Before a property developer decides to contract a contractor, bids for tender are usually called by the developer. Therefore it rests upon the contractors to come up an offer that best suits the property developer and the contractor. There are several ways that the contactors can approach the construction project with regard to the contract. One of the methods is to allow the construction firm develop the property at a refundable cost and then allow a profit that will granted upon completion. This type of contract is commonly referred to as the cost-plus contract. The other type of the contract is whereby the full amount required to design and build the property is defined and the contractor paid in lump sum to complete the project. Here property developers are not concerned with the cost of the project rather that the project is completed on time. This second kind of contract is referred to as Lump sum design and build contract. Each of these kinds of contract has a defining difference and competing risks and advantages. This report reviews the two kinds of contracts with particular interest on the risk and advantages of each contract. The report will further provide a reasoned evaluation on the preferred contract.
Lump Sum Design and Build Contract
As the name suggest, this contract requires the contractor to come with a total estimate of the entire project and in a sense avoid the process of bidding on component items . Here, the client is always seeking to avoid the cost of designing and managing the project. Hence, the property developer transfers the entire project to the contractor at the cost of a single agreed figure, the lump sum. This is the most common kind of contracting where most projects with defined scope and requirement can be evaluated and cost determined. On the contractor side it should be clear that the property developer is simply seeking to transfer all risk and therefore measures must be taken to include possible risk in determining the lump sum figure.
Niece(2009) illustrates that this fixed figure must include among others, the labor and material cost, contractors overhead, possible margin for foreign exchange fluctuations, management cost and the profit margin. Difference in the contractor’s overhead may be the point of difference in most project valuation. This overhead is normally determined based on the risk assessment of the project, the level of expertise and quality of construction that the contractor purports to offer the client. However, in most cases, it is this calculation of overhead that may determine whether one construction firm will be offer the contract or not. Difference in the lump sum figure is usually a product of the difference in the overhead .
The lump sum design and build contract is best used in projects whose scope and nature can be fully determined before the work begins. This implies that construction designs and drawing have been completed without the possibility of significant changes to the design. Rodriguez (2010) argues that this kind of requirements is best suited for not-so-huge projects such as buildings that do not cover a huge geographical location.
Advantages of Bidding with Lump Sum Design and Build Contract
There are several advantages that can be associated with the lump sum contract. One of the greatest advantages that can be singled out is the limited amount of changes that can be introduced during the construction. This is due to the fact that the contract requires all aspect of the project to be predetermined before the construction work begin. Thus the constructor has the advantage of working without any interruption and will attempt to deliver the project on or in time. Moreover, most contracts have an additional pay for early completion of the project. Additionally, since the risk management has been transferred to the contractor, there will concerted effort to minimize overhead cost that can be avoided. For these reasons, most property developer prefers this kind of contracts .
Disadvantages of the Lump Sum Contract
One of the major disadvantages that can be derived from lump sum method of constructing is the fact that all the risk is transferred to the contractor. Here any variation in the cost of material is directly transferred to the contractor without any reference to the property developer. Additionally, any delays in completion of the project usually attract penalties on the contractor. Furthermore, if the project fails to meet any single requirement, the project may be cancelled and offered to another contractor leading to a total loss on the side of the contractor.
Cost-Plus Contract
This is a kind of contract that attempts to avert a situation where only one party suffers all the risk of the project. As the name suggest, the cost-plus contract is where the contractor is paid for all the cost that has been met plus an additional profit based on this cost . In this kind of contract, the project expenses are agreed upon on a regular basis during the project implementation. The property developer usually sets a ceiling for the cost that the contractor is allowed to work with. Thus in receiving payment for the costs accrued, the contractor presents the cost estimate together with relevant proof for the same. In cases where the cost ceiling was breached, there is room to review whether this over expenditure can be justified. However, should the excess cost be not justifiable enough or be as a result of negligence on the part of the contractor, this is usually passed to the contractor.
There are three basic costs that are usually agreed upon in the cost-plus contract. The first is the direct cost, which is cost of material, labor, equipment, expert consultation and supplies. Here the contract stipulates the nature and extent to which these costs may be apportioned. The second cost is the overhead cost which is commonly referred to the indirect cost. These costs include the expense that must be met in order for the business to run smoothly. Examples of indirect cost include insurance, communication costs, renting charges and mileage. The final cost that must be expressly defined is the profit or fee on works. This amount is usually calculated as a proportion of the labor cost .
Advantages of Using Cost-Plus Contract
The greatest advantage that cost–plus contract provides the contractor is the minimized risk. Cost-Plus contract allows a regular review of the cost and changes thereon in order to allow a revision of the cost ceiling. Thus the contractor, if work is performed with due diligence may not experience any losses due to the cost of the project. In addition, with the issue of risk now eliminated, the contractor now shifts focus to the quality of work performed. Here the contractor will be seeking to improve goodwill with the client and thus will work towards improving the quality of the work done.
Disadvantages
Selection of Option
Depending on the contract management principle of a construction company based on a risk-averse model then the cost-plus contract is best suited for a bidding process. This is due to the fact that this kind of contracting allows a win-win situation for both parties. In addition, it is very important to state that the emergence of the rising tiger economies has presented new dynamics to the cost and prices of steel and other building material . Costs of material now fluctuate at immense rate and this risk is very imminent in any construction business. To cushion oneself from such eventualities, shared risk is perhaps the best way forward.
Conclusion
The modern nature of contracting has introduced several ways to approach a contracting process. This has allowed several construction firms to have differentiated approaches to bidding for a project. However, there is need to evaluate the risk-returns analysis in order to make sound decision when it comes to bidding. While one approach may eliminate nearly all the risk involved, it may curtail the returns on investment. On the other hand, the contractor may take up all the risk however the returns are quite encouraging.
Gray, C., & Hughes, W. (2010). Building Design Management. New York : Routledge,.
Niece, W. S. (2009, Feb 2). Design-Build Construction Projects: Overview and Tips for Success. Retrieved July 12, 2012, from www.constructionweblinks.com: http://www.constructionweblinks.com/Resources/Industry_Reports__Newsletters/20090202/desi.html
Rodriguez, J. (2010). Cost-plus Contract Basic Information. Retrieved July 12, 2012, from construction.about.com: http://construction.about.com/od/Procurement-Process/a/Cost-Plus-Contract-Basics.htm
