Of the many concerns an owner must navigate during the pre-construction process, one of the most critical issues to be resolved is how the construction contract will be priced. The pricing method ultimately selected will inevitably impact how the project proceeds as well as set the groundwork for the interaction between the owner and contractor for the duration of the project. There are five major pricing mechanism that can be utilized in a construction contract including (1) a fixed-price contract; (2) cost-plus pricing; (3) cost-plus guaranteed maximum price, (4) cost-plus fixed fee; and (5) unit price. While all of the different pricing mechanisms have advantages and disadvantages, the most frequently utilized pricing mechanism is, by far, the fixed-price arrangement.
What are the advantages and disadvantages to a fixed-price arrangement?
A fixed-price contract, also known as a lump-sum or firm-price contract is widely used across the construction industry. In fact, fixed price contracts are often required by law if the project is a public contract. With a fixed-price contract, the owner provides detailed specifications and the contractor agrees to perform the work for a fixed price. A fixed-price contract provides an owner with certainty as to the exact nature of the work the contractor is obligated to perform. Accordingly, a significant amount of risk falls to the contractor (as opposed to the owner) under a fixed-price arrangement since the contractor is agreeing to perform the work on-time and for a predetermined amount, regardless of whether costs and expenses such as labor or supplies rise. Accordingly, it is incumbent on a contractor who agrees to a fixed-price arrangement to accurately price the project and schedule work on the job in order to avoid financial hardship during the implementation of the construction plan.
While fixed-price contracts have obvious advantages for the owner of the project by providing certainty in the pricing structure, all is not lost for a contractor under a fixed-price arrangement. A contractor can benefit under this pricing mechanism if he is able to work effectively and efficiently, thereby saving money, which ultimately results in more profit to the contractor.
CAN RESULT IN DISCORD
At times, the fixed-price contract can result in discord between the owner and the contractor due to their juxtaposed positions; the contractor wants to work quickly and use inexpensive materials to save money and expedite the project whereas the owner, who is certain of the maximum payment for the scope of the work, will often argue that the contract requires better quality materials and workmanship. Moreover, a fixed-price contract may lead to tension between the owner and the contractor as to the scope of work. Owners will argue that all matters fall within the scope of work so as to avoid any further costs. On the other hand, a contractor will argue that specific items are outside the scope of the contract to justify and increase in the contract price.
LESS ADMINISTRATIVE OVERSIGHT
Notwithstanding certain drawbacks to a fixed-price contract, there are significant benefits as well. As a general rule, fixed-price contracts require less administrative oversight for both the owner and the contractor. Under alternate pricing mechanisms such as the cost-plus pricing arrangements, contractors must maintain a file of all receipts for materials purchased and subcontractors paid, determine the amount of the contractor’s mark-up and then, detail the expenses on an accounting to the owner. With the fixed-price contract, this administrative work is unnecessary and both the owner and the contractor can instead focus on completing the project on-budget and on-time.
In considering the type of pricing mechanism to use on an upcoming construction project, due consideration should be given to the fixed-price arrangement. If properly implemented, it can be an effective and efficient means to complete an on-time and on-budget project.
About the Author:
Laura Colca is a partner in the law firm Goldberg Segalla, where she is a member of the leadership committee of the Corporate Services and Commercial Litigation practice group. Laura is also a member of the National Association of Women in Construction as well as Professional Women in Construction. Laura has counseled countless clients on all types of business transactional matters including representing owners and contractors on both private sector and public construction projects. She can be reached at 716.710.5840 or firstname.lastname@example.org.
Modern Contractor Solutions, June 2018
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