Construction projects, whether residential or commercial, have one thing in common: variability. The time span from the date the bid is submitted by the contractor to the date the project begins can be months if not years. Most contractors have clauses to protect themselves in the case of extended periods of time between awarding of the contract and breaking ground because the price of materials, labor and regulatory costs may change. Another common problem is changes introduced by the client.
A stipulated sum, also known as a lump sum contract, shifts all liability for costs from the client to the contractor. For this reason, when submitting a bid, the contractor generally builds in a large markup to accommodate unforeseen expenses. In most stipulated sum contracts, the contractor also agrees to a specific schedule, a system of management reporting or a quality control program. If the contractor bids low to win the bid, he may lose money on the contract unless he exercises strict control of time and expense. A high bid, on the other hand, may not win the contract.
Types of Cost-Plus Contracts
Cost-plus contracts represent an attempt to mitigate some of the liability for project expenses. There are several types of cost-plus contract structures including cost-plus-fixed-percentage, cost-plus-fixed-fee and cost-plus-variable-percentage options.
A cost-plus-fixed-percentage contract places the liability on the client and rarely is used unless there is some urgency associated with the need for the facility to be built. It gives the contractor no incentive to bring the project in on budget. A cost-plus-fixed-fee contract places the cost liability on the client but also presents the contractor with the incentive to finish the project quickly. A cost-plus-variable-percentage contract provides an incentive for the contractor to bid the job accurately because his percentage will be higher if the job comes in under budget and lower if the job costs more than estimated.
Guaranteed Maximum Cost
Guaranteed maximum cost, called G-Max, is an alternative contract structure that can be used only with a well-defined project in which the client makes little or no changes during construction. The liability to bring the project in on or below budget lies with the contractor, who estimates a maximum cost, similar to a stipulated sum contract. Any savings in cost, at the option of the client, can be split with the contractor but that depends on the terms negotiated in the contract.