There are several types of contracting approaches between owner and contractor and each supports different project environments and project approaches. The Project Execution Plan and procedures are developed based on the contract type including terms and conditions. There is two main type of contract: a fixed price and a reimbursement, and:
Fixed Price (Lump Sum) Contract
Cost plus (Reimbursable) Fee Contract
Unit Price Contract
A. Fix Price Contract
Fixed Price Contract (called as a Lump Sum Contract) is a type of contract where the contract amount does not depend on resources used or time expended.
Lump Sum Contract (known as a Fixed Price Contract) is a contract under which an owner agrees to compensate to contractor a specified contracted amount for the completion of project or works. Under the lump sum contract, a single lump sum price for all of the works is agreed before the contract validated, and the contractor is responsible for completing the project within the agreed fixed cost set forth in the contract. If the contractor completes the project under the fixed total cost, then the contractor makes additional profits from the project. The owner is not entitled to any savings if the project is completed below the fixed total cost. The lump sum contract is generally a closed book arrangement, so the contractor does not have to report the cost of labor and materials to the owner.
The Lump Sum contract is normally used in the construction industry to reduce design and contract administration costs. The lump sum contract is the most recognized agreement form on simple and small projects, and project is well-defined scopes and responsibilities of both parties.
The Lump Sum Contract is generally appropriate where the project is already well defined, and changes are unlikely therefore the owner must have sufficiently detailed and complete drawings and specifications, and construction documents at the time of the bid to allow the bidders to properly estimate the cost of labor and materials. This means that the contractor is able to accurately price the risk they are being asked to accept. The Lump Sum Contract is also often ideal when an owner has very tight budget constraints or lacks experience in the construction industry.
The Lump Sum Contract can include incentives or benefits for early completion, or can also have penalties, called liquidated damages, for a late completion.
A Lump Sum Contract requires that a contractor agrees to provide specified services or works for an agreed fixed amount or price. In the Lump Sum Contract, the owner has essentially assigned all the risk to the contractor, who in turn can be expected to ask for a higher markup in order to take care of unforeseen contingencies. A Contractor being contracted under a Lump Sum agreement will be responsible for the proper job execution and will provide its own means and methods to complete the work.
The Lump Sum contract usually is developed by estimating labor costs, material costs, and adding a specific amount that will cover contractor’s overhead and profit margin. The amount of overhead calculated under a lump sum contract will vary from contractors, but it will be based on their risk assessment study and labor expertise.
Lump Sum Turnkey (LSTK) is a combination of Lump Sum (LS) contract and Turnkey (TK). A Lump Sum Contract is a contract under which an owner agrees to pay a contractor a specified contracted amount for completing work, and the contractor is responsible for completing the project within the agreed fixed cost set forth in the contract under the contractor’s financial risk. Turnkey (TK) specifies that the scope of work includes start-up of the facility and achievement of the normal operation status under the contractor’s responsibility.
Progressive LSTK is in very large projects or very urgent project may be split into phases where an agreed fixed price (lump sum) at the start of the project or each phase, and convert to lump sum fixed price after the project is fully developed. This reduces the overall project risk taken by the contractor at the start of the project, and this increases flexibility to owner to incorporate requirements into the project until the project is fully developed.
B. Reimbursable Contract (known as a Cost plus Fee Contract)
Cost plus Fee Contract (called as a Cost Reimbursement Contract), is a contract where a contractor is reimbursed by the owner for the actual cost of performing the work plus additional payment to allow for an overhead and profit in accordance with the terms of the contract. The contractor is not supposed to make an additional profit on any cost items which is an open book basis. Prior to the project commencement, the owner and contractor agree on a fee that the contractor will retain for profit and overhead, the Owner and contractor should specify early on in the process what is a reimbursable expense to the contractor, and what is considered a cost to the owner.
An experienced owner in the construction industry, or for an owner who cannot initially define or sufficiently detail the scope of the work, and the kinds of labor, material and equipment needed are also uncertain, the Cost plus Contract is an adequate. Under this contract terms and conditions, complete records of all time and materials spent by the contractor on the work must be maintained.
Cost plus Fee contract can provide the initially negotiated fee to be adjusted later by a formula based on the relationship of total allowable costs to total target costs such as target fee, minimum and maximum fees, and a fee adjustment formula. After project performance, the fee payable to the contractor is determined in accordance with the formula.
Type of Cost plus Fee Contract: Cost plus Fee Contract can be defined as follows:
Cost plus Fixed Fee (CPFF) Contract is an owner to compensate to contractor a fixed amount of fee for contractor’s overhead and profit that was agreed upon at the time of contract formation. The owner agrees to reimburse the contractor's actual costs, regardless of amount, and in addition pay a negotiated fee for contractor’s overhead and profit.
Cost plus Incentive Fee (CPIF) Contract is an owner to pay an incentive to contractor if the project is successfully completed and meet or exceed performance targets: under budget; ahead of schedule; excellent in safety record, etc., and can be included any cost savings rather than compensate fixed fee for contractor’s overhead and profit.
Cost plus Award Fee (CPAF) Contract is to pay a fee based upon the contractor's work performance. In some contracts, the fee is determined subjectively by an awards fee based upon objective performance metrics. An aircraft development contract, for example, may pay award fees if the contractor achieves certain speed, range, or payload capacity goals.
Cost plus Percentage of Cost Contract to compensate a fee based on a percentage of the cost. Also, there is a Cost plus Percentage of the Construction Cost.
Cost Plus with Guaranteed Maximum Price (GMP) Contract is a type of contract, while the traditional cost-plus agreement does not have a fixed budget, an owner and contractor often agree to cap the price once the project’s design is substantially complete. Under a GMP agreement, a contractor who exceeds the capped amount is responsible for the difference, and if the total cost of the project is below the capped cost, the owner and contractor often agree to a shared savings benefit.
Cost Plus with Guaranteed Maximum Price and Incentive Contract is compensated based on a fixed cost of money. The total project cost will not exceed an agreed upper limit and a bonus is given if the project is finished below budget, ahead of schedule etc.
Cost plus Fixed Fee with agreement for sharing any cost savings Contract is to compensate an agreed fixed sum plus any cost savings are shared with the owner and the contractor.
Incentive Contract is an owner to compensate based on the project performance according to the contract terms and conditions, such as cost, schedule, quality, and safety. There is two possible incentive contracts are fixed price incentive contracts, and cost reimbursement incentive contracts. Fixed price incentive contracts is preferred when contract costs and performance requirements are reasonably certain.
Unit Price Contract is a type of contract based on estimated quantities of items included in the project and unit prices (hourly rates, rate per unit work volume, etc.) In general, contractor’s overhead and profit is included in the rate. The final price of the project is dependent on the quantities needed to carry out and complete the work.
In general this contract is only suitable for well-known resources involved project but unknown quantities at the time of the contract which will be defined when the design and engineering or construction work is completed.
C. Other Definition
Provisional Sum: A Provisional Sum is for the present time but likely to change, is an amount of allowance money tentatively agreed for the work to be performed. The Provisional Sum may be included in the Contract as a specific contingency for the execution of work or the supply of materials or services which may be used in whole or in part or not at all based on the contract terms and conditions. The Provisional Sum may be changed when the additional information is available or work definition is more clearly defined.
Not to Exceed: A Not to Exceed (NTE) Contract is the portion of an estimated price for specific work scope, the contractor is allowed to bill the client before reaching a final agreement on contract terms. Commitments and expenditures for this work scope are limited to this value.
Lump Sum is a price amount of an entire project or scope of work where no breakdown is given for individual items, and is paid in one large amount on one occasion.