Lump Sum Contracts: Advantages, Disadvantages & When to Use

All construction contracts address critical aspects of a project, including its scope of work,
price and payment terms, schedule and an explanation of each party’s rights and
responsibilities. However, lump sum contracts have specific criteria that can be both a benefit
and a hindrance to a construction project.

What Is a Lump Sum Contract?

Under a lump sum contract, also known as a stipulated sum contract, the project owner
provides explicit specifications for the work, and the contractor provides a fixed price for the
project. These contracts require the owner to complete the project’s plans, designs,
specifications and schedule before the contractor can establish a price. The contractor then
estimates the costs of materials, tools, labor and indirect costs such as overhead and profit
margin and provides a quote. If the project’s final costs are lower than the contactor’s
estimate, then their profit increases. If the estimate is too low, the contractor’s bottom line
suffers. However, the project owner’s finances are unaffected in either scenario.

So, what does lump sum mean in a contract? Despite the “lump-sum” moniker, this term
refers to how the project is priced rather than the payment terms. With these contracts,
payment usually occurs on an instalment basis. This can be as project benchmarks are met or
in regular increments (e.g., monthly). To modify a lump-sum contract, project owners must
submit a change order document that the contractor must approve along with any price
changes. That makes lump-sum contracts somewhat inflexible, but they provide a reliable
price for owners and reliable revenue for contractors, making them one of the most popular
types of construction agreements.

Contractors and project owners often wonder, “what is the difference between fixed price and
lump sum contracts?” Simply put, these terms are interchangeable and are two names for the
same concept. However, there are some crucial distinctions between lump sum contracts and
other construction agreements.

Lump Sum vs. Cost-plus Contracts

Cost-plus contracts are similar to lump sum contracts in that the owner agrees to pay the
contractor’s costs, including labor, subcontractors, equipment and materials and an amount
for the contractor’s profit and overhead. But instead of a lump sum to cover all the expenses,
those costs are reimbursed individually.

These agreements do not require the project owner to have finalized plans for the project.
That means that the scope and cost are subject to change. Unlike lump-sum agreements,
owners take on more risk and will benefit or be disadvantaged if the final costs are lower or
higher than estimated as they are directly reimbursing the contractor’s expenses.

There are three types of cost-plus contracts:

  A cost-plus-fixed-fee contract where the contractor is paid a base amount independent of
the final project cost.
 A cost-plus fixed fee with a guaranteed maximum price contract where the contractor’s
compensation is based on a fixed amount that does not exceed a specific threshold.
 A cost-plus fixed percentage contract where the contractor’s compensation is based on a
percentage of the cost.
These contracts are most common when designs, plans or other specifications are still in flux,
but the owner still wants to begin construction, such as when the project is on a tight
schedule.

The main advantage of cost-plus contracts for both owners and contractors is that the work
likely gets done to specifications because the contractor won’t incur any extra costs for
increased materials or labor costs. However, contractors and project owners must track costs
and supervise the project carefully to ensure fair payment, requiring more burdensome
paperwork and oversight.

Lump Sum vs. Time and Materials Contracts

Time and materials (T&M) contracts stipulate that the owner provides reimbursement for
materials and a daily or weekly payment for labor costs. Like cost-plus contracts, time and
materials contracts work well with project specifications and scopes that are still ambiguous
as the project starts.

T&M contracts provide contractors with a daily or weekly rate, providing a steady income.
Project owners benefit from the adaptability of these agreements, ensuring that the work
occurs to specification. Time and materials contracts require additional paperwork compared
to lump sum contracts because labor costs must be recorded accurately.

Lump Sum vs. Unit Price Contracts

For unit price contracts, the price is based on the estimated per-unit cost of the materials and
is divided into stages, usually by construction trade (e.g., carpentry, electric, plumbing and
more). For this reason, unit price contracts are standard in subcontracting agreements. Many
painting contracts, for example, follow a unit-price structure as painting is generally charged
on a square-foot basis.

As with cost-plus and T&M contracts, unit price contracts benefit project owners when they
have a general idea of the project that needs to be done, but the concrete planning isn’t
completed. For example, you may establish a per-square-foot price for flooring and
installation, even though you don’t know exactly how many square feet of flooring you’ll
need covered.

Because you know approximately how much materials and labor would cost, you can
establish a unit price for this and other aspects of a construction project. Contractors can get a
handle on good approximations of costs and revenue from each stage. Both owners and
contractors can adapt the project as necessary without having to submit change orders and
renegotiate prices, as they would have to do with a lump sum contract.
A notable shortcoming is that there is a significant risk of cost overrun since these contracts
usually lack a unit threshold.

Lump Sum vs. Guaranteed Maximum Price Contracts

A guaranteed maximum price contract (GMP), also known as a not-to-exceed price contract,
requires owners to compensate contractors for their direct costs as well as a fixed fee for
overhead and profit — but only to a certain threshold. The contractor is responsible for
additional costs once reaching this amount. The maximum price can be increased via a
change order if the project’s scope changes, but not for errors or cost overruns.

Remember, with lump sum contracts, whether or not the project actually cost the estimated
amount, the contractor gets the same amount. That is not the case with maximum price
contracts and the owner, not the contractor, will keep cost savings if things come in under
budget. In some cases, the owner can share a portion of any savings with the contractor to
encourage timely work and keep costs low.

These contracts are suitable for owners who have a tight budget as there is an absolute upper
limit. For contractors, however, GMP contracts increase their financial risk if costs exceed
the limit.

When Would You Use a Lump Sum Contract?

Lump sum contracts are standard in construction projects, but they aren’t suitable for every
situation. These contracts work best for projects with finalized plans, clearly defined scopes
and schedules and proper documentation of all assessments and other pre-construction
activities. These aspects are crucial to allow the contractor to estimate project costs and
provide the lump-sum amount accurately.

These agreements are best suited for simple projects with subcontractors, specific parameters
and a low risk of unforeseen problems.

When all of these elements align, lump sum contracts provide an uncomplicated agreement
that both project owners and contractors can easily understand and agree on. But what are the
advantages and disadvantages of a lump sum contract? Advantages for owners include
simplified accounting and little financial risk, and disadvantages include rigidity in project
scope and a need to have every detail planned before beginning the project. Advantages for
contractors include clear directions, less paperwork and a potential for profit if the project
comes in well under budget, and disadvantages include risk if the project is more costly than
expected.

Advantages of Lump Sum Contracts

The simplicity of lump sum contracts provides benefits for both owners and contractors.

Advantages for project owners

The predictability of lump sum contracts is the primary benefit to project owners. The owner
can expect the project to be completed within budget and often more quickly so that the
contractor can maximize resources and save on labor costs. Lump sum contracts also render
little financial risk for owners as the contractor is responsible for any cost overruns. These
factors make it easier for project owners to obtain financing since lenders prefer to fund
defined projects with clearly delineated costs.

Owner supervision of lump-sum contracts is minimal as the owner does not need to track
costs. Also, the payment structure of lump sum contracts usually comprises regular payments
at specific iterations or as a percentage of the work that has been completed, simplifying
accounts payable processes.

Advantages for contractors

Despite the increased financial risk of lump sum contracts compared to some other types of
agreements, contractors still receive many benefits. Under a lump sum agreement, project
owners must provide contractors with finalized plans and thorough documentation, resulting
in specific, linear project tasks. Lump sum contracts also require less paperwork,
management and accounting, decreasing administrative costs.

Another advantage of lump sum contracts is that they do not require contractors to disclose
how they calculated their materials or labor costs, allowing them to provide estimates with
sufficient cushion to avoid going over budget. If the project is under budget, the contractor
keeps the profit.

Disadvantages of Lump Sum Contracts

Lump sum contracts can have downsides for owners and contractors, as well.

Disadvantages for project owners

Owners must submit and adhere to completed designs and finalized plans, making the project
inflexible. If a change is needed, lump sum contracts stipulate the use of a formal change
order process and a considerable amount of paperwork.

There is also the risk of being charged a higher amount to cover the contractor costs for
unforeseen situations. Similarly, contractors could use inferior materials or otherwise cut
costs to increase their profit from the fixed price. That’s why it’s prudent for owners to
specify materials in the pre-construction documentation they provide to the contractor.

Disadvantages for contractors

Contractors incur the cost of going over budget, which can eat into profits. Contractors also
share the disadvantage of time-consuming change order paperwork if modifications need to
occur.
Variations in Lump Sum Contracts

Variations are prevalent triggers of disputes in construction projects. With lump sum
contracts, any change in the plan, scope or costs is considered a variation. The most common
causes of variations include:

 Design errors, omissions and discrepancies

 Incorrect interpretation of plans or designs
 Specification changes
 Increases or decreases in necessary material quantities
There are two types of variations. Beneficial variations reduce or eliminate costs, shorten the
schedule or otherwise improve the project, which can be a boon to owners and contractors.
Detrimental variations negatively affect costs, time and other aspects of the project, such as
discovering an unexpected water main which results in an overhaul of the original
construction plans.

In either case, some variations require a formal change order request from either the owner or
the contractor. Change orders must include four key points:

 A comprehensive description of the requested modification

 A credible justification of the change
 An estimation of the costs of the proposed change
 An explanation of the impact that the proposed change could have on the project
completion date
Modifications cannot occur unless all parties agree to the new terms. That often requires
negotiations that can go on for some time, halting work.

Lump sum contracts are designed to reduce variations significantly, but they can still occur if
there are overlooked details or unforeseen circumstances. Ensuring that all materials are
available, the design and plan are accurate and that everyone fully understands the project can
further protect project owners and contractors from time- and money-consuming variations.

Common Issues with Lump Sum Contracts

While lump sum contracts are straightforward and reduce many common constructions
contract headaches, they are not without issues that can have varying impacts on project
owners and contractors.

Delays
Delays are often consequences of unforeseen circumstances out of either party’s control, such
as weather or supply chain disruptions. Other times, a lack of clarity, failure to provide timely
instructions, inadequate labor or a lack of equipment or materials is to blame.
Lump sum contracts should include provisions that stipulate the circumstances under which
each party would be responsible for delays and the associated costs. That can reduce the risk
of contract breaches as well as the need for time-consuming and costly litigation.

Cost fluctuations
The price of labor and materials can be fluid and subject to change throughout the project.
Lump sum contracts generally do not account for these fluctuations, so contractors have to
absorb the cost if prices rise. However, they can also realize savings if rates go down. These
risks are arguably more pronounced in extended projects.

Contractors must factor in possible upward fluctuations and price the project accordingly
when providing the estimate.

Provisional sums
Although lump sum contracts are pretty iron-clad as far as scope and cost, provisional or
stipulated sums refer to the price of optional project work. The provisional sum is included as
a separate estimate within the contract and only changes if the owner decides it’s a good idea
to move forward with the elective work.

The work associated with stipulated sums can cause issues with the project schedule,
primarily if implemented later in the project. It can also lead to modifications that require
formal change orders. That’s why it’s essential that the terms of a lump sum detail how to
handle provisional sums and the limits of any related changes.

Lump Sum Contract Construction Example

It’s essential to develop a lump sum contract correctly and fulfill it to the letter. But what is a
lump sum contract in construction? It’s one kind of construction contract where a single price
is used for an entire project. The estimated cost is developed after the contractor understands
all the details of the construction project, including specifications, materials and timelines.
Proper creation and execution of a lump sum contract for a construction project look
something like this:

A project owner needs to build a storage shed to increase inventory space, so he approaches a
contractor for the job. The owner has already completed the building design and construction
plan, performed the necessary surveys and received the required permits. In the construction
plan, the project owner also notes that he would like to use a particular cement brand. The
contractor evaluates the documentation and calculates how much the labor and materials will
cost. She takes the pricier cement that the owner requested into account and includes a buffer
amount to allow for unanticipated expenses. She then adds another amount to cover overhead
and profit to the final project estimate.
The project owner agrees to the price, and the lump sum contract:

 Adequately lays out the scope of the project

 Contains robust project modification controls
  States a price that includes all costs related to the project
 Details who is responsible for various additional costs
 Delineates provisional sums and the associated work
 Includes the estimated completion date
Both parties agree to the contract’s terms. The work, which should take six months, begins.
The owner pays one-sixth of the fee every month.

Halfway through the project, the project owner decides to install tile flooring over the
concrete. That is outside of the original agreement’s scope, so the owner submits a formal
change order that the contractor reviews and then provides a new estimate for the project. The
project owner agrees, and work continues. Installing the tile pushes the estimated completion
date out by two weeks and increases labor costs for the contractor, but the additional amount
that was agreed to via change order protects the contractor’s profits. When the project is
complete, the contractor managed to come in under budget, providing her with additional
profits.

Construction Contracts Compared | Lump Sum,

Cost Plus, Re-measurable & Target Cost
If you’ve ever had construction or maintenance work carried out in your home, then you
already know the different ways you can pay someone. For instance, you can pay someone an
hourly or day rate, you could agree a fixed price, or you can pay a unit rate (for
instance, you pay for each door to be installed, or each fence panel to be replaced).
And if you work in construction, you know the same applies, and that the contract determines
the method of payment. In this article, we’re going to compare the four most popular
construction contracts, discuss when they should be used and understand why.
Lump Sum
Lump sum otherwise known as fixed price, or fixed sum, or fixed lump… okay that
last one was a lie, there are lots of different terms people use. However, the general
concept remains the same. A price is agreed at the start of the project and the
contractor is paid the agreed price. Lump sum doesn’t mean the price is
unchangeable. However, variations are often limited to unforeseen circumstances or
changes in scope. So under what circumstance is lump sum the appropriate contract
choice?
Well, think of it this way, for a contractor to offer a fixed price for the works, they’ll
need to know exactly what the works will entail. In construction you have different
levels of design, from concept design to detailed design. In most cases, you’ll need
to have a detailed design in place to maximise value under this contract. Otherwise,
time may be spent negotiating variations which isn’t helpful to either party.

Pros to this contract include:

Risk to the client is minimal
· Capital can be arranged according to the payment plan
· Contractor’s cash flow is predictable
· The tendering process is more transparent and impartial
Cons to this contract include:
· Contractor’s risk is high, meaning they’ll likely charge a higher fee
· If the design is incomplete, or contains ambiguities then disputes are likely
· The design often needs to be complete before tendering
· Procurement times are often elongated

Cost reimbursable
Cost reimbursable, otherwise known as cost plus. Essentially, under this option the
contractor is paid actual cost for works carried out, plus an agreed fee. This type of
contract is normally used when the scope cannot be properly defined when works
start, and usually used when risk associated with the works are high and require
immediate attention. For example, emergency work.
Pros to this contract include:
· Works can start immediately with no time spent on agreeing a price beforehand
Cons to this contract include
· Risk to the client is high as the final cost is not known when the contract is initiated
· Productivity can be low, as there is often no monetary incentive for the contractor to
finish ahead of schedule

Re-measurable
Re-measurable contracts, otherwise known as measurement contracts or unit price
contract. Under this contract, payment is made against an agreed schedule of rates.
Each month a valuation of work is undertaken using the agreed schedule of rates
and site measurements.
This contract is used when the scope of works can be described in detail, but the
quantities or amount cannot. For example, under term maintenance contracts, the
maintenance work required maybe fairly repetitive and therefore easy to cost for.
However, the amount of work required is unforeseeable. This contract type may also
be appropriate when design for a project contains insufficient detail for a bill of
quantities to be produced.

Pros to this contract include:

· Works can start without a detailed design and complete BoQ
· Potential reduction in design cost
· Prices (or unit rates) are competitive
· Increased possibility of value engineering
· Contractor’s risk is comparatively low

Cons to this contract include

· Client has no assurance of final cost of project
· Higher administration required to assess and measure works
· Client’s risk is comparatively high
· Potential cash flow issues for contractor if work output required is low

Target Cost
You could say this contract is a hybrid of both lump sum and cost reimbursable.
Essentially, a contractor will be reimbursed for the actual cost on an interim basis
similarly to cost reimbursable. However, what makes target cost different, is that
financial gain and financial loss is shared between the client and contractor using a
percentage split agreed at pre-contact stage. This is calculated by taking the agreed
price and deducting the actual cost incurred, the difference is then split between
parties by the agreed percentages (sometimes this is 50/50). The agreed price may
be changed through variations during the project. Financial gain or pain is usually
calculated once works are complete and reflected in the final payment/ final account.

Pros to this contract include:

· Both the contractor and client is inclined to work collaboratively as they both share
the same financial incentive
· The contractor is inclined to work productively to reduce risk of financial loss
· Contractor is motivated not to overspend by finding innovative ways to complete
the project

The re-measurable/remeasurement contract is the most popular type of contract

used in the former construction industry. But even so, large construction companies
are using this method to hire subcontractors for tasks such as painting, plastering,
etc. In this method, the companies will receive the payment based on actual work.
Compared to other procurement methods, the client’s risk is much higher, and the
contractor’s risk is minimal in this method

There is a little difference between the term remeasurement and the term
admeasurement. Remeasurement is the whole procedure of re-measuring the
completed amount of work. On the other hand, the admeasurement is the difference
between the estimated amount and the real amount.

What is Remeasurement contract / Unit price contract or Re-measurable

contract

Remeasurement contracts, Re-measurable contracts or measure and pay contracts

may be required on projects where the nature of the critical work can be stated in
relevant detail when they are tendered, but not amount. For example, excavation
work, It is difficult to estimate the quantity of excavation work until the job has
started. Instead of offering a fixed price, rates are provided in the contractor’s tender,
either according to the price estimate or in the price schedule. The actual amount of
work done then measured, and the tender rates apply to those quantities. The
contractor gets payment based on his completed work. As a result, pricing may differ
from actual estimates.

Re-measurable contract (re-measurement contracts) agreements can allow an initial

start on site before the design is complete. It also supports the relatively smooth
modification of works. However, there is inevitably some risk to the client because he
does not know the cost of the works. The client is taking the risk of any ‘unknown
persons’, and while this may result in competitive prices from contractors. The level
of uncertainty for the client means that in addition to civil engineering projects, the re-
measurable contracts are extraordinary.

Let me explain to you more, in re-measurement contracts (re-measurable

contracts), completed work will depend on default unit rates. The contractors will get
all payments based on their actual work done after measuring the complete work.
Therefore, the final cost of the project will rely on the unit prices and the exact
quantity. The contractor will provide its rates based on the BOQ supplied by the
client.
Moreover, the contract is helpful for several tasks that quantities cannot determine in
the initial stage as we mentioned in the lump sum contracts, the procurement
process to perform the work mainly based on the client’s requirements. Such
requirements may consist of the budget, quality, and time frame. Let me
explain where measurable contracts are necessary;

 The client does not have a tight budget.

 The client wants to improve and change the design and the finishes at a
later stage.
 And the client wants to start works immediately based on competitive
unit rates. Therefore, based on the above requirement, the project
management team (consultants) should prepare a preliminary design and
approximate BOQ to start work immediately. Most of the traditional closed
envelope tendering method helps in this procurement method to select the
right contractor. The team will choose the appropriate contractor after
comparing the unit rates of each contractor.

All the above information is to help you to know about re-measurement contracts.
But I didn’t stop here; there’s more to know about the plus and negative points of
remeasurement contracts.

What are the advantages and disadvantages of remeasurement/re measurable

or unit price contracts

Advantages of remeasurement contract (unit price contracts)

1. works can start after finalizing the initial design and BOQ
2. Can reduce the design cost.
3. High possibility to do value engineering
4. Prices (unit rates) will be competitive
5. Contractor’s risk is comparatively low

Disadvantages of re-measurable contract/remeasurement contract (unit price

contracts)

1. Can not predict the final value of the project

2. Delays in contractor’s payments (assessment of the measurements takes
time)
3. Client’s risk is comparatively high
4. Controlling and reporting will be a difficult task
5. A high number of consultant team may require for handling the project (Ex: for
remeasuring)
lump sum contract vs remeasurement contract

Below are the main differences between lump-sum contracts and remeasurement
contracts

Lump-Sum Contracts Re-measurable Contracts

Client’s risk is very low Client’s risk is very high

Contractor’s risk is high Contractor’s risk is low

Final contract value is fixed Final contract value is unknown

Tendering process is lengthy Easy and quick bid process