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(Financing of Constructed Facilities) (Construction Planning)
Construction Pricing and Contracting
    Pricing for Constructed Facilities
    Contract Provisions for Risk Allocation
    Risks and Incentives on Construction Quality
    Types of Construction Contracts
    Relative Costs of Construction Contracts
    Principles of Competitive Bidding
    Principles of Contract Negotiation
    Negotiation Simulation: An Example
    Resolution of Contract Disputes
    References
    Problems
    Footnotes

8. Construction Pricing and Contracting

8.1 Pricing for Constructed Facilities
Because of the unique nature of constructed facilities, it is almost imperative to have
a
separate price for each facility. The construction contract price includes the direct
project
cost including field supervision expenses plus the markup imposed by contractors
for
general overhead expenses and profit. The factors influencing a facility price will
vary by
type of facility and location as well. Within each of the major categories of
construction
such as residential housing, commercial buildings, industrial complexes and
infrastructure,
there are smaller segments which have very different environments with
regard to price
setting. However, all pricing arrangements have some common features in
the form of the
legal documents binding the owner and the supplier(s) of the facility.
Without addressing
special issues in various industry segments, the most common types of
pricing
arrangements can be described broadly to illustrate the basic principles.

Competitive Bidding

The basic structure of the bidding process consists of the formulation of detailed
plans and
specifications of a facility based on the objectives and requirements of the
owner, and the
invitation of qualified contractors to bid for the right to execute the
project. The definition
of a qualified contractor usually calls for a minimal evidence of
previous experience and
financial stability. In the private sector, the owner has
considerable latitude in selecting the
bidders, ranging from open competition to the
restriction of bidders to a few favored
contractors. In the public sector, the rules are
carefully delineated to place all qualified
contractors on an equal footing for
competition, and strictly enforced to prevent collusion
among contractors and unethical or
illegal actions by public officials.

Detailed plans and specifications are usually prepared by an architectural/engineering

firm
which oversees the bidding process on behalf of the owner. The final bids are
normally
submitted on either a lump sum or unit price basis, as stipulated by the owner. A
lump sum
bid represents the total price for which a contractor offers to complete a
facility according
to the detailed plans and specifications. Unit price bidding is used in
projects for which the
quantity of materials or the amount of labor involved in some key
tasks is particularly
uncertain. In such cases, the contractor is permitted to submit a
list of unit prices for those
tasks, and the final price used to determine the lowest
bidder is based on the lump sum
price computed by multiplying the quoted unit price for
each specified task by the
corresponding quantity in the owner's estimates for quantities.
However, the total payment
to the winning contractor will be based on the actual
quantities multiplied by the respective
quoted unit prices.

Negotiated Contracts

Instead of inviting competitive bidding, private owners often choose to award

construction
contracts with one or more selected contractors. A major reason for using
negotiated
contracts is the flexibility of this type of pricing arrangement, particularly
for projects of
large size and great complexity or for projects which substantially
duplicate previous
facilities sponsored by the owner. An owner may value the expertise and
integrity of a
particular contractor who has a good reputation or has worked successfully
for the owner
in the past. If it becomes necessary to meet a deadline for completion of
the project, the
construction of a project may proceed without waiting for the completion
of the detailed
plans and specifications with a contractor that the owner can trust.
However, the owner's
staff must be highly knowledgeable and competent in evaluating
contractor proposals and
monitoring subsequent performance.

Generally, negotiated contracts require the reimbursement of direct project cost plus
the
contractor's fee as determined by one of the following methods:

1. Cost plus fixed percentage

2. Cost plus fixed fee
3. Cost plus variable fee
4. Target estimate
5. Guaranteed maximum price or cost

The fixed percentage or fixed fee is determined at the outset of the project, while
variable
fee and target estimates are used as an incentive to reduce costs by sharing any
cost savings.
A guaranteed maximum cost arrangement imposes a penalty on a contractor for
cost
overruns and failure to complete the project on time. With a guaranteed maximum price
contract, amounts below the maximum are typically shared between the owner and the
contractor, while the contractor is responsible for costs above the maximum.

Speculative Residential Construction

In residential construction, developers often build houses and condominiums in

anticipation of the demand of home buyers. Because the basic needs of home buyers are
very
similar and home designs can be standardized to some degree, the probability of
finding
buyers of good housing units within a relatively short time is quite high.
Consequently,
developers are willing to undertake speculative building and lending
institutions are also
willing to finance such construction. The developer essentially set the
price for each
housing unit as the market will bear, and can adjust the prices of remaining
units at any
given time according to the market trend.

Force-Account Construction

Some owners use in-house labor forces to perform a substantial amount of construction,
particularly for addition, renovation and repair work. Then, the total of the
force-account
charges including in-house overhead expenses will be the pricing arrangement
for the
construction.
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8.2 Contract Provisions for Risk Allocation

Provisions for the allocation of risk among parties to a contract can appear in
numerous
areas in addition to the total construction price. Typically, these provisions
assign
responsibility for covering the costs of possible or unforeseen occurances. A
partial list of
responsibilities with concomitant risk that can be assigned to different
parties would
include:

Force majeure (i.e., this provision absolves an owner or a contractor for payment for
costs due to "Acts of God" and other external
events such as war or labor strikes)
Indemnification (i.e., this provision absolves the indemified party from any payment
for losses and damages incurred by a third party such as adjacent property owners.)
Liens (i.e., assurances that third party claims are settled such as "mechanics
liens" for
worker wages),
Labor laws (i.e., payments for any violation of labor laws and regulations on the job
site),
Differing site conditions (i.e., responsibility for extra costs due to unexpected site
conditions),
Delays and extensions of time,
Liquidated damages (i.e., payments for any facility defects with payment amounts
agreed
to in advance)
Consequential damages (i.e., payments for actual damage costs assessed upon impact
of
facility defects),
Occupational safety and health of workers,
Permits, licenses, laws, and regulations,
Equal employment opportunity regulations,
Termination for default by contractor,
Suspension of work,
Warranties and guarantees.

The language used for specifying the risk assignments in these areas must conform to
legal
requirements and past interpretations which may vary in different jurisdictions or
over
time. Without using standard legal language, contract provisions may be
unenforceable.
Unfortunately, standard legal language for this purpose may be difficult to
understand. As a
result, project managers often have difficulty in interpreting their
particular
responsibilities. Competent legal counsel is required to advise the different
parties to an
agreement about their respective responsibilities.

Standard forms for contracts can be obtained from numerous sources, such as the
American
Institute of Architects (AIA) or the Associated General Contractors (AGC). These
standard
forms may include risk and responsibility allocations which are unacceptable to
one or
more of the contracting parties. In particular, standard forms may be biased to
reduce the
risk and responsibility of the originating organization or group. Parties to a
contract should
read and review all contract documents carefully.

The three examples appearing below illustrate contract language resulting in different
risk
assignments between a contractor (CONTRACTOR) and an owner (COMPANY). Each contract
provision allocates different levels of indemnification risk to the contractor. [1]

Example 8-1: A Contract Provision Example with High Contractor Risk

"Except where the sole negligence of COMPANY is involved or alleged,

CONTRACTOR
shall indemnify and hold harmless COMPANY, its officers, agents
 and employees, from and
against any and all loss, damage, and liability and from
any and all claims for damages on
account of or by reason of bodily injury,
including death, not limited to the employees of
CONTRACTOR, COMPANY, and of
any subcontractor or CONTRACTOR, and from and against any and
all damages to
property, including property of COMPANY and third parties, direct and/or
consequential, caused by or arising out of, in while or in part, or claimed to have
been caused by or to have arisen out of, in whole or in part, an act of omission of
CONTRACTOR or its agents, employees, vendors, or subcontractors, of their
employees or
agents in connection with the performance of the Contract
Documents, whether or not
insured against; and CONTRACTOR shall, at its own
cost and expense, defend any claim,
suit, action or proceeding, whether
groundless or not, which may be commenced against
COMPANY by reason
thereof or in connection therewith, and CONTRACTOR shall pay any and all
judgments which may be recovered in such action, claim, proceeding or suit, and
defray any
and all expenses, including costs and attorney's fees which may be
incurred by reason of
such actions, claims, proceedings, or suits."

Comment: This is a very burdensome provision for the contractor. It makes the
contractor
responsible for practically every conceivable occurrence and type of damage,
except when a
claim for loss or damages is due to the sole negligence of the owner.
As a practical matter,
sole negligence on a construction project is very difficult to
ascertain because the work is so
inter-twined. Since there is no dollar limitation to the
contractor's exposure, sufficient
liability coverage to cover worst scenario risks will be
difficult to obtain. The best the
contractor can do is to obtain as complete and broad
excess liability insurance coverage as
can be purchased. This insurance is costly, so the
contractor should insure the contract price
is sufficiently high to cover the expense.

Example 8-2: An Example Contract Provision with Medium Risk Allocation to

Contractor

"CONTRACTOR shall protect, defend, hold harmless, and indemnify COMPANY

from and
against any loss, damage, claim, action, liability, or demand whatsoever
(including, with
limitation, costs, expenses, and attorney's fees, whether for
appeals or otherwise, in
connection therewith), arising out of any personal injury
(including, without limitation,
injury to any employee of COMPANY,
CONTRACTOR or any subcontractor), arising out of any
personal injury
(including, without limitation, injury to any employee of COMPANY,
CONTRACTOR, or any subcontractor), including death resulting therefrom or out
of any
damage to or loss or destruction of property, real and or personal
(including property of
COMPANY, CONTRACTOR, and any subcontractor, and
including tools and equipment whether
owned, rented, or used by CONTRACTOR,
any subcontractor, or any workman) in any manner
based upon, occasioned by ,
or attributable or related to the performance, whether by the
CONTRACTOR or
any subcontractor, of the Work or any part thereof, and CONTRACTOR shall at
its
own expense defend any and all actions based thereon, except where said
personal
injury or property damage is caused by the negligence of COMPANY or
COMPANY'S employees.
Any loss, damage, cost expense or attorney's fees
incurred by COMPANY in connection with
the foregoing may, in addition to other
remedies, be deducted from CONTRACTOR'S
compensation, then due or
thereafter to become due. COMPANY shall effect for the
benefit of CONTRACTOR a
waiver of subrogation on the existing facilities, including
consequential damages
such as, but not by way of limitation, loss of profit and loss of
product or plant
downtime but excluding any deductibles which shall exist as at the date
of this
CONTRACT; provided, however, that said waiver of subrogation shall be expanded
to
include all said deductible amounts on the acceptance of the Work by COMPANY."
Comment: This clause provides the contractor considerable relief. He still has
unlimited
exposure for injury to all persons and third party property but only to the
extent caused by
the contractor's negligence. The "sole" negligence issue does
not arise. Furthermore, the
contractor's liability for damages to the owner's property-a
major concern for contractors
working in petrochemical complexes, at times worth
billions-is limited to the owner's
insurance deductible, and the owner's insurance
carriers have no right of recourse against
the contractor. The contractor's limited
exposure regarding the owner's facilities ends on
completion of the work.

Example 8-3: An Example Contract Provision with Low Risk Allocation to

Contractor

"CONTRACTOR hereby agrees to indemnify and hold COMPANY and/or any

parent,
subsidiary, or affiliate, or COMPANY and/or officers, agents, or employees
of any of them,
harmless from and against any loss or liability arising directly or
indirectly out of any
claim or cause of action for loss or damage to property
including, but not limited to,
CONTRACTOR'S property and COMPANY'S property
and for injuries to or death of persons
including but not limited to
CONTRACTOR'S employees, caused by or resulting from the
performance of the
work by CONTRACTOR, its employees, agents, and subcontractors and
shall, at the
option of COMPANY, defend COMPANY at CONTRACTOR'S sole expense in any
litigation involving the same regardless of whether such work is performed by
CONTRACTOR,
its employees, or by its subcontractors, their employees, or all or
either of them. In
all instances, CONTRACTOR'S indemnity to COMPANY shall be
limited to the proceeds of
CONTRACTOR'S umbrella liability insurance coverage."

Comment: With respect to indemnifying the owner, the contractor in this

provision has
minimal out-of-pocket risk. Exposure is limited to whatever can be collected
from the
contractor's insurance company.

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8.3 Risks and Incentives on Construction Quality

All owners want quality construction with reasonable costs, but not all are willing to
share
risks and/or provide incentives to enhance the quality of construction. In recent
years, more
owners recognize that they do not get the best quality of construction by
squeezing the last
dollar of profit from the contractor, and they accept the concept of
risk sharing/risk
assignment in principle in letting construction contracts. However, the
implementation of
such a concept in the past decade has received mixed results.

Many public owners have been the victims of their own schemes, not only because of the
usual requirement in letting contracts of public works through competitive bidding to
avoid
favoritism, but at times because of the sheer weight of entrenched bureaucracy. Some
contractors steer away from public works altogether; others submit bids at higher prices
to
compensate for the restrictive provisions of contract terms. As a result, some public
authorities find that either there are few responsible contractors responding to their
invitations to submit bids or the bid prices far exceed their engineers' estimates. Those
public owners who have adopted the federal government's risk sharing/risk assignment
contract concepts have found that while initial bid prices may have decreased somewhat,
claims and disputes on contracts are more frequent than before, and notably more so than
in privately funded construction. Some of these claims and disputes can no doubt be
avoided by improving the contract provisions. [2]

Since most claims and disputes arise most frequently from lump sum contracts for both
public and private owners, the following factors associated with lump sum contracts are
particularly noteworthy:

unbalanced bids in unit prices on which periodic payment estimates are based.
change orders subject to negotiated payments
changes in design or construction technology
incentives for early completion

An unbalanced bid refers to raising the unit prices on items to be completed in the
early
stage of the project and lowering the unit prices on items to be completed in the
later stages.
The purpose of this practice on the part of the contractor is to ease its
burden of
construction financing. It is better for owners to offer explicit incentives to
aid construction
financing in exchange for lower bid prices than to allow the use of
hidden unbalanced bids.
Unbalanced bids may also occur if a contractor feels some item of
work was underestimated
in amount, so that a high unit price on that item would increase
profits. Since lump sum
contracts are awarded on the basis of low bids, it is difficult to
challenge the low bidders on
the validity of their unit prices except for flagrant
violations. Consequently remedies should
be sought by requesting the contractor to submit
pertinent records of financial transactions
to substantiate the expenditures associated
with its monthly billings for payments of work
completed during the period.

One of the most contentious issues in contract provisions concerns the payment for
change
orders. The owner and its engineer should have an appreciation of the effects of
changes for
specific items of work and negotiate with the contractor on the identifiable
cost of such
items. The owner should require the contractor to submit the price quotation
within a
certain period of time after the issuance of a change order and to assess whether
the change
order may cause delay damages. If the contract does not contain specific
provisions on cost
disclosures for evaluating change order costs, it will be difficult to
negotiate payments for
change orders and claim settlements later.

In some projects, the contract provisions may allow the contractor to provide
alternative
design and/or construction technology. The owner may impose different
mechanisms for
pricing these changes. For example, a contractor may suggest a design or
construction
method change that fulfills the performance requirements. Savings due to such
changes
may accrue to the contractor or the owner, or may be divided in some fashion
between the
two. The contract provisions must reflect the owners risk-reward objectives in
calling for
alternate design and/or construction technology. While innovations are often
sought to save
money and time, unsuccessful innovations may require additional money and
time to
correct earlier misjudgment. At worse, a failure could have serious consequences.

In spite of admonitions and good intentions for better planning before initiating a
construction project, most owners want a facility to be in operation as soon as possible
once
a decision is made to proceed with its construction. Many construction contracts
contain
provisions of penalties for late completion beyond a specified deadline; however,
unless
such provisions are accompanied by similar incentives for early completion, they
may be
ruled unenforceable in court. Early completion may result in significant savings,
particularly in rehabilitation projects in which the facility users are inconvenienced by
the
loss of the facility and the disruption due to construction operations.

Example 8-4: Arkansas Rice Growers Cooperative Association v. Alchemy Industries

A 1986 court case can illustrate the assumption of risk on the part of contractors
and
design professionals. [3] The Arkansas Rice Growers Cooperative contracted
with
Alchemy Industries, Inc. to provide engineering and construction services
for a new
facility intended to generate steam by burning rice hulls. Under the
terms of the
contract, Alchemy Industries guaranteed that the completed plant
would be capable of
"reducing a minimum of seven and one-half tons of rice hulls
 per hour to an ash and
producing a minimum of 48 million BTU's per hour of
steam at 200 pounds pressure."
Unfortunately, the finished plant did not meet this
performance standard, and the Arkansas
Rice Growers Cooperative Association
sued Alchemy Industries and its subcontractors for
breach of warranty. Damages
of almost $1.5 million were awarded to the Association.

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8.4 Types of Construction Contracts

While construction contracts serve as a means of pricing construction, they also
structure
the allocation of risk to the various parties involved. The owner has the sole
power to decide
what type of contract should be used for a specific facility to be
constructed and to set forth
the terms in a contractual agreement. It is important to
understand the risks of the
contractors associated with different types of construction
contracts.

Lump Sum Contract

In a lump sum contract, the owner has essentially assigned all the risk to the
contractor,
who in turn can be expected to ask for a higher markup in order to take care
of unforeseen
contingencies. Beside the fixed lump sum price, other commitments are often
made by the
contractor in the form of submittals such as a specific schedule, the
management reporting
system or a quality control program. If the actual cost of the
project is underestimated, the
underestimated cost will reduce the contractor's profit by
that amount. An overestimate has
an opposite effect, but may reduce the chance of being a
low bidder for the project.

Unit Price Contract

In a unit price contract, the risk of inaccurate estimation of uncertain quantities for
some
key tasks has been removed from the contractor. However, some contractors may submit
an
"unbalanced bid" when it discovers large discrepancies between its estimates
and the
owner's estimates of these quantities. Depending on the confidence of the
contractor on its
own estimates and its propensity on risk, a contractor can slightly
raise the unit prices on
the underestimated tasks while lowering the unit prices on other
tasks. If the contractor is
correct in its assessment, it can increase its profit
substantially since the payment is made
on the actual quantities of tasks; and if the
reverse is true, it can lose on this basis.
Furthermore, the owner may disqualify a
contractor if the bid appears to be heavily
unbalanced. To the extent that an
underestimate or overestimate is caused by changes in
the quantities of work, neither
error will effect the contractor's profit beyond the markup in
the unit prices.

Cost Plus Fixed Percentage Contract

For certain types of construction involving new technology or extremely pressing needs,
the
owner is sometimes forced to assume all risks of cost overruns. The contractor will
receive
the actual direct job cost plus a fixed percentage, and have little incentive to
reduce job cost.
Furthermore, if there are pressing needs to complete the project,
overtime payments to
workers are common and will further increase the job cost. Unless
there are compelling
reasons, such as the urgency in the construction of military
installations, the owner should
not use this type of contract.

Cost Plus Fixed Fee Contract

Under this type of contract, the contractor will receive the actual direct job cost
plus a fixed
fee, and will have some incentive to complete the job quickly since its fee
is fixed regardless
of the duration of the project. However, the owner still assumes the
risks of direct job cost
overrun while the contractor may risk the erosion of its profits
if the project is dragged on
beyond the expected time.

Cost Plus Variable Percentage Contract

For this type of contract, the contractor agrees to a penalty if the actual cost
exceeds the
estimated job cost, or a reward if the actual cost is below the estimated job
cost. In return
for taking the risk on its own estimate, the contractor is allowed a
variable percentage of the
direct job-cost for its fee. Furthermore, the project duration
is usually specified and the
contractor must abide by the deadline for completion. This
type of contract allocates
considerable risk for cost overruns to the owner, but also
provides incentives to contractors
to reduce costs as much as possible.

Target Estimate Contract

This is another form of contract which specifies a penalty or reward to a contractor,

depending on whether the actual cost is greater than or less than the contractor's
estimated
direct job cost. Usually, the percentages of savings or overrun to be shared by
the owner and
the contractor are predetermined and the project duration is specified in
the contract.
Bonuses or penalties may be stipulated for different project completion
dates.

Guaranteed Maximum Cost Contract

When the project scope is well defined, an owner may choose to ask the contractor to
take
all the risks, both in terms of actual project cost and project time. Any work change
orders
from the owner must be extremely minor if at all, since performance specifications
are
provided to the owner at the outset of construction. The owner and the contractor
agree to a
project cost guaranteed by the contractor as maximum. There may be or may not
be
additional provisions to share any savings if any in the contract. This type of
contract is
particularly suitable for turnkey operation.

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8.5 Relative Costs of Construction Contracts

Regardless of the type of construction contract selected by the owner, the contractor
recognizes that the actual construction cost will never be identical to its own estimate
because of imperfect information. Furthermore, it is common for the owner to place work
change orders to modify the original scope of work for which the contractor will receive
additional payments as stipulated in the contract. The contractor will use different
markups
commensurate with its market circumstances and with the risks involved in
different types
of contracts, leading to different contract prices at the time of bidding
or negotiation. The
type of contract agreed upon may also provide the contractor with
greater incentives to try
to reduce costs as much as possible. The contractor's gross
profit at the completion of a
project is affected by the type of contract, the accuracy of
its original estimate, and the
nature of work change orders. The owner's actual payment
for the project is also affected by
the contract and the nature of work change orders.

In order to illustrate the relative costs of several types of construction contracts,

the pricing
mechanisms for such construction contracts are formulated on the same direct
job cost plus
corresponding markups reflecting the risks. Let us adopt the following
notation:
E=
contractor's original estimate of the direct job cost at the time of contract award
M=
amount of markup by the contractor in the contract
B=
estimated construction price at the time of signing contract
A=
contractor's actual cost for the original scope of work in the contract
U=
underestimate of the cost of work in the original estimate (with negative value of
U
denoting an overestimate)
C=
additional cost of work due to change orders
P=
actual payment to contractor by the owner
F=
contractor's gross profit
R=
basic percentage markup above the original estimate for fixed fee contract
Ri =
premium percentage markup for contract type i such that the total percentage
markup
is (R + Ri), e.g. (R + R1) for a lump sum contract, (R + R2) for a unit
price contract, and (R
+ R3) for a guaranteed maximum cost contract
N=
a factor in the target estimate for sharing the savings in cost as agreed upon by
the
owner and the contractor, with 0 N 1.

At the time of a contract award, the contract price is given by:

(8.1)

The underestimation of the cost of work in the original contract is defined as:

(8.2)

Then, at the completion of the project, the contractor's actual cost for the original
scope of
work is:

(8.3)

For various types of construction contracts, the contractor's markup and the price for
construction agreed to in the contract are shown in Table 8-1. Note that at the time of
contract award, it is assumed that A = E, even though the effects of underestimation on
the
contractor's gross profits are different for various types of construction contracts
when the
actual cost of the project is assessed upon its completion.

TABLE 8-1  Original Estimated Contract Prices

Type of Contract Markup Contract Price
1. Lump sum M = (R +R1)E B = (1 + R + R1)E
2. Unit price M = (R + R2)E B = (1 + R + R2)E
3. Cost plus fixed % M = RA = RE B = (1 + R)E
4. Cost plus fixed fee M = RE B = (1 + R)E
5. Cost plus variable % M = R (2E - A) = RE B = (1 + R)E
 6. Target estimate M = RE + N (E-A) = RE B = (1 + R)E
7. Guaranteed max cost M = (R + R3)E B = (1 + R + R3)E

Payments of change orders are also different in contract provisions for different types
of
contracts. Suppose that payments for change orders agreed upon for various types of
contracts are as shown in column 2 of Table 8-2. The owner's actual payments based on
these provisions as well as the incentive provisions for various types of contracts are
given
in column 3 of Table 8-2. The corresponding contractor's profits under various
contractual
arrangements are shown in Table 8-3.

TABLE 8-2  Owner's Actual Payment with Different Contract Provisions

Type of Contract Change Order Payment Owner's Payment
1. Lump sum C(1 + R + R1) P = B + C(1 + R + R1)
2. Unit price C(1 + R + R2) P = (1 + R + R2)A + C
3. Cost plus fixed % C(1 + R) P = (1 + R)(A + C)
4. Cost plus fixed fee C P = RE + A + C
5. Cost plus variable % C(1 + R) P = R (2E - A + C) + A + C
6. Target estimate C P = RE + N (E - A) + A + C
7. Guaranteed max cost 0 P=B

TABLE 8-3  Contractor's Gross Profit with Different Contract Provisions

Type of Contract Profit from Change Order Contractor's Gross Profit
1. Lump sum C(R + R1) F = E - A + (R + R1)(E + C)
2. Unit price C(R + R2 F = (R + R2)(A + C)
3. Cost plus fixed % CR F = R (A + C)
4. Cost plus fixed fee 0 F = RE
5. Cost plus variable % CR F = R (2E - A + C)
6. Target estimate 0 F = RE + N (E - A)
7. Guaranteed max cost -C F = (1 + R + R3)E - A - C

It is important to note that the equations in Tables 8-1 through 8-3 are illustrative,
subject to
the simplified conditions of payments assumed under the various types of
contracts. When
the negotiated conditions of payment are different, the equations must
also be modified.

Example 8-5: Contractor's Gross Profits under Different Contract Arrangements

Consider a construction project for which the contractor's original estimate is

$6,000,000.
For various types of contracts, R = 10%, R1 = 2%, R2 = 1%, R3 = 5%
and N = 0.5. The contractor
is not compensated for change orders under the guaranteed
maximum cost contract if the
total cost for the change orders is within 6% ($360,000) of
the original estimate. Determine
the contractor's gross profit for each of the seven types
of construction contracts for each of
the following conditions.

(a) U = 0, C = 0
(b) U = 0, C = 6% E = $360,000
(c) U = 4% E = $240,000, C = 0
(d) U = 4% E = $240,000 C = 6% E = $360,000
 (e) U = -4% E = -$240,000, C = 0
(f) U = -4% E = -$240,000, C = 6% E = $360,000

In this example, the percentage markup for the cost plus fixed percentage contract is
10%
which is used as the bench mark for comparison. The percentage markup for the lump sum
contract is 12% while that for the unit price contract is 11%, reflecting the degrees of
higher
risk. The fixed fee for the cost plus fixed fee is based on 10% of the estimated
cost, which is
comparable to the cost plus fixed percentage contract if there is no
overestimate or
underestimate in cost. The basic percentage markup is 10% for both the
cost plus variable
percentage contract and the target estimator contract, but they are
subject to incentive
bonuses and penalties that are built in the formulas for owners'
payments. The percentage
markup for the guaranteed maximum cost contract is 15% to account
for the high risk
undertaken by the contractor. The results of computation for all seven
types of contracts
under different conditions of underestimation U and change order C are
shown in Table 8-4

TABLE 8-4  Contractor's Gross Profits under Different Conditions (in

$1,000)
U=0 U=0 U=4%E U=4%E U=-4%E U=-4%E
Type of Contract C=0 C=6%E C=0 C=6%E C=0 C=6%E
1. lump sum $720 $763 $480 $523 $960 $1,003
2. unit price 660 700 686 726 634 674
3. cost + fixed % 600 636 624 660 576 612
4. cost + fixed fee 600 600 600 600 600 600
5. cost + Var % 600 636 576 616 624 660
6. target estimate 600 600 480 480 720 720
7. guar. max. cost 900 540 660 300 1,140 780

Example 8-6: Owner's Payments under Different Contract Arrangements

Using the data in Example 8-5, determine the owner's actual payment for each of the
seven
types of construction contracts for the same conditions of U and C. The results of
computation are shown in Table 8-5.

TABLE 8-5  Owner's Actual Payments under Different Conditions (in

$1,000)
U=0 U=0 U=4%E U=4%E U=-4%E U=-4%E
Type of Contract C=0 C=6%E C=0 C=6%E C=0 C=6%E
1. lump sum $6,720 $7,123 $6,720 $7,123 $6,720 $7,123
2. unit price 6,660 7,060 6,926 7,326 6,394 6,794
3. cost + fixed % 6,600 6,996 6,864 7,260 6,336 6,732
4. cost + fixed fee 6,600 6,960 6,840 7,200 6,360 6,720
5. cost + Var % 6,600 6,996 6,816 7,212 6,384 6,780
6. target estimate 6,600 6,960 6,720 7,080 6,480 6,840
7. guar. max. cost 6,900 6,900 6,900 6,900 6,900 6,900