Pros and Cons of Contracts
Content
ATTACHMENT 1 TYPES OF CONTRACTS
Options
Advantages
Disadvantages
Contractor Relationships
Comments
I. COST REIMBURSABLE (AND CONVERTIBLE) A. Cost Reim. + % Fee • • • • Maximum contracting flexibility Can fast track easier Best for development/ changing scope Easier to insert proprietary needs • • • • • • • • • • Required financial controls Requires highest owner staffing Many interfaces to manage Limited incentive by contractor to contain cost Owner assumes all risks Rework is profitable for contractor Limited contractor profits may invite less staffing (quality or quantity) • • Collaborative Owner can substantially influence contractor decisions; assumes more responsibility for results • • • Use where market place is saturated with work Use with poorly defined scope Use with known, trusted contractor resources
B. Cost Reim. + Fixed Fee
As above, but with market place more competitive Rework provides no profit As above, but relates fee to performance and provides contractor with incentives to control cost and schedule Allows alignment of Owner and contractor goals
•
As above
•
Use when market place supports some competitive pressure
C. Cost Reim. + Incentive Fee
•
•
•
•
Difficult to establish incentive goals that differentiate outstanding performance from good/ normal performance Scope changes impact on incentives requires management and control More record keeping required
•
Contractor will “push back” on item affecting their fee
• • •
Can results be achieved w/o incentives? Good negotiating skills required Incentive must relate to key project objective (never to both budget and schedule, for example)
EQAG/105ATT1.doc
Page 1 of 4
ATTACHMENT 1 TYPES OF CONTRACTS
Options D. Cost Reim. W/Guaranteed Maximum •
Advantages Knowing top side cost risk in advance • • •
Disadvantages Required scope to be more than 80% defined Changes must be documented and cost negotiated Maintaining profit margin will be prime objective of contractor Can lengthen schedule Requires skillful owner negotiation •
Contractor Relationships Adversarial on changes •
Comments Rarely of value
E. Convertible Contract (start cost reim., then convert to fixed price)
•
• • •
Reduces owner’s cost risk to definition phase. Allows opportunity to negotiate or bid subsequent phases Provides time to reduce uncertainties Use when scope is clear except for quantities Cost risk reduced to quantity impact or material price changes
• •
•
Engineering contractor providing definition can be at a disadvantage in design bidding. (They will bid high on known uncertainties)
•
Use becoming more frequent
F. Unit Price w/ Adjustments
• •
Scope & quality must be controlled, much record keeping Owner takes price risk
•
Collaborative
•
Used mainly for construction. Can be used for equipment
EQAG/105ATT1.doc
Page 2 of 4
ATTACHMENT 1 TYPES OF CONTRACTS
Options II. FIXED PRICE A. Lump Sum • • • • •
Advantages
Disadvantages
Contractor Relationships
Comments
Contractor assumes cost risk Less owner management required Allows competitive bidding on total scope Incentive for contractor to furnish best resources Can test unknown contractors with minimum risk Shorter contract period More accurate pricing
• • • •
Quality and schedule risk increased Changes will cost more than cost reimbursable Complete definition required up front Bidding process will lengthen total schedule
•
Adversarial, contractor’s profit at risk
• • •
Good for known technology projects Difficult to define sufficiently for development activities Early/preliminary can be done reimbursable to protect schedule
B. Multiple Lump Sum
• •
• • •
Contract interfaces must be clear Project completion dependent on slowest contractor Good, complete engineering package required Requires changing contract documents and negotiating new price
•
Owner has overall project accountability
•
Good choice where labor unknown, unions are militant and cost a high priority
C. Fixed Price w/ Incentives
•
Further reduce cost where scope is susceptible to lower cost option/methods Contractor does not have to provide large contingencies to out guess inflation
•
•
Contractor will push back on items negatively impacting incentive amount
•
Best done after contract award w/successful bidder
D. Fixed Price w/ Escalation
•
•
Owner carries inflation risk
•
Used where inflation is high or project start uncertain
EQAG/105ATT1.doc
Page 3 of 4
ATTACHMENT 1 TYPES OF CONTRACTS
Options E. Design/Construct Multiple Entities • • • • F. Design/Construct Single Entity • • • • • G. Design/Construct/ Start (Turnkey) • • •
Advantages Contracting flexibility More flexibility in alternate studies More technical control Reduced owner staffing • • • • • •
Disadvantages Owner involved in interface management Lose advantage of single point accountability Longer schedule More technical reliance on contractor Quality may be lower than expected Must know construction site labor situation •
Contractor Relationships Construction contractor not accountable for engineering errors nor engineering contractor for construction errors • • • • • •
Comments Not applicable in high change situation Best with high level of proprietary work Owner can purchase equipment and assign Reduced capital cost is the major driving force Excellent for special work Owner can purchase equipment and assign
Single interface mgt. Faster completion Single contractor accountability Able to buy contractor’s special knowledge Less owner staffing Contractor assumes all cost and performance risk Provides opportunity for new state-of-the-art technology Least owner project staffing
•
Arm’s length; contractor responsible for errors
• •
•
Must accept contractor’s technical solution Difficult to pre-specify all performance criteria (operating cost, maintenance, clean design) Loss schedule control
• • •
Owner must trust contractor for end result Mfg. must accept installation “as is” if performing No timely recourse if contractor fails
• • • •
Recognize finished installation might not meet all expectation “Industry standard” result is normal Contractor should procure everything Performance guarantee by contractor has limitations
EQAG/105ATT1.doc
Page 4 of 4
Options
Advantages
Disadvantages
Contractor Relationships
Comments
I. COST REIMBURSABLE (AND CONVERTIBLE) A. Cost Reim. + % Fee • • • • Maximum contracting flexibility Can fast track easier Best for development/ changing scope Easier to insert proprietary needs • • • • • • • • • • Required financial controls Requires highest owner staffing Many interfaces to manage Limited incentive by contractor to contain cost Owner assumes all risks Rework is profitable for contractor Limited contractor profits may invite less staffing (quality or quantity) • • Collaborative Owner can substantially influence contractor decisions; assumes more responsibility for results • • • Use where market place is saturated with work Use with poorly defined scope Use with known, trusted contractor resources
B. Cost Reim. + Fixed Fee
As above, but with market place more competitive Rework provides no profit As above, but relates fee to performance and provides contractor with incentives to control cost and schedule Allows alignment of Owner and contractor goals
•
As above
•
Use when market place supports some competitive pressure
C. Cost Reim. + Incentive Fee
•
•
•
•
Difficult to establish incentive goals that differentiate outstanding performance from good/ normal performance Scope changes impact on incentives requires management and control More record keeping required
•
Contractor will “push back” on item affecting their fee
• • •
Can results be achieved w/o incentives? Good negotiating skills required Incentive must relate to key project objective (never to both budget and schedule, for example)
EQAG/105ATT1.doc
Page 1 of 4
ATTACHMENT 1 TYPES OF CONTRACTS
Options D. Cost Reim. W/Guaranteed Maximum •
Advantages Knowing top side cost risk in advance • • •
Disadvantages Required scope to be more than 80% defined Changes must be documented and cost negotiated Maintaining profit margin will be prime objective of contractor Can lengthen schedule Requires skillful owner negotiation •
Contractor Relationships Adversarial on changes •
Comments Rarely of value
E. Convertible Contract (start cost reim., then convert to fixed price)
•
• • •
Reduces owner’s cost risk to definition phase. Allows opportunity to negotiate or bid subsequent phases Provides time to reduce uncertainties Use when scope is clear except for quantities Cost risk reduced to quantity impact or material price changes
• •
•
Engineering contractor providing definition can be at a disadvantage in design bidding. (They will bid high on known uncertainties)
•
Use becoming more frequent
F. Unit Price w/ Adjustments
• •
Scope & quality must be controlled, much record keeping Owner takes price risk
•
Collaborative
•
Used mainly for construction. Can be used for equipment
EQAG/105ATT1.doc
Page 2 of 4
ATTACHMENT 1 TYPES OF CONTRACTS
Options II. FIXED PRICE A. Lump Sum • • • • •
Advantages
Disadvantages
Contractor Relationships
Comments
Contractor assumes cost risk Less owner management required Allows competitive bidding on total scope Incentive for contractor to furnish best resources Can test unknown contractors with minimum risk Shorter contract period More accurate pricing
• • • •
Quality and schedule risk increased Changes will cost more than cost reimbursable Complete definition required up front Bidding process will lengthen total schedule
•
Adversarial, contractor’s profit at risk
• • •
Good for known technology projects Difficult to define sufficiently for development activities Early/preliminary can be done reimbursable to protect schedule
B. Multiple Lump Sum
• •
• • •
Contract interfaces must be clear Project completion dependent on slowest contractor Good, complete engineering package required Requires changing contract documents and negotiating new price
•
Owner has overall project accountability
•
Good choice where labor unknown, unions are militant and cost a high priority
C. Fixed Price w/ Incentives
•
Further reduce cost where scope is susceptible to lower cost option/methods Contractor does not have to provide large contingencies to out guess inflation
•
•
Contractor will push back on items negatively impacting incentive amount
•
Best done after contract award w/successful bidder
D. Fixed Price w/ Escalation
•
•
Owner carries inflation risk
•
Used where inflation is high or project start uncertain
EQAG/105ATT1.doc
Page 3 of 4
ATTACHMENT 1 TYPES OF CONTRACTS
Options E. Design/Construct Multiple Entities • • • • F. Design/Construct Single Entity • • • • • G. Design/Construct/ Start (Turnkey) • • •
Advantages Contracting flexibility More flexibility in alternate studies More technical control Reduced owner staffing • • • • • •
Disadvantages Owner involved in interface management Lose advantage of single point accountability Longer schedule More technical reliance on contractor Quality may be lower than expected Must know construction site labor situation •
Contractor Relationships Construction contractor not accountable for engineering errors nor engineering contractor for construction errors • • • • • •
Comments Not applicable in high change situation Best with high level of proprietary work Owner can purchase equipment and assign Reduced capital cost is the major driving force Excellent for special work Owner can purchase equipment and assign
Single interface mgt. Faster completion Single contractor accountability Able to buy contractor’s special knowledge Less owner staffing Contractor assumes all cost and performance risk Provides opportunity for new state-of-the-art technology Least owner project staffing
•
Arm’s length; contractor responsible for errors
• •
•
Must accept contractor’s technical solution Difficult to pre-specify all performance criteria (operating cost, maintenance, clean design) Loss schedule control
• • •
Owner must trust contractor for end result Mfg. must accept installation “as is” if performing No timely recourse if contractor fails
• • • •
Recognize finished installation might not meet all expectation “Industry standard” result is normal Contractor should procure everything Performance guarantee by contractor has limitations
EQAG/105ATT1.doc
Page 4 of 4
