Second in a series of articles addressing ten key provisions in construction contracts. Show
One of the most fundamental provisions of any construction contract is the price to be paid for work performed. Different pricing methods may be utilized. Factors such as budget constraints, status of design completion, anticipated risks and project difficulties, construction schedule, and certainty of costs and time impact how the parties select and negotiate contract provisions regarding pricing. In general, there are three industry standards for pricing options: fixed price or lump sum pricing, cost-plus pricing (with or without a guaranteed maximum price) and unit price. Fixed Price / Lump Sum PricingFixed price or lump sum pricing, as the name indicates, provides for payment of a set amount. The amount of the fixed price or lump sum is determined by a contractor by estimating their cost to provide the work, and then adding overhead and a profit margin. Provided an owner finds the lump sum calculation acceptable, either through a bidding process or negotiation, then the lump sum price becomes part of the contract. The lump sum amount is typically paid out monthly during the project depending upon the percentage of work completed. To aid in payment on this percentage basis, often a contractor will prepare a schedule of values to assign value to each component of the work that makes up the overall contract. Payment occurs over time commensurate with completion of the work (often through estimated percentages). Advantages:
Disadvantages:
Cost-Plus – With or Without a Guaranteed Maximum Price“Cost-Plus” is a pricing option in which a party providing the work calculates the cost to complete the work, and then adds a fee. Costs to complete the work typically include all amounts paid to subcontractors for labor and materials, plus general conditions – or those items that are outside direct labor and materials such as project management, site office, tools and equipment. The fee, which is the profit estimated by the contractor, and with some contracts all or part of overhead, may be one defined amount or it may be based on a percentage of the defined costs. It is not hard to imagine a pricing method based on costs, which are often a moving target, escalating out of control. That is why cost-plus pricing is often combined with a guaranteed maximum price (GMP). Cost-plus with GMP provides an upper limit on total construction costs and fees for which an owner is responsible. If the party providing the work under this pricing method runs over GMP, it is responsible for such overruns. Recognize, however, that changes to the scope of work may increase the GMP. The parties to a cost-plus with GMP contract negotiate at the outset how any costs savings (i.e., work performed for less than GMP) will be allocated, often agreeing to share in these savings. Advantages:
Disadvantages:
Unit PriceYet another pricing option is unit pricing, where the party providing the work sets a price for each unit of work. This type of pricing is more common on certain public works projects, such as road building projects. The contractor quotes an owner a price for a particular task or scope of work, though at the time of contracting the parties may not know the actual number of the units of work to be completed. Advantages:
Disadvantages:
Additional Construction Contract Pricing ConsiderationsParties should also take note of the considerations below when negotiating the price to be included in a construction contract:
What are the disadvantages of fixed price contracts?Disadvantages of fixed-price. Lack of flexibility. A fixed-price project has a defined scope (requirements). ... . Writing specifications is hard and takes a lot of time. ... . Wasted time negotiating change. ... . Less client involvement.. What kind of risk is a fixedAs shown in Exhibit 1, fixed-price contracts are the highest risk to the supplier and the lowest risk to the client (Gray and Larson, 2014, p. 453). Cost-based contracts, on the other hand, are the highest risk to the client and lowest risk to the supplier.
What is the problem with fixed prices?Shortcoming of a fixed term contract
A fixed pricing contract gives a buyer more certainty about future service or goods costs, but it does come at a cost. Because sellers may recognise that they're taking a risk by having a fixed price, they may charge more than they would for a variable price.
Who bears the majority of the risk in a fixedFixed Price Contracts Fixed price (FP) contracts (also called lump-sum contracts) involve a predetermined fixed price for the product and are used when the product is well defined. Therefore, the seller bears a higher burden of the cost risk than the buyer.
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