreed with a cost plus, not to exceed and to split the difference between the expected contract price, and the top end. It served as a reward to me to keep the costs down and accept the risk. The price was high enough to cover all possible situations.

I ended up using every penny and there was nothing to split. We didn't go over however because it was bid on the worst case scenario and then doubled.

I got the profitable job, while the other, non-flexible bidders lost out. The client understood the risks and appreciated the chance to save a little if it was at all possible. It wasn't.

blue

(post #163878, reply #24 of 58)

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Blue
What would have happened had you exceeded the not to exceede price? Then who would have lost? Who really holds the cards in this scenario?

This one worked out for you but others may not.

Louis

(post #163878, reply #25 of 58)

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Mike Smith,

In my world on a T&M you are delivering labor hours and materials.
On Cost plus you are delivering a product at a price that is soft.

In other words, on T&M you work 80 hours you get paid 80 hours at the agreed to rate. You deliver 8 sheet of plywood and 30 2x's, you get paid for those, if the product is useful or not. Cost plus you are suppose to deliver a product as agreed to.

If I want a dog house under Cost+, you are expected legally to deliver a dog house, even if the cost of building it went up or down. T&M, you provide the labor and materials, if you what you build as a dog house isn't suitable as a dog house, you still delivered what you contracted for, labor and materials.

Good relationship etc, it doesn't matter.

Things go sour, what the contract calls for can be the difference of winning or losing in court.

All pricing should take into consideration overhead etc in insuring that your cash outflow is covered. This can get tricky if you haven't decided on your pricing schemes, know your overhead etc.

Getting into soft situations and trickey/complicated contractual relationships is easyily turned into disaster. All the different types of contractual types (including those fixed price variations different from firm fixed price, which is what is normally discussed here) have advantages and disadvantages. Getting both sides to understand what the risks are and which type to use is not easy in the residential market. Also, what information might be needed in the alternatives (from firm fixed price) can be taken as offense by those not familar. Too much information can also be asked to be provided.

(post #163878, reply #26 of 58)

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ok, bobl... good answer..

too many in the trades think they are covering their bases with T&M..

when they are really just twisting in the wind because they ARE NOT covering their costs...

lessons learned the hard way...from my early days doing cost -plus.......

(post #163878, reply #27 of 58)

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Hi MIke
I agree with you! A contractor does need to cover all of his costs when he does a cost plus job and it is possible to do a T&M job and cover all your costs.

And your right 20% does not cover your costs!!

When I do a cost plus job or a T&M I take all of my costs into consideration.

I have a question. Are all contractors just scum of the earth and all are looking for any opportunity to take advantage of unsuspecting consumers? Are the contractors that post here like this?

Louis

(post #163878, reply #28 of 58)

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Louis, we would have lost if the job went over. That is the same situation that a fixed price offers.

The cards were held, and played, before the first nail was driven. I/we pretty much knew, from experience, what the worst case scenario was. In this particular situation, the superintendent hired his friend, the plumber wannabe, and told him the situation, basically telling him to use it all up.

If you can't make a cost plus, not to exceed work, you probably shouldn't be giving fixed bids either.

blue

(post #163878, reply #29 of 58)

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Louis, what's with the scum of the earth question?

What does taking advantage of unsuspecting consumers mean?

blue

(post #163878, reply #30 of 58)

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>Louis, what's with the scum of the earth question?

>What does taking advantage of unsuspecting consumers mean?

Some of the posts make it sound like a customer could nor possible trust a contractor to do a T&M or a cost plus job.

I have news. I have customers who only want to do cost plus jobs because they trust me and I trust them. What a novel idea. And I make money on these jobs and I cover my costs.