No.

2: Price
Price is No. 2 on the list of ten most important construction contract terms. Sometimes youll see
the price called the "contract price" or the "contract sum." To keep it simple today, well just keep
it as the "price." The price makes it to No. 2 because its another of those few things you must
have in a construction contract: one side (a prime contractor, subcontractor, sub-subcontractor,
etc.) provides the Work (the "working side") in exchange for the other side paying the price
(the "paying side"). Theres three common ways to price construction work and many issues that
affect each. Today well talk about each of the three types of pricing and introduce some of the
important issues affecting each. At the end well also talk about Schedules of Value, an important
price breakdown device that helps you keep track of how, when, and where the price is spent as
the Work progresses.

Lump Sum Price

The lump sum is the simplest and easiest price. The working side estimates their cost to provide
the Work, adds a profit margin, then proposes the sum as a price to the paying side. When the
paying side accepts that amount, its included in their contract and becomes a lump sum price for
the Work. Keep these issues in mind when considering a lump sum price:

Working Side Benefits. The working side benefits from a lump sum price because, if they
manage to keep costs below their estimate, they keep the money they would otherwise have
spent on costs. The result is a higher profit margin on the contract. A lump sum price also
requires less intense accounting, reporting, and back office work. So it imposes fewer
overhead costs on the working side too

Working Side Drawbacks. The lump sum price has risks for the working side too. Among
them, if they underestimate their costs, their profit margin shrinks. It may even disappear.
Depending on their contract terms, the working side might even have to come out of their own
operating profit on other projects, use cash reserves, or even borrow, to pay the extra costs
and complete the Work in exchange for the lump sum price

Paying Side Benefits. The paying side benefits from a lump sum price too. Depending on
their contract terms and the working sides creditworthiness, they get a level of certainty on
how much the Work will cost. If its a prime contract, the paying sides lender usually likes
this too
 Paying Side Drawbacks. Among the drawbacks, there theres no "transparency." The paying
side doesnt know how large or small a profit margin the working side has. If the paying side
suspects its too big, theyre inclined to think theyre overpaying. If they suspect its too little,
they could think theres a risk of too little quality control with the working side tempted to cut
corners to maintain their margin. Though it doesnt fix everything, competitive bidding for a
lump sum price can allay at least some of the paying sides overpayment concerns

Payment Timing and Sequence. One of the most important issues with lump sum pricing is
identifying when the paying side pays. Although the price is a lump sum, the paying side
doesnt usually pay it all at once. Instead, they usually pay once a month in proportion to the
amount of Work completed during the immediately preceding month (i.e., pay in August for
Work provided in July). For example: if, during July, the Work goes from 45% complete to
53% complete, in August the paying side will pay 8% of the lump sum price, less a certain
amount for retainage depending on other terms of the contract
A lump sum price is simple to structure and easy to manage. It usually has more appeal when:

One or both sides, especially the paying side, has no, or only little, construction management
resources and experience, and

The price is modest

Cost Plus A Fee Price

Cost plus a fee pricing, usually referred to as just "cost plus," is set by adding two components
together: (a) costs the working side incurs to provide the Work (usually just referred to as the "cost
of the Work") and (b) the working sides fee for providing the Work. Cost plus pricing provides
the transparency missing from a lump sum price. It allows the paying side to share in benefits that
come from more efficient Work and costs that are lower than originally estimated. But cost plus
pricing is not simple and not easy. It raises many issues and complications. Some examples:
Cost Identification. Identifying what does, and what does not, qualify as a cost of the Work.
For instance:

o Should the working sides cost to re-perform rejected Work qualify as a cost of the Work?

o If the working side rents equipment needed to provide the Work (e.g., a crane, a hoist)
from an affiliated rental company, how much of the rental fee should qualify as a cost of
the Work?

Amount of the Fee. How much should the working sides fee be? How should it be
structured?

o As a percentage of the cost of the Work? This is simple, but it rewards the working party
for increasing the cost of the Work
 o A fixed fee regardless of the the cost of the Work? This is simple too, but if the scope of
the Work changes, when amending the contract to change the Work, both sides need to
remember to adjust the amount of the fee to preserve its proportion to the cost of the
Work

High Maintenance. Cost plus pricing is more burdensome for both sides. The working side
must devote extra time to tracking and reporting on costs and getting cost data from those
providing Work on their behalf downstream. The paying side must scrutinize the working
sides reporting to ensure its accurate. Cost plus a fee contracts require a lot of professional
expertise, familiarity with construction costs, and back office work. That makes them more
labor intensive and more expensive

Audit. If the money at stake is big enough and the paying side wants to ensure that the cost
of the Work and amount of the fee is accurate, theyll need to perform at least one audit.
Audits take time and cost someone money. They also require the working side to maintain
records for some minimum amount of time and impose disruption on the working sides
operation while auditors scrutinize records and analyze data. That adds costs for both sides

Challenging Contracts. Because theres more issues, negotiating a cost plus contract often
takes longer and requires more involvement from lawyers and consultants. That also means
higher costs for both sides. And those are "soft costs" that arent popular with investors and
lenders

Guaranteed Maximum Price

With few exceptions, cost plus contracts include a guaranteed maximum price (the "GMP",
sometimes called a "GMAX"). Under a GMP contract, the working side guarantees that the paying
side will pay no more than the GMP for completion of the Work. Ideally, regardless of how high
the actual cost of the Work, plus the working sides fee actually gets, the paying side wont pay
more than the GMP in exchange for the Work. Keep these issues in mind when considering a cost
plus with a GMP contract:
Who Gets the Savings? "Savings" is the difference between (a) the GMP and (b) the final
cost of the Work, plus the working sides fee:
Savings = (GMP) ((Total Cost of the Work) + (Total Working Side Fee))
 By default, the paying party benefits from savings. Theyre obliged to pay no more than the
cost of the Work plus the fee. So if that amount is lower than the GMP, the paying side owes
no more and they enjoy all of the savings

Sharing the Savings. To offer the working side extra incentive to minimize the cost of the
Work thereby maximizing savings some GMP contracts set up a sharing of any savings.
Usually the contract will identify a percentage of savings that goes to the working party.
Sometimes its a single percentage of all savings. Other contracts increase or decrease the
percentage at various levels of savings. For example, the working party may get 25% percent
of the first $50,000 of savings, 40% of the savings between $50,001 and $100,000, and 50%
of all savings above $100,001

Sub-GMPs. Some contracts set a sub-GMP for select cost categories. A frequent example in
prime contracts is a sub-GMP on the prime contractors general conditions costs (sometimes
called "jobsite overhead" costs). Some cost plus contracts take a hybrid approach, they set:(a)
a sub-GMP for some cost categories, (b) a lump sum for some cost categories, and (c) no limit
on other categories (as long costs in those categories dont make total of the cost of the Work,
plus the working sides fee, exceed the overall GMP)
But be cautious if youre on the paying side! Proposing spending limits in specific cost
categories ordinarily arouses controversy with the working side. They may be inclined to
accept a sub-GMP, or a lump sum, for general conditions costs, but youll usually find
them very reluctant, often with good reason, to impose limits on other cost categories.
So before you ask for these kinds of limits, make sure you really need them and carefully
analyze whether theyre really going to be worth your while

Cost vs. Benefit. The allure of keeping savings often attracts the paying side to a GMP
contract, especially when the paying side is an owner. But its easy to overlook the extra costs
that come with the GMP contract. It may be worth it for owners (a) with the in-house
construction expertise to analyze and manage the payment process and scrutinize cost of the
Work reporting or (b) have the budget to hire qualified consultants. But owners who dont
have either should really stop and think twice before opting for a GMP contract. They may
just be better off with a lump sum contract, especially if the project isnt really big enough to
justify the extra professional costs needed to negotiate a GMP contract and review cost of the
Work in each application for payment

Unit Prices
Unit pricing is another simple way to price the Work. The working side simply sets a price for
each unit of Work, or category of cost. Road building contracts are a good example. The paying
side pays the working side a set unit price for each kilometer or mile of road they build over a
specified area or type of terrain. Because units of Work usually must be very similar for accurate
unit pricing, youll see unit pricing most often used on public infrastructure projects (e.g., roads,
runways). Youll see it only infrequently on private building projects, and then usually only on
select cost categories (e.g., door handles, faucets).
Schedule of Values
A Schedule of Values breaks the price down and allocates it among various components of the
Work: excavation, foundation, superstructure steel, curtain wall, electrical, plumbing, HVAC,
vertical transportation, drywall, paint, general conditions costs. This sample contract has a scaled-
down example of what a Schedule of Values ordinarily looks like. This breakdown helps you
compare progress of the Work to how much of the price has been paid to date. Its critical to
architects, engineers, other consultants, and lenders who review the Work each month, compare
its progress to how much money has already been paid, and how much the working side is
requesting in their latest monthly application for payment. The Schedule of Values allows
everyone to see whether progress of the Work is "in balance" with payment of the price. And, if
its not, identify how far its out of balance. A Schedule of Values is especially critical to a prime
contract. Construction lenders often insist on them before theyll fund any loan proceeds. If youre
the paying side on a prime contract, be you need to use extreme caution approaching a contract
that doesnt have a Schedule of Values, or that says the Schedule of Values will come later, after
you sign.