The Rest of the Story…Part 2

After our client (whose story we have been talking about in our last several eBits) settled on how to deliver his project, the conversation went to which type of Contract Methodology should be used. When dealing with contract types, it always comes down to Risk & Reward. The one who accepts the risk should get the reward. So, no matter which method of contract you choose, how to allocate risk and reward is the measuring stick. Here are the three basic types of contracts used to deliver capital projects:

LUMP SUM.  With this method, the Risk/Reward is the Contractor’s. The following are true about this method:

  • Costs are fixed at time of bidding
  • Schedule is fixed at time of bidding
  • High probability for Change Orders if the scope is not well defined

COST PLUS A FEE. With this method, the Risk/Reward is the Owner’s. The following are true about this method:

  • Costs are based on the project scope and passed directly through to the owner
  • All bidding, negotiations, and construction costs are “open book”
  • The fee (lump sum or percent of cost) is negotiated at the start of the project

GUARANTEED MAXIMUM PRICE (GMP). With this method, the Risk/Reward is Shared. The following are true about this method:

  • Maximum cost is guaranteed at the start of the project, based on an approved scope of work
  • All bidding, negotiations, and construction costs are “open book”
  • At the completion of the project all savings to the GMP are shared per the formula agreed to at the start of the project.

Due to the financial institution our client was working with, he chose the Lump Sum contract method. The underwriter of the loan required firm bids prior to closing and did not want to accept any risk after the contracts were executed. As with Delivery Methods, different contract methods work for different projects. Again no “One Size Fits All” answers. Give me a call and we can talk more about the truths of each method and see which method would best fit your next capital project.

Our next e-Bits I will unpack the sequencing of Planning, Designing, and Implementing a project, in the meantime- Stay Tuned for the Rest of the Story…

 

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