Cayabyab, Ian Keneth G. Ar. Brigette Faye S.

Cortez
Specialization 3: Construction Management

Formative Assessment 8: Contract Management

Reading Assignment:
 What are the different types of Construction Contract? Differentiate.

A construction contract is a legal binding agreement for which both the owner and
the builder has a document, so that the executed job will receive the specific amount
of compensation or how the compensation will be distributed. There are several types
of construction contracts used in the industry, but there are certain types of construction
contracts preferred by construction professionals.

Construction contract types are usually defined by the way, the disbursement is
going to be made and details other specific terms, like duration, quality, specifications,
and several other items. These major contract types can have many variations and can
be customized to meet the specific needs of the product or the project.

1. Lump Sum or Fixed Price Contract Type

This type of contract involves a total fixed priced for all construction-related
activities. Lump sum contracts can include incentives or benefits for early
termination, or can also have penalties, called liquidated damages, for a late
termination. Lump Sum contracts are preferred when a clear scope and a defined
schedule has been reviewed and agreed upon. It is the basic type of construction
contracts. That’s because they outline one fixed price for all the work done under
them. Thus, lump sum contracts are extremely common in construction. Odds are
most contractors have entered into multiple lump sum contracts in the past.

This contract shall be used when the risk needs to be transferred to the builder
and the owner wants to avoid change orders for unspecified work. However, a
contractor must also include some percentage cost associated with carrying that
risk. These costs will be hidden in the fixed price. On a lump sum contract, it is harder
to get credit back for work not completed, so consider that when analyzing your
options. Therefore, lump sum contracts are best suited for smaller projects with
predictable scopes of work.

Pros of Lump Sum

 Lump sum contracts simplify bidding. Naming a total price rather

than submitting multiple bids simplifies the selection process for
owners and GCs.

 Finishing under-budget means high profit margins. Because the

price for the project is set in stone, finishing under-budget means
you pocket the savings.
 Cons of Lump Sum

 Miscalculations destroy margins. When drafting a lump sum

contract, you need to account for every variable. Since there’s
one set price, unexpected setbacks or changes during a project
cut directly into your profit margin.

 The bigger the project, the more room for loss. If you’re
working with subs and suppliers, there is no room for error. The
cost of those inevitable missteps and setbacks from sub-tiers
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.

2. Cost Plus Contracts

Also known as cost-reimbursement contracts, this type of contract involves

payment of the actual costs, purchases or other expenses generated directly from
the construction activity. It involves 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. Cost Plus contracts
must contain specific information about a certain pre-negotiated amount (some
percentage of the material and labor cost) covering contractor’s overhead and profit.
Costs must be detailed and should be classified as direct or indirect costs. There
are multiple variations of Cost Plus contracts and the most common are:

 Cost Plus Fixed Percentage

 Cost Plus Fixed Fee
 Cost Plus with Guaranteed Maximum Price Contract
 Cost Plus with Guaranteed Maximum Price and Bonus Contract

Cost plus contracts are used when the scope has not been clearly defined and
it is the owner responsibility to establish some limits on how much the contractor
will be billing. When some of the aforementioned options are used, those
incentives will serve to protect the owner's interest and avoid being charged for
unnecessary changes. Be aware that cost-plus contracts are difficult or harder to
track and more supervision will be needed, normally do not put a lot of risk in the
contractor
 Pros:

 Cost-plus contracts are flexible. Cost-plus contracts allow

owners to make design changes along the way, and contractors
know they’ll be paid for the extra time or materials those changes
incur.

 Miscalculations aren’t devastating. Since cost-plus contracts

are flexible by nature, inaccuracies in the initial bid aren’t as
detrimental as they are with lump sum contracts.
Cons:

 Justifying some costs can be difficult. Cost-plus contracts

require contractors to justify the costs on a given project.
Sometimes those costs can be hard to account for, and owners
can be resistant to reimbursing indirect costs like administrative
expenses and mileage.

 Fronting the cost of materials can put contractors in a bind.

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.

3. Time and Material Contracts When Scope is Not Clear

Time and material contracts are usually preferred if the project scope is not
clear, or has not been defined. The owner and the contractor must establish an
agreed hourly or daily rate, including additional expenses that could arise in the
construction process.

The costs must be classified as direct, indirect, markup, and overhead and
should be included in the contract. Sometimes the owner might want to establish a
cap or specific project duration to the contractor that must be met, in order to have
the owner’s risk minimized. These contracts are useful for small scopes or when you
can make a realistic guess on how long it will take to complete the scope.

Pros:

 Time and materials contracts are agile. Since the customer

reimburses the contractor for the cost of materials and pays an
hourly wage, unexpected delays, roadblocks, and other changes
to the scope of work are covered.
 Time and materials contracts allow for simple negotiations.
Setting rules for what materials will be covered and what the
hourly wage will be is simple with time and materials contracts.
 Cons of T&M

 Tracking time and materials is time consuming. Logging each and

every material cost on a project is no small task, and failure to provide
an accurate number upon completion means lower profit margins.
Doing a thorough job here means you spend more time crunching
numbers and less time doing the work.

 Efficiency isn’t rewarded. Since time and materials contracts pay by

the hour or day, there’s no real incentive to finish a project early.
However, it’s common practice to stipulate a bonus for finishing
ahead of schedule.

4. Unit Pricing Contracts

Unit pricing contracts is probably another type of contract commonly used by

builders and in federal agencies. Unit prices can also be set during the bidding
process as the owner requests specific quantities and pricing for a pre-determined
amount of unitized items.

By providing unit prices, the owner can easily verify that he's being charged
with un-inflated prices for goods or services being acquired. Unit price can easily be
adjusted up and/or down during scope changes, making it easier for the owner and
the builder to reach into agreements during change orders.

Pros of Unit Price

 Unit price contracts simplify invoicing. Unit price contracts allow for
increased transparency. Owners can easily understand each cost that
goes into the final price of the contract because the price of each unit
is predetermined. This helps avoid disputes and arguments when it’s
time to pay up.

 If more work is required, the profit margin stays the same. 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.
Cons of Unit Price

 Predicting the final value of the contract can be difficult. Usually,

the amount of units needed to complete a project isn’t known
immediately. This means owners may pay more than they expected.

 Remeasurement can delay payment. Remeasurement, or the

owner’s ability to compare the price of each unit with the total cost of
the project, can slow down payment. Although transparency is
something we should all strive towards, this may be something you
want to consider.