Lump-Sum Contract: Meaning, Advantages,

Disadvantages and More

Lump-Sum Contract: Meaning
A lump-sum contract is a legal contract where the contractor promises to complete
the whole project at a pre-agreed price. In other words, the contractor is
responsible for completing the whole task at a mutually agreed price in such type of
contract. Here the focus is on the completion of the whole project and not on the
smaller tasks. The contractor doesn’t ask the client to pay for smaller tasks, instead
asks to pay a lump-sum amount for the whole task.

On the basis of the nature of the project, the contractor estimates the total cost of
the project. The contractor has to be very optimal at the time of estimating the cost
of the project. In the computation of lump-sum cost, consideration of labor cost,
material cost, and overheads costs along the profits margin take place. Mostly, the
client makes the total payment in small installments in a staggered manner to the
contractor.

A lump-sum contract works best

Table of Contents
when the scope of the project is Lump-Sum Contract: Meaning
narrow and predefined. This contract Understanding Lump Sum Contract
is not useful when there are many Advantages
dimensions and multistage Disadvantages
innovations to the project. When the Lump-Sum Contract Vs. Cost Plus Contract
Lump-Sum Contract Vs. Unit Price Contract
project is straightforward, the lump
Conclusion
sum contract serves its best. The
contractor under this type of project
mostly charges mark-up prices for bearing the risk of any future unforeseen
situations.

The lump-sum contract is also known as a stipulated sum contract or fixed-price

contract.

Understanding Lump Sum Contract

A lump-sum contract is one of the very popular construction contracts. The
contractor has to decide on the design of the project even before the construction
work begins for the project. Mostly under this type of contract, the construction
project is mediocre and predictable in nature. Because of the simplicity of the
project, it becomes easy for the contractor to estimate the lump-sum cost of the
project. Although, the estimated lump-sum cost can fluctuate due to various
elements.

Also Read: Cost Plus Contract: Meaning, Types, Advantages, Example, and More

These elements are as follows:- 

There could be variations in the nature and type of the project work, natural and/or
man-made events can fluctuate the set price, Inflation can also impact the lump-
sum price, prices can fluctuate due to non-consideration of few payments to the
external party, changes in the statutory fees or commission can also lead to
variation, increase or decrease in the prices of inputs (raw material), etc.

Advantages
 Under the lump-sum contract, the client of the project faces very little
amount of risk.
This contract has a minimal amount of variations. Mostly the target, the
inputs, and the outputs, everything is fixed.
In such types of contracts, the client is fully aware of the total cost and scope
of the project even before the beginning of the project. And therefore, it
becomes easy to manage the sources of finance timely by the client.
The cash flows for the contractor and the client is mostly predictable.
The whole process of tender is very transparent and clean in nature.
It becomes easy to avail of a construction loan on the basis of a lump-sum
contract.
Under this type of contract, there are high chances of higher profit margins
for the contractor.
The bidding process and the selection process are very crystal clear under the
stipulated sum contract.
The time of the client is saved because of less supervision is required.
This contract reduces the overhead expenditures on the contractor’s side also.

These advantages are non-exhaustive in nature.

Disadvantages
The lump-sum contract doesn’t work where the project is complicated in
nature.
Lump-sum contracts are not suitable for speedy projects.
Under this type of contract, the contractor faces a very high amount of risk.
The contractor mostly has to complete the project within the set price.
Therefore his estimation has to be near perfect, or else it may land him in
losses.
Sometimes, the cost of preparing a tender for the contract is even higher
than the actual cost of the project.
These contracts may have a high chance of disputes between the contractor
and the client if the scope of work is not well spelt out.
The requirement of precise documentation under this type of contract may
sometimes become a time-consuming task.
Such contracts become expensive if the client is constantly modifying or
adding structures to the existing model. The contractor charges an additional
price for each such kind of addition or modification.
Under this type of contract, the contractor selects the construction method
according to its own convenience. The client may not have enough say in this
situation.
Conflict of interest can occur between the contractor and the client. The focus
of the client is to generate as much as productivity out of the total money
spent. Whereas the focus of the contractor is to generate as much profit as
possible.
 There are high chances of quality deterioration because the contractor has to
finish the job at the set price.

These disadvantages are non-exhaustive in nature.

Lump-Sum Contract Vs. Cost Plus Contract
Both these contracts are types of incentive contracts. There are a few differences
between a cost-plus contract and a stipulated sum contract; they are as follows:- 

In a cost-plus contract, the client pays all the costs (including fixed, variable, and
overheads) and additional fees/margin to the contractor, unlike the lump sum
contract, where payment of the approximate amount takes place. There is a high
possibility of more profit generation in the stipulated sum contract in comparison to
the cost-plus contract. In a lump-sum contract, it is compulsory to have proper
designs and structures before the beginning of the construction project. In the case
of a cost-plus contract, it is not compulsory to do the same. An increase and
decrease in the cost of the project will impact the profits in the stipulated sum
contract and not in the cost-plus contract.

A cost-plus contract requires a lot of documentation in comparison to a lump-sum

contract. Constant watch, changes, follow-up, and differences in cost because of
each and every modification/additional work need to be recorded by both parties in
detail at each stage to avoid any dispute at a later date.

Also Read: Incentive Contract: Meaning, Types, Advantages, Disadvantages and

More
Lump-Sum Contract Vs. Unit Price Contract
There are a few differences between the unit price contract and the stipulated sum
contract; they are as follows:-

A Unit price contract is a broader concept in comparison to a lump-sum contract. A

unit price contract is a combination of many lump-sum contracts altogether. Lump-
sum contracts are not that flexible in nature, while the unit price contracts are
flexible and deal with multistage projects. The cost of the project mostly stays the
same in the stipulated sum contract, but in the unit price contract, with the increase
in units, the cost also increases.

Conclusion

There are many disadvantages of the lump-sum contract. All these disadvantages
can be overcome if the project is well-defined and structured in nature. A solid and
basic construction design (drawings), mediocre construction structure, and foolproof
documentation are the best-supporting scenarios for a lump-sum contract. This
contract reduces the risk on the side of the contractor and allows the contractor to
earn high-profit margins. This is also beneficial for the client as everything about
the project – cost, structure, timeline, funding, etc. remains crystal clear for him.
And there remains a lesser effort on account of supervision, validation, and
recording of the details. Thus using a lump-sum contract in selective projects gives
outstanding results.