For many organizations, capital construction projects represent a large capital outlay, often being one of the largest expenditures they take on. However, not all construction contracts are created equal—there are advantages and disadvantages to each method. Since there are many types of contracts and project delivery methods, it can be difficult to fully understand the arguments for and against each contracting method.
Time & Material
Advantage: Owners have the freedom to change the specifications of the project and can add or remove components of the project much easier.
Disadvantage: With no incentive to be efficient, the contractor could overbill and costs could be inflated.
Guaranteed Max Price (GMP)
Advantage: The owner can benefit from cost savings, and these contracts help protect owners from large fee increases.
Disadvantage: The contractor often thinks the GMP amount is the budget. In addition, contractors sometimes inflate the price on a GMP contract, which can burden the owner with more project management. Change orders need to be scrutinized under this contracting method, since contractors often try to make up lost profits through change orders.
Advantage: This works well on clearly defined tasks (no unknowns) and can be executed quicker if prices are agreed on in advance.
Disadvantage: It doesn’t work well for larger projects. Instead, it works better for smaller task items, e.g., laying sod, installing light fixtures, etc.
Lump Sum (Fixed Price)
Advantage: This contract type helps you be aware of project cost for cash flow and budgeting purposes, has less administrative burden and typically doesn’t see budget increases.
Disadvantage: If costs increase, contractors can cut corners to save money, thus sacrificing quality—and possibly safety.
Note: Keep in mind that contractors build in extra profits when developing a lump sum to account for any contingencies. If none arise, the owner could have paid more for the work under this contract method.
Cost Plus Fixed Fee
Advantage: This type helps execute projects quicker while the design is still being finalized and can add a cost-savings clause to split savings.
Disadvantage: It requires more work from the owner to analyze invoices for accuracy. Despite having a shared-savings clause, the owner is giving the contractor extra money.
Construction projects are costly and inherently contain opportunities for overcharges. Whichever contract type you choose, be sure to review the contract before accepting it. Many organizations make the mistake of accepting a contract drafted by the contractor or architect.
For more on how BKD can help with your capital construction contract, contact your trusted BKD advisor or Adam Rouse, leader of BKD’s construction contract services within BKD’s Enterprise Risk Solutions division.