When managing construction projects, it’s important to understand the different types of contracts in order to scope work out properly. Choosing the right type of contract depends on the project, but can make the difference in gaining or losing money in the end.
Here are four main construction contracts to choose from, plus their pros and cons:
1. Lump-Sum Contracts
Lump-Sum contracts are the most frequently-used contract, particularly for building construction. The idea is that all aspects of the project are pre-determined and laid out in a fixed scope of work. The cost is known and upfront for the owner, and the contractor is able to manage expectations.
The pros:
- The amount of the project is known and upfront before the project begins.
- Expectations are managed on the owner’s side.
The cons:
- If any out-of-scope work is needed, a change order will be required, which could delay the timeline of the project.
- If the project goes out of scope as a result of the contractor’s poor time management, rework, or weather, the contractor will suffer loss if a change order was not used.
2. Cost-Plus-Fee Contracts
A Cost-Plus-Fee contract does not require a predefined scope of work with a fixed cost. Instead, the contractor keeps track of the time and materials spent throughout the project and the owner is responsible for reimbursement, plus a fixed fee for the contractor.
The pros:
- There is guaranteed profit for the contractor since they can add on work at any point in the project, plus the percentage of the total cost is added at the end.
The cons:
- There is a significant risk for the owner, who is responsible for reimbursing all time and materials spent on the project.
- A ton of paperwork is involved with these contracts because every receipt and time stamp needs to be accounted for in order to bill the owner properly.
Industry tip: For this contract to be profitable for both the contractor and the owner, it is the owner’s responsibility to spell out which costs will be reimbursed and which will be viewed as part of the contractor’s fixed fee.
3. Guaranteed Maximum Price Contracts
Guaranteed Maximum Price (GMP) contracts combine the first two together, where there’s a firm cap over overall contract price, but the owner is only obligated to pay for anything additional needed (similar to a cost-plus-fee contract). This option is very popular for those using the “design-build” project method.
The pros:
- The owner is more protected with this contract as opposed to a cost-plus-fee contract because there is a cap, and any money beneath that cap is kept by them (shows cost savings).
- Allows early start to construction once the cap is established.
The cons:
- Any costs over the project cap have to be absorbed by the contractor.
Industry tip: Smart owners will use project savings to entice contractors to do the work quicker and more efficiently. They can offer a 60/40 split to the contractor to reward them for the quick project turnaround. This creates a win-win scenario.
4. Unit-Price Contracts
Unit-Price contracts are necessary when the work materials can’t be measured accurately ahead of time. These are most common with civil projects. For example, if a contractor is tasked with building a highway, dirt removal would be something that can’t be accurately quantified but would require time and heavy machinery.
For this contract, owners provide fixed quantities for the project materials, and contractors apply their personal unit pricing. Contractors can then bid for the project, and the owner will choose whichever unit price works best for them.
The pros:
- Unit prices are fixed (this is a huge pro for owners).
- If the owner’s original unit estimates are inaccurate, they are responsible for covering any additional costs.
The cons:
- If the owner’s original estimates are inaccurate, they will need additional work from contractors and go over budget (for contractors, this would be a pro, since more work = more money)
- The full price of the contract is not known until the project is near completion.
If you have any additional contract questions or aren’t sure which contract is right for your project, feel free to contact us to get our recommendation.
