Construction Contracts: Lump Sum  

 

Before a construction project begins, the project owner has a big decision to make regarding how to purchase construction. There are many options: GMP, unit price, and competitive bidding, but the lump sum construction contract is one of the most commonly used contracts, for several reasons.

 

What Is It?

The lump sum contract (also known as a fixed price contract) is the most basic form of an agreement between an a purchaser and the contractor.  Under the lump sum contract, a single “lump sum” price for all of the work is agreed to before the work begins.

Under this type of agreement, the contractor is responsible for completing the project within the agreed upon fixed cost set forth in the contract. If the contractor completes the project under the fixed total cost, the contractor keeps the difference and makes a profit from the work. The owner is not entitled to any savings if the project is completed below the fixed total cost.

 

When to use it:

For this type of contract to be effective, the purchaser must have detailed and complete drawings and specifications. The construction documents must be well defined at the time of the bid to allow the bidders to properly estimate the cost of labor and materials. The lump sum contract also works well for projects with very tight budget constraints and for businesses that lack experience in the construction industry.

 

Advantages:

For the owner/construction purchaser-

A key advantage for the construction purchaser is that the lump sum contract is easy to manage. Payments to the contractor are based on the percentage of completed work, which can be verified by the real estate project management team. Additionally, because of the predictability of the lump-sum arrangement, the owner’s risk and liability during construction are somewhat limited. The contractor has agreed upon a sum and the owner is not liable for any of the contractor’s cost overruns.

For the contractor-

The contractor can generally achieve a higher profit margin than they would in other types of construction contracts. Additionally, because construction drawings are well established with this type of contract, there is more predictability. For both sides, accounting and billing is less intensive, which reduces overhead costs. For the contractor, lump-sum arrangements allow for a more steady cash flow.

 

Disadvantages:

For the owner/construction purchaser-

The main disadvantage is that there is much less flexibility in the project outcome with this type of construction contract. If the project owner wants to make changes to the project during the course of construction, the owner may find that the lump sum contract does not provide for much flexibility. Making changes during construction becomes very difficult because the contractor bid on the project according to completed plans.

For the contractor-

Though the lump-sum construction contract does pose a greater opportunity for profit, the contractor does take on greater risk and liability in this type of contract.

Katie Boova
Katie Boova is Marketing Manager at Watchdog Real Estate Project Managers, a real-estate consulting firm that provides owner’s representation and project management services. More about Watchdog Real Estate Project Managers as well as additional blog posts can be found here.
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