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Contract Type Description
A fixed total price is set for the entire project rather than individual aspects. Usually
BA olin colticct reserved for straightforward projects with a clear scope of work.
Time and materials Contractors are reimbursed for the cost and materials as well as labor at an
contract established pay rate. Often used for projects without a well-defined scope of work.
Owner pays the contractor for costs (materials, labor, overhead) incurred during the
Cost-plus contract project as well as a preset profit margin. Can offset contractor risk for projects that
involve design changes throughout.
Divides the work to be completed into separate units, which the contractor bills for
Unit price contract individually. Best for repetitive construction tasks without an estimate of the amount
of work required.
Guaranteed maximum Establishes an upper limit for construction costs, and contractors absorb costs
price (GMP contract) above this set point. Best for projects with relatively few unknown variables.1. Lump sum contracts
Lump sum contracts, also known as fixed price contracts, are the most basic type of
construction contracts. That's because they outline one fixed price for all the work done
under them. For this reason, lump sum contracts are extremely common in construction.
Odds are most contractors have entered into multiple lump sum contracts in the past.
Benefits
Risks
‘Simplified bidding: Naming a total price rather
than submitting multiple bids simplifies the
selection process for owners and GCs.
Miscalculations are costly: Since there's one set price,
unexpected setbacks or changes during a project cut
directly into your profit margin.
Potentially high profit margins: Because the price
for the project is set in stone, finishing under-
budget means you pocket the savings.
Bigger projects amplify risk: The cost of missteps and
setbacks from subcontractors comes right out of the
lump sum price.
As you can see, lump sum contracts involve a fair amount of risk for contractors
because they don't account for unexpected costs or delays after the project is started.
Missteps mean you make less money, or, even worse, lose money on a project.
Best for: Smaller projects with predictable scopes of work.2. Time and materials contracts
As opposed to lump sum contracts, time and materials (T&M) contracts work best for
projects in which the scope of work is not well-defined. Time and materials contracts
reimburse contractors for the cost of materials and establish an hourly or daily pay rate.
Benefits Risks
More agile: Since the customer reimburses Potentially time consuming: Logging each and every material
for time and materials, unexpected delays, cost on a project is no small task, and failure to provide an
roadblocks, and changes to scope are accurate number upon completion means lower profit
covered. margins.
May not reward efficiency: Since time and materials contracts
pay by the hour or day, there's no real incentive to finish a
project early. Therefore, it's common practice to stipulate a
bonus for finishing ahead of schedule.
Simple negotiations: Setting rules for what
materials will be covered and what the
hourly wage will be is straightforward.
When you consider the unpredictable nature of any given construction project, the owner
bears a considerable amount of risk with time and materials contracts. That's because
they're required to pay the contractor for any unexpected costs, changes, or time
overruns that take place over the course of the project, costing them more than they
initially planned for.
Best for: Projects without a well-defined scope of work.3. Cost-plus contracts
Cost-plus contracts, otherwise known as cost-reimbursement contracts, involve the
owner paying the contractor for the costs incurred during the project plus a set amount
of money for profit, which can be determined by a percentage of the total price of the
project.
The costs covered by cost-plus contracts can involve direct costs like labor and
materials, indirect costs like travel, insurance, or overhead, and profit.
Here are the advantages and disadvantages of using a cost-plus contract for a
construction project.
Benefits Risks
Flexible and adaptable: Owners can make design
changes along the way, and contractors know
they'll be paid for the extra time or materials
those changes incur.
Difficult to justify some costs: Contractors must account
for all costs, and some (like administrative expenses or
mileage) can be hard to justify for reimbursement.
Must front materials costs: Since cost-plus contracts
operate through reimbursement, paying more than you
expected for materials could mean you're spread thin for
the remainder of the project.
Handles miscalculations Inaccuracies in the
initial bid aren't as detrimental as they are with
lump sum contracts.
When it comes to cost-plus contracts, the majority of the risk is placed on the owner.
That's because the contractor is paid for all costs incurred during the project, and any
unforeseen expenses come out of the owner's pocket.
Best for: Projects in which a lot of creative flexibility is needed.4. Unit price contracts
Unit price contracts divide the total work required to complete a project into separate
units. They are also known as measurement contracts, measure and pay contracts, or
remeasurement contracts. The contractor provides the owner with price estimates for
each unit of work, rather than an estimate for the project as a whole.
dependent on material costs, and the amount of work needed isn't clear before the
project is started.
Here are some of the pros and cons of using unit price contracts.
Benefits Risks
Difficult to predict total volume: Owners may pay
more than expected if the amount of units
needed to complete the project isn't immediately
known.
Simplified invoicing: Owners can easily understand each
cost that goes into the final price of the contract because
the price of each unit is predetermined.
Consistent profit margin: Any extra work that's needed is
simply added on as another pre-priced unit, making it
easier to manage change orders and other alterations to
the scope of work.
Remeasurement can delay payment: The owner's
ability to compare the price of each unit with the
total cost of the project can slow down payment.
When it comes to unit price contracts, the majority of the risk lies with the owner
because they must reimburse the cost of unexpected units that are added. However, the
transparency they afford is a massive benefit to all parties involved.
Best for: Projects with repetitive tasks without a clear estimate of the amount of work
required.5. GMP contracts
Guaranteed maximum price (GMP) contracts establish a cap on the contract price. With
this type of construction contract, the property owner won't exceed the contract price.
Any material or labor costs above that price should be covered by the contractor.
Sometimes, another type of construction contract may also include a GMP provision. For
example, a cost-plus contract could include a clause that limits total costs to a
guaranteed maximum price.
Guaranteed maximum prices are a common feature in construction contracts, and
they're best suited to projects with few unknowns. For example, the construction of a
retail chain with plans that have been used over and over.
Here are the pros and cons of using guaranteed maximum price contracts.
Benefits
Risks
Quicker bidding and financing: Having a final contract
price accelerates the bidding process, and it makes
financing projects easier because lenders know the
maximum amount a given project will cost early on
Can be tough for contractors: These contracts
force the party doing the work to absorb cost
overages in the event the contract price maximum
is exceeded.
Incentivize savings: Having a fixed price overhead
incentivizes contractors to reduce costs and finish
ahead of schedule. Owners usually agree to share cost
savings with their contractors.
May take longer to negotiate In order to protect
themselves from exceeding the price cap,
contractors may try to increase the maximum price
of the contract, potentially extending negotiations
Since the owner won't pay for any cost overruns, guaranteed price contracts shift a lot of
tisk onto contractors. Considering that risk, one thing contractors can do is use a good
cost estimating software. Job costing is an important accounting process on any
construction project, and having a solid estimate will minimize risk by helping
contractors avoid overcharging or undercharging the owner.
Best for: Projects with relatively few unknown variables, and for incentivizing contractors
to complete work under budget and ahead of schedule.