Contract Pricing: The Good, The Bad And The Ugly

As a specialty contractor, Kraemer Gunite, Inc. has been involved in just about every type of contract pricing.   Fixed price, fixed fee, time and material, open book, cost plus, unit pricing, even some creative combinations.   We are sometimes asked which we prefer.     There is no clear cut answer and there may be several good choices for a given project.   And since there is rarely two identical projects, what's best for one may be unsuitable for another.   There are, however, at least two things common to all projects.   Owners want the most for their money and contractor's want to make a profit.     It is our experience, that with enough forethought and planning both parties can emerge successful.

Fixed Price (Lump Sum) Pricing

In a fixed price contract the owner outlines the project requirements and solicits lump sum prices from an interested group of contractors.   The owner generally will select the lowest qualified bidder.

The Good 

• Fixed price or lump sum contracts can provide a fair comparison of pricing between competing contractors.
• Minimizes paper work and associated costs.

The Bad

• Contractors bids may not be identical.   Some may include items that others do not.   To get a fair comparison between bids, owners must sort out the differences and get all proposals on equal ground.
• Most contractors add an arbitrary amount to their bid to cover unknowns.   For example, bad weather, employee absenteeism, delayed material deliveries, equipment malfunction, or other unexpected delays that have the "potential" to cost the contractor money.   The owner pays for unexpected expenses whether they occur or not.

The Ugly

• Contractors that underbid or don't consider unknowns can find themselves incurring unexpected, profit eroding, expenses.   With no other recourse, corners may be cut and prices for changes in scope of work can be inflated in the contractor's attempt to save the project from financial failure.
• Intangibles, such as; productivity and the contractors reliability cannot be determined from a single price.   A contractor that shows up intermittently, works with an inadequate crew, schedules tasks and/or handles subcontractors and vendors poorly, can take longer to finish a project.    When downtime is costly to an owner, the price of the job can become insignificant in relation to extended downtime costs.

Time and Materials Pricing

In a time and materials contract the owner reimburses the contractor for all direct costs for labor, materials, equipment, subcontractors and all purchases.   A mutually agreed to percentage is then added  for the contractor's home office overhead, indirect costs and profit.    The usual format is hourly rates for labor; daily, weekly or monthly rates for equipment rentals and materials at direct cost plus the agreed to percentage.

The Good   

•  With T&M contracts the owner pays for exactly what they get based on actual hours worked and costs incurred.
• The scope of work can be undefined and take shape as the job progresses under the complete control of the owner.
• The contractor can focus on the job at hand confident that every effort is compensated.
• The owner can easily calculate the cost of the job at any point in time, knowing when to expand or reduce the scope of work based on the available funds.
• The project can be stopped at any time at the owner's discretion without penalty.

The bad

• Productivity, quality and technology factors are invisible when comparing hourly rates between various contractors.   These factors can have a tremendous impact on the final price of the project.   What take one contractor a week to complete can take another a month.
• T&M contracts require detailed accounting by both the owner and contractor which adds to the cost of the job.

The Ugly

• Contractors that go in with inadequate price rates may over man, over equip and/or drag out a project in an attempt to build up profit.
• Nickel and dime charges can emerge in the contractors attempt to supplement low rates.

Fixed Fee Pricing

With a fixed fee contract the owner pays a pre-determined "fixed fee" for the contractors indirect costs and profit usually based on the project size and duration.   The owner directly reimburses the contractor for all direct costs for labor, materials, equipment and subcontracts.  

The Good

• A Fixed Fee contract can provide a fair comparison between equally productive qualified contractors.
• The contractor can focus attention on the job at hand confident that they are being compensated for every effort.

The Bad

• Vital productivity, technology and quality factors are invisible during the evaluation process.   An unproductive contractor that uses antiquated technology can cost the owner significant extended downtime costs.
• The need for detailed accounting adds to the cost of the job.
• Quality can be sacrificed for speed.   Since the contractor is getting a fixed amount for indirect costs and profit, regardless of project duration, an "earlier the better" mentality can be quickly adopted by the contractor.     The sooner the job is done the faster the contractor can collect and get on with the next project.    The owners best interest can take a back seat to getting the project done in a hurry.

The Ugly

• Contractors that go in with an inadequate fee can lead to strenuous negotiations for a fee adjustment when more or less work is required, especially when there is no contract provision to handle changes in the scope of work.

Unit Pricing

With a Unit Price contract the contractor is paid a fixed amount for each unit of measure that's completed.   Standard units of measure vary from industry to industry.   Examples from our line of work include; linear foot, square foot, cubic foot, cubic yard, bag, gallon among others.   Often there is a fixed price component over and above the unit pricing that covers invariable costs like the contractors mobilization and demobilization.

The Good

• Unit Price contracts can provide a fair comparison between equally productive qualified contractors.
• The owner only pays for what work is done based on actual field measurements.
• Marginally more or less work can be done without the need for unit price renegotiation.   Unit price adjustments can be built in for the addition or deletion or work.
• The owner can determine what they are spending at any point in time since price is directly related to the number of units completed.

The Bad

•  Since more units done gets the contractor more money the emphasis is put on quantity not quality.
• A Unit Price is only as good as the estimated number of units used for the price base.   A poor estimate will cause the Unit Price to be out of whack.  The usual relationship is the greater the number of units the lower the unit price and vice versa.    The accuracy of the initial unit quantity estimate can determine the success or failure of the project for both parties.
• Unit Price contracts can become complicated when variables other than unit quantity exist, such as work area location and imposed deadlines which may require overtime work to meet.  For example, it cost substantially more to paint 1000 separate areas measuring 1 square foot each on a Holiday than it does to paint 1000 square feet in a single area during a normal workday.   
• A detailed account of the amount of work done must be logged on a regular basis by the owner and contractor which adds to the cost of the job.

The Ugly

• Negotiations can become strenuous when the number of units differs significantly from the initial estimate and there is no contract provision addressing the matter.

So what do we recommend to owners to help them get the most for their money?

1. Define the work.  

• Write down the exact scope of work in as much detail as possible.
• Make it clear what facilities you have for the contractor to use and what you expect them to provide for themselves.
• Carefully select what information to give the contractors.   More is not always better.  The task of sorting out needed from useless information can become overwhelming, add to the cost of the job and discourage qualified contractors.

2. Prequalify the bidders.

• Find companies that specialize in the type of work you want done and have the support needed to see the job through to completion; that is; experienced management and supervisors, trained personnel, equipment, suppliers,  financing, bonding, etc.
• Be sure the contractors have a successful work history performing similar work.     Request a list of clients from the candidates and by all means call several or all of them.  Beware if a contractor is reluctant to supply references or only gives one or two.   This could be a sign the contractor is trying to keep you from contacting dissatisfied clients.
• Get feedback from friends, colleagues and acquaintances about the contractor's reputation.

3. Get Pricing On Equal Ground

• List exclusions and items some contractors provide and others do not using a pro and con format.   Beware of companies that take many exclusions and leave owners wide open to additional charges that can make an apparent low bid the highest.   Look out for the fine print.
• Determine what method will be used for adjustments if more or less work is done.   Include this in the evaluation process.   Beware if the contract price skyrockets with a minor change.

Owners can gain the benefits and avoid the pitfalls of contract pricing by starting out with a clear definition of the scope of work including how fast the job must be done.   If the work scope is unclear and difficult to define in detail, a fixed price contract is probably not the best choice.   Be suspect is bids are scattered high and low.   The US government routinely re-bids projects when this happens.   Experienced contractors know at a glance what price range a project falls into.

The key to successful contract work is to secure a reliable and trustworthy contractor and get the terms of the agreement; pricing, payment terms, schedules, etc. spelled out in advance.    By carefully considering what type of contract would be most suitable for a given project, owners can maximize the good, minimize the bad and avoid the ugly.

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