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Const. Mgmt. Chp. 08 - Construction Pricing and Contracting

Const. Mgmt. Chp. 08 - Construction Pricing and Contracting

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Published by Faiz Ahmad

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Published by: Faiz Ahmad on Sep 26, 2009
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8. Construction Pricing and Contracting
8.1 Pricing for Constructed Facilities
Because of the unique nature of constructed facilities, it is almost imperative to have aseparate price for each facility. The construction contract price includes the direct projectcost including field supervision expenses plus the markup imposed by contractors forgeneral overhead expenses and profit. The factors influencing a facility price will vary bytype of facility and location as well. Within each of the major categories of constructionsuch as residential housing, commercial buildings, industrial complexes and infrastructure,there are smaller segments which have very different environments with regard to pricesetting. However, all pricing arrangements have some common features in the form of thelegal documents binding the owner and the supplier(s) of the facility. Without addressingspecial issues in various industry segments, the most common types of pricingarrangements can be described broadly to illustrate the basic principles.
Competitive Bidding
The basic structure of the bidding process consists of the formulation of detailed plans andspecifications of a facility based on the objectives and requirements of the owner, and theinvitation of qualified contractors to bid for the right to execute the project. The definitionof a qualified contractor usually calls for a minimal evidence of previous experience andfinancial stability. In the private sector, the owner has considerable latitude in selecting thebidders, ranging from open competition to the restriction of bidders to a few favoredcontractors. In the public sector, the rules are carefully delineated to place all qualifiedcontractors on an equal footing for competition, and strictly enforced to prevent collusionamong contractors and unethical or illegal actions by public officials.Detailed plans and specifications are usually prepared by an architectural/engineering firmwhich oversees the bidding process on behalf of the owner. The final bids are normallysubmitted on either a lump sum or unit price basis, as stipulated by the owner. A lump sumbid represents the total price for which a contractor offers to complete a facility accordingto the detailed plans and specifications. Unit price bidding is used in projects for which thequantity of materials or the amount of labor involved in some key tasks is particularlyuncertain. In such cases, the contractor is permitted to submit a list of unit prices for thosetasks, and the final price used to determine the lowest bidder is based on the lump sumprice computed by multiplying the quoted unit price for each specified task by thecorresponding quantity in the owner's estimates for quantities. However, the total paymentto the winning contractor will be based on the actual quantities multiplied by the respectivequoted unit prices.
Negotiated Contracts
Instead of inviting competitive bidding, private owners often choose to award constructioncontracts with one or more selected contractors. A major reason for using negotiatedcontracts is the flexibility of this type of pricing arrangement, particularly for projects of large size and great complexity or for projects which substantially duplicate previous
facilities sponsored by the owner. An owner may value the expertise and integrity of aparticular contractor who has a good reputation or has worked successfully for the owner inthe past. If it becomes necessary to meet a deadline for completion of the project, theconstruction of a project may proceed without waiting for the completion of the detailedplans and specifications with a contractor that the owner can trust. However, the owner'sstaff must be highly knowledgeable and competent in evaluating contractor proposals andmonitoring subsequent performance.Generally, negotiated contracts require the reimbursement of direct project cost plus thecontractor's fee as determined by one of the following methods:1.
Cost plus fixed percentage2.
Cost plus fixed fee3.
Cost plus variable fee4.
Target estimate5.
Guaranteed maximum price or costThe fixed percentage or fixed fee is determined at the outset of the project, while variablefee and target estimates are used as an incentive to reduce costs by sharing any costsavings. A guaranteed maximum cost arrangement imposes a penalty on a contractor forcost overruns and failure to complete the project on time. With a guaranteed maximumprice contract, amounts below the maximum are typically shared between the owner andthe contractor, while the contractor is responsible for costs above the maximum.
Speculative Residential Construction
In residential construction, developers often build houses and condominiums inanticipation of the demand of home buyers. Because the basic needs of home buyers arevery similar and home designs can be standardized to some degree, the probability of finding buyers of good housing units within a relatively short time is quite high.Consequently, developers are willing to undertake speculative building and lendinginstitutions are also willing to finance such construction. The developer essentially set theprice for each housing unit as the market will bear, and can adjust the prices of remainingunits at any given time according to the market trend.
Force-Account Construction
Some owners use in-house labor forces to perform a substantial amount of construction,particularly for addition, renovation and repair work. Then, the total of the force-accountcharges including in-house overhead expenses will be the pricing arrangement for theconstruction.Back to top 
8.2 Contract Provisions for Risk Allocation
Provisions for the allocation of risk among parties to a contract can appear in numerousareas in addition to the total construction price. Typically, these provisions assign
responsibility for covering the costs of possible or unforeseen occurances. A partial list of responsibilities with concomitant risk that can be assigned to different parties wouldinclude:
Force majeure (i.e., this provision absolves an owner or a contractor for paymentfor costs due to "Acts of God" and other external events such as war or laborstrikes)
Indemnification (i.e., this provision absolves the indemified party from anypayment for losses and damages incurred by a third party such as adjacent propertyowners.)
Liens (i.e., assurances that third party claims are settled such as "mechanics liens"for worker wages),
Labor laws (i.e., payments for any violation of labor laws and regulations on the jobsite),
Differing site conditions (i.e., responsibility for extra costs due to unexpected siteconditions),
Delays and extensions of time,
Liquidated damages (i.e., payments for any facility defects with payment amountsagreed to in advance)
Consequential damages (i.e., payments for actual damage costs assessed uponimpact of facility defects),
Occupational safety and health of workers,
Permits, licenses, laws, and regulations,
Equal employment opportunity regulations,
Termination for default by contractor,
Suspension of work,
Warranties and guarantees.The language used for specifying the risk assignments in these areas must conform to legalrequirements and past interpretations which may vary in different jurisdictions or overtime. Without using standard legal language, contract provisions may be unenforceable.Unfortunately, standard legal language for this purpose may be difficult to understand. As aresult, project managers often have difficulty in interpreting their particular responsibilities.Competent legal counsel is required to advise the different parties to an agreement abouttheir respective responsibilities.Standard forms for contracts can be obtained from numerous sources, such as the AmericanInstitute of Architects (AIA) or the Associated General Contractors (AGC). These standardforms may include risk and responsibility allocations which are unacceptable to one ormore of the contracting parties. In particular, standard forms may be biased to reduce therisk and responsibility of the originating organization or group. Parties to a contract shouldread and review all contract documents carefully.The three examples appearing below illustrate contract language resulting in different risk assignments between a contractor (CONTRACTOR) and an owner (COMPANY). Eachcontract provision allocates different levels of indemnification risk to the contractor.[1] 
Example 8-1: A Contract Provision Example with High Contractor Risk

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