Lump Sum Contract Basics
A lump sum contract or a stipulated sum contract will require that the supplier agree to provide specified services for a stipulated or fixed price. In a lump sum contract, the owner has essentially assigned all the risk to the contractor, who in turn can be expected to ask for a higher markup in order to take care of unforeseen contingencies. A supplier being contracted under a lump sum agreement will be responsible for the proper job execution and will provide its own means and methods to complete the work. This type of contract usually is developed by estimating labor costs, material costs, and adding a specific amount that will cover contractor’s overhead and profit margin.
The amount of overhead calculated under a lump sum contract will vary from builder to builder, but it will be based on their risk assessment study and labor expertise. However, estimating a very large overhead cost can lead the contractor to present higher construction costs to the project owner. The expertise of the contractor will determine how their estimated profit will actually be; furthermore, a poor executed and long-delayed job will raise your construction costs and eventually diminish the contractor's profit.
Lump Sum: When to Use It
A lump sum contract is a great contract agreement to be used if the requested work is well-defined and construction drawings are completed. The lump sum agreement will reduce owner risk, and the contractor has greater control over profit expectations. It is also a preferred choice when stable soil conditions, complete pre-construction studies and assessments are completed and the contractor has analyzed those documents. The stipulated sum contract might contain, when agreed-upon parties, certain unit prices for items with indefinite quantities and allowance to cover any unexpected condition. The time to award this type of contract is also longer; however, it will minimize change orders during construction.
Lump Sum Contract Advantages
A lump sum contract offers the following advantages:
- Low risk to owner.
- 'Fixed' construction cost.
- Minimize change orders.
- Owner supervision is reduced when compared to Time and Material Contract.
- Contractor will try to complete the project faster.
- Accepted widely as a contracting method.
- Bidding analysis and selection process is relatively easily.
- Contractor will maximize its production and performance.
Lump Sum Contract Disadvantages
This type of contracting has also limitations:
- It presents higher risk to contractor.
- Changes are difficult to quantify.
- The Owner might reject change order requests.
- The project needs to be designed completely before the commencement of activities.
- The construction progress could take longer than other contracting alternatives.
- Contractor will select its own means and methods.
- Higher contract prices that could cover unforeseen conditions.
Lump Sum Critical Items
Lump sum contracts are a great tool for smaller jobs and quite simple projects. However, lump sum contracts could eventually produce large dispute and claims that will arise from contract documents. The most common arguing factors are:
- Unbalanced Bids
- Change Orders
- Design Changes
- Early Completion
Some projects might require to produce an application for payment using unit quantities and unit prices. Many contractors will produce an unbalanced bid by rising unit prices on items to be completed early in the project, such as mobilization, insurances and general conditions, and lowering unit prices on items needed in later stages.
If the owner produces or receives a change order proposal from the contractor, the price quotation could be possibly disputed. The Owner might appeal that the requested change was already covered under contract provisions. It is important to prepare specific contract clauses specifying how change orders are going to be managed and to what extent the contractor could claim delay damages.
A contractor may suggest design changes based on their experience. Contract provisions should be clear on how those changes will be addressed and how those costs will be divided or who will be responsible for the economic impact of the proposed changes.
Lump sum contracts might include an early completion compensation for the contractor. Early completion might produce higher savings for the project owner; however, those clauses might be explicit in the construction contract.