Contract Procurement Methods and Price Adjustment

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Table of Contents

Introduction
Contract Procurement Methods
Remeasurement Contract
Lump-Sum Price Contract
Cost Plus
Guaranteed Maximum Price
Target Cost
Conclusion
References
Footnotes

Introduction

The total contract price is the cumulative cost of completing a project. The total cost comprises the total compensation of the project cost and all the quoted amount in the proposal for the services rendered to the client. The total contract price includes all the professional fees and any other extra charges incurred during service delivery, including taxes.¹ The concept of the total contract price is applied to understand the value of a contract and revenue expectation from an executed project or services rendered. The onboarding fee, consultation fee, and any other charge incurred throughout project execution are included while calculating the total revenue. The total contract price is calculated based on the procurement methods, whether re-measurable, lump-sum price, cost plus, guaranteed maximum price, or target cost. However, adjusting the price in the contracts under English common law, UAE law, and FIDIC forms of warranty is possible.

Contract Procurement Methods

Procurement has been a norm in day-to-day lives while acquiring services and commodities. Different contact procurement methods are applied to ensure the applied manner is efficient and cost-efficient to reduce time wastage at the compensation stage. The favorable procurement method will be selected based on the requirements of the contractors and the arrangements done at the planning stage of the contract.² Before deciding on the best procurement method, the constructor should understand the needs of the client and the total cost of the project. Some important considerations while choosing the most appropriate procurement method include speed, the quality expected, project constraints, the risk associated with the project, financing, and construction materials. Through such consideration, the constructor will have the best strategy of compensation to accomplish the task.

Remeasurement Contract

In this type of contract method, the measurement is done alongside the stipulated rates—professional measures to get the value of the total project. The removal contract does not have a lump sum agreement, but there is an agreed basis used to arrive at the project’s total value. The professional analysis is expected to look back at the quantity and quality of work done and develop an analysis of the full compensation. The method applies in situations where the project details are available, but the project’s cost cannot be discussed in detail.³ An example of a work that can be valued using the remeasurement method in excavation services. It might not be easy to predetermine the number of excavation services until the job is initiated. After the project is completed, the contractor will be better positioned to determine the quantity of the excavation services and determine the value of the services. At this stage, the remeasurement is done to assess the value of the services rendered to the client.

The remeasurement type of contract is primarily used in the construction industry. Large construction companies used this method to subcontract with other companies where the services are paid based on the type of work done.⁴ The risk to the client is high, while the contractor has a minimum chance. The rates provided in the contractor’s tender are not considered until the work is done so that prices can be estimated based on the services rendered. The possibility of the work beginning before the design is completed puts the client at risk because the client does not know the project’s cost. The client might be shocked by the prices, which might go beyond the estimated budget.

The remeasurement contract is associated with advantages and disadvantages. The benefits of a remeasurement contract include; Work begins upon finalizing the actual design, reducing design cost, value engineering can quickly be done, competitive prices, and minimum risk to the contractor.⁵ The disadvantages include; it is difficult to predict the project’s final cost, delayed payment of the contractor because of the timely assessment period, the client’s risk is high, and reporting and controlling is a strenuous activity. Finally, consulting services might be required to carry out the remeasurement services. While choosing the contract method, it is essential to consider all the factors which might affect service delivery.

The provision for price adjustment allow unforeseeable ground conditions implied the undesired occurrences in the ground and were not projected by the contractor. The UAE and English law allow adjustment of the prices to cater for the unforeseeable ground conditions.

Lump-Sum Price Contract

A lump sum price contract allows the contractor to complete a project based on the agreed set price for the services rendered. The lump-sum agreement is also referred to as stipulate total. It submits the total cost of completing a project rather than valuing individual units of the project. It is generally accepted because of its simplicity and open agreement between the contractor and the client.⁶ It is essential to consider the situation of the project before choosing a lump sum price. There are various situations where the lump sum price method is the best option for both parties of the contract. In particular, the project which fits the lump sum price method has some distinctive features which differentiate them from other projects.

The projects should have a scope of work that is clearly defined and straightforward in terms of completion and execution. A relevant example is a lump builder, according to Rahmani et al. (2017, 593). A lump builder will use a lump sum contract more effectively. The drawing design remains unchangeable throughout the project, which allows the contractor to have a clear scope. The materials can be purchased once to avoid risks associated with the fluctuation of prices. In complicated projects, it might be challenging to use lump-sum pricing. Klee (2018, 27) states that the complexity of the projects might facilitate changes that were not foreseen. Best planned projects can be affected by the changing nature of the project. In a project where there are more moving pieces, the contractor will have difficulty choosing a lump sum project. Many government projects are executed using lump sum projects. The government approves this method as the best utilize taxes paid by citizens and ensure services are rendered.

Successful use of lump-sum contracts will depend on the perfect anticipation of the project schedule, the cost of raw materials, and labor costs involved in the project. The contractor is also expected to understand the profit margins incorporated while pricing the undertaking. Lack of profit margin knowledge might lead the contractor to operate on losses. The total prices set should be competitive to win the client’s confidence that the project will be completed and deliver the best results. Predetermined pricing is essential for comparison on the value of the project. There are various pros and cons associated with the lump-sum method.

The Pros of Lump Sum Pricing

The pros include simplicity, which is the simplest form of contract applied in construction projects. They are easy to understand and design.⁷ The contract documents are intended to explain the project which is in question and the standard charges involved to complete the project. The contractor prefers the lump sum pricing because of the autonomy involved in the execution of the project. The client chose this pricing method because they can understand the total cost of the project. The client can ensure the budget is constrained within the available budget. Profitability is another advantage arising when contractors use this piecing method. They can save some amount that will be used to increase the profit margin. The contractors can take insurance policies to protect them from some unseen occurrences, enabling the company to rescue its profit. If the contractor can control the overhead cost, the profit margin will be high because the yield is calculated from the total charges of the project.

The method facilitates more accessible financing as well, where the contractor can seek funds from lenders using the project documents. The loaners will be interested in knowing the total cost of completing a project and the profit margin from the project. The lender will be willing to finance such a project because the project’s scope is clearly defined in the presented documents. Further, there is little paperwork because the documentations in the lump sum pricing contract are well stipulated. The project requirements are well articulated on the papers, and the client does not need to be bothered by the material prices because the project schedule outlines every stage of the project.

There is easier management of the cash flow because the owner has a well-designed roadmap of revenue in the project. The owner utilizes this opportunity to manage the cash flow and formulate a budget that will help to complete a task. Moreover, the contractor is aware of the percentage payment at various stages of the project. The cash flow management is made more accessible by the knowledge of the deductions involved in the project. When calculating the price, the contract owner will be able to minus all the retentions. The mobilization of the initial cost will not strangle the contractor.

The Cons of Lump Sum Pricing

The contractor is at high risk- When the contractor reaches into an agreement to use the lump sum pricing, they assume all the risks involved in the project. The contractor will bear all the risks which will occur while bringing the project to completion.⁸ Although they can pay the insurance policies to cover the project, the risk might overwhelm the insurance project. If the project exceeds the available budget, the contractor pays the extra cost of running the project. The client does not pay for any additional cost, and any other price is the contractor’s responsibility.

It is relatively expensive due to the risks involved in project execution. The client understands the risk assumed in the project, and the client is expected to stretch their pockets to facilitate the contractor. The client might not get the value of the project if the risks are more than projected. Unethical contractors might buy inferior materials which are relatively cheap to increase their profit.

Legislation might change, which might lead to increased cost of completing the project. Legislations such as taxation solely rest in the hands of the sovereign government. If the government decides to raise the tax paid by the contractor, the contractor can adjust the prices in such cases. Taxation varies from one country to the other. What applies in one country might be challenging to be involved in another one. It is essential to understand the various factors that might lead to the adjustment of prices to avoid conflict between the two parties of the contract.

Cost Plus

A cost-plus contract is an agreement reached to reimburse the construction company for the cost incurred and a certain amount of profit, which is presented in a given percentage of the contract’s total price. This type of contract is used where the client assumes some of the risk involved in the contract and the contact, but there is define flexibility to the contractor. The parties in the contract think that the contractor will honor his/her part of the agreement and deliver the best results. Bailey (2011, 18) found that an organization agrees to pay more to the client when the project is completed, increasing the contractor’s profit in the long run.

Two parties can agree on the fixed cost, which does not consider the actual expenses from the contractor. The advantage of the price plus method includes removing some risks from the side of the contactor. Also, it allows the contractor to focus on the quality of the work rather than focusing on the total cost of the project. The disadvantages include battles in the process of claiming construction-related expenses. UAE and English Law and FIDIC Standard form contracts providing provisions for price adjustment under the cost plus construction procurement methods. The rules offer standards of construction contracts and ensure quality services to the clients.

Guaranteed Maximum Price

This type of contract has a set limit or maximum price which the client is expected to pay the company without regarding the cost of completing the project. The method puts the total guaranteed price and the limit within which it cannot be exceeded. The contractor’s charge exceeds the top cap. GMP is enticing to the clients because the program shifts some risks to the contractor. Advantages of using guaranteed maximum pricing include savings incentives for the clients and accelerated schedules. On the other hand, disadvantages include increased risk to the contractor, cost reporting inaccuracy where the client wants to enjoy cost reduction. UAE and English Law and FIDIC legislations ensure a harmonious relationship between the client and the contractor through regulation of terms of services and price adjustment. The law allow adjustment of prices on guaranteed maximum price.

Various factors can lead to price adjustment in the form of variation, unforeseeable ground conditions, and force majeure. Regarding variations, price adjustment could arise from the changes that engineers or contractors initiate as a result of the complex nature of construction projects.⁹ They include work acceleration, changing quantities, dimensions, and positions, increasing work plant materials, and efficiency improvements. Unforeseeable ground conditions can necessitate price changes due to the hazards caused by geological properties of the ground and physical obstructions such as utilities constructed underground. Previous land developers might have made changes that were not physically assessed during project design. Lastly, prices could vary due to force majeure, where a project is canceled or prices changed due to defective work.¹⁰

Target Cost

The target cost contract has a reimbursable cost in which the actual price is paid to the contractor. The actual cost is defined in the work contract, and it includes the cost incurred while executing the project. Baker et al. (2009, 24) state that the total cost is subject to the target cost, which both parties formulate at the initial stage of the project. The target cost comprises; cost of physical work, profit, and the contingencies for risks that might occur in the project. The target contract has a benefit to both parties because it aligns the interests of both the client and the contractor. Both parties have a win-win situation and work together to ensure the project’s cost remains below the target amount. The law has some provisions where the prices can be adjusted. Various factors might lead to an adjustment of the fees agreed upon using target cost procurement methods. Contractor’s action such as tranfering the risk to the client can lead adjustment of the price.

Conclusion

The above analysis explains the contract procurements method and various factors that might adjust the contract price. Construction professionals should understand the various contract procurement methods used to negotiate the project’s price, cost, and value. Every contractor should know how to determine the value of a project and the best way to be applied while procuring the contract. It is highly recommended that selecting the best procurement method is the beginning of executing a successful project. Attention should be paid to this process because it is the first step towards a construction project to avoid unnecessary adjustments.

References

Bailey, Julian. Construction Contract. London: Routledge, 2011.

Baker, Ellis, Mellors Ben, Chalmers Scott, and Lavers Anthony. FIDIC Contracts: Law and Practice. London and New York: Routledge, 2009.

Farshid, Rahmani, Maqsood Tayyab, and Khalfan Malik. “An Overview Of Construction Procurement Methods In Australia.” Engineering, Construction And Architectural Management 24, no. 4 (2017): 593-609. Web.

Godwin, William. International Construction Contracts: A Handbook. Oxford: Wiley-Blackwell, 2013.

Gross, Michael. Construction Law in the United Arab Emirates and the Gulf. Oxford: Wiley Blackwell, 2016.

Jaeger, Axel-Volkmar, and Hok Gotz-Sebastian. FIDIC-A Guide for Practitioners. New York: Springer, 2010.

Klee, Lukas. International Construction Contract Law (2^nd ed.). Oxford: Wiley-Blackwell, 2018.

Footnotes

Michael Gross, Construction Law in the United Arab Emirates and the Gulf (Oxford: Wiley Blackwell, 2016): 9.
William Godwin, International Construction Contracts: A Handbook (Oxford: Wiley-Blackwell, 2013): 24.
Lukas Klee, International Construction Contract Law (2^nd ed.) (Oxford: Wiley-Blackwell, 2018): 12.
Rahmani Farshid et al., “An Overview Of Construction Procurement Methods In Australia”. Engineering, Construction And Architectural Management 24, no. 4 (2017): 593-609. Web.
Gross, Construction Law in the United Arab Emirates and the Gulf, 26.
Julian Bailey, Construction Contract (London: Routledge, 2011): 25.
Klee, International Construction Contract Law, 33.
Bailey, Construction Contract, 22.
Michael, Construction Law in the United Arab Emirates and the Gulf, 153.
Ibid, 180.

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