Accomplished | Experienced | Knowledgeable

One of the most fundamental provisions of any construction contract is knowing how to calculate the price to be paid for work performed. Several different pricing methods are commonly utilized. Factors such as budget constraints, status of design completion, anticipated risks and project difficulties, construction schedule, and certainty of costs and time impact how the parties select and negotiate pricing contract provisions.

In general, there are three industry standards for pricing options: (1) fixed price or lump sum pricing, (2) cost-plus pricing (with or without a guaranteed maximum price), and (3) unit price.  These pricing options are summarized below:

  1. Fixed Price / Lump Sum Pricing. Fixed price or lump sum pricing, as the name indicates, provides for payment of a set amount. The fixed price or lump sum is determined through a contractor by estimating their cost to provide the work, and then adding overhead and a profit margin. If the owner finds the lump sum calculation acceptable, either through a bidding process or negotiation, then the lump sum price is integrated into the contract. The lump sum amount is typically paid out monthly during the project depending upon the percentage of work completed. To aid in payment on this percentage basis, a contractor will often prepare a schedule of values to assign value to each component of the work that makes up the overall contract. Thus, payment occurs over time commensurate with completion of the work (often through estimated percentages).
  2. Cost-Plus – With or Without A Guaranteed Maximum Price. “Cost-Plus” is a pricing option under which a party providing the work calculates the cost to complete the work and then adds an agreed-upon fee. Costs to complete the work typically include all amounts paid to subcontractors for labor and materials, plus general conditions. General conditions are those items that are outside direct labor and materials, such as project management, site office, tools, and equipment. The fee, which is the profit estimated by the contractor, and with some contracts a defined amount of overhead, may be one defined amount or it may be based on a percentage of the defined costs.  It is not hard to imagine a pricing method based on costs, which are often a moving target, escalating. That is why Cost-Plus pricing is often combined with a guaranteed maximum price (“GMP”). A Cost-Plus pricing option with GMP provides an upper limit on total construction costs and fees for which an owner is responsible. If the party providing the work under this pricing method runs over GMP, it is responsible for such overruns. Recognize, however, that changes to the scope of work may increase the GMP. The parties to a Cost-Plus with GMP contract negotiate at the outset how any costs savings (i.e., work performed for less than GMP) will be allocated, often agreeing to share in these savings.
  3. Unit Price. “Unit Price” contracts break down construction costs according to a series of line items that identify discrete units of work.  Under this type of contract, each unit price includes material, equipment, overhead, permit and inspection costs, and/or labor necessary to complete the scope of work, as well as the contractor’s profit.  The project’s total price is the sum of these unit’s prices.  This type of contract has positives for both owners and contractors.   Unit pricing is transparent and enables owners to easily break down and verify the price contractors charge for goods and services to ensure the owners are being charged fairly and according to their contract.  On the other hand, contractors like Unit Price contracts because they help contractors keep track of their cost of goods and variable costs on the project.  These contracts also make it easier to invoice customers and less likely that an invoice-related argument will arise.  For under Unit Price contracts, the price-per-unit should be determined well in advance of the work’s actual performance.

Unit Price contracts are best suited for projects where the work is relatively repetitive and easily measured, and especially where the price is heavily dependent on materials, and the ultimate quantity of work might not be obvious from the get-go. Conversely, Unit Price contracts may not be a good fit for complex projects that involve blending build units using different trades and/or materials.  They may, however, be utilized with great success in some circumstances as part of a hybrid-contract where this contract methodology is applied to portions of a project that can be easily quantified.

Additional Construction Contract Pricing Considerations:

Parties should also ask the following questions and take note of the following considerations when negotiating the price to be included in a construction contract:

  • How do parties define costs in a Cost-Plus pricing method, and what is included in the definition of costs? For example, do costs include the contractor re-doing rejected work? Do costs include rental fees for equipment rented to perform the work? What about equipment owned by the contractor, and at what rate?
  • How do parties define the fee in a Cost-Plus pricing method? Is the fee calculated as a set amount, or is it a percentage added to the sum of costs?
  • In a Cost-Plus method, how are savings to be allocated? Do all savings go to the party obligated to pay for the work, or do the parties agree to share the savings?
  • What allowances are utilized? Allowances allocate a portion of the price to certain parts of work with costs that cannot be specified with particularity at the time of contracting.
  • Allowances may also be used because of the volatility in pricing of materials. The price paid will be adjusted to the extent the actual cost of an allowance item is more or less than the allowance stated in the contract.
  • Finally, parties should ensure that any assumptions on which the price is based (e.g., services provided by owner, atypical site access, etc.) are appropriately identified in the contract and/or contract documents.

The development of these construction agreements is complex and has substantial implications if not done correctly. At Galbut Beabeau, P.C., we specialize in crafting precise, tailored agreements for each project’s demands. We look forward to assisting our clients with these matters and answering any questions they may have. Please contact Keith Galbut ([email protected]) or Michaile Berg ([email protected]) to discuss your specific needs.