Fixed Price or Cost Plus?
I am just about to provide technical recommendations to the Client for a £350k plant movements package that I have tendered out and the potential sub-contractors have offered two pricing options for the Client to choose from. Therefore I would be interested to hear other peoples real world experience of these two options:
Fixed Price
We will sign a fixed price contract. This is a low risk option but the package is likely to be subject to continual change meaning that change requests will need to be used extensively and additional costs will be incurred due to out of scope changes, omits and additions. This means that the total cost of the package is highly likely to go over the agreed fixed sum.
Cost Plus
The potential sub-contractors have offered to sell us a set number of labour days (at gang rate) and how we use these resources is up to us. The number of days sold will be based on the current schedule and programme. This option is high risk as we could use more labour and equipment than planned and will have to pay for it but it also offers the Client with opportunity since any savings due to more efficient use of resources and due to not using the full allocation of days will go straight back to the Client. Another benefit of this commercial arrangement is flexibility. Since the package scope is likely to change numerous times, this contract removes the requirement for change requests and additional charges for change since we would simply use our allocation resources for the change. If we do use more than our allocated days of labour and/or plant, additional days will sold at a pre-agreed daily rate.
So does anyone have any experience of these two contractual arrangements and if so how did the final package costs compare to the initial agreed sum?
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Morning Gary, re: fixed price proposal. If you think the ‘cost of the package is highly likely to go over the agreed fixed sum’ it isn’t really a fixed price is it? Wouldn’t it make more sense to agree an increase in the budget with client via a Provisional Sum for changes in work to be instructed by the PM and then keep contemporary records of the time spent on these changes? These can used to calculate a fair payment or if you have the luxury of time you can ask and agree a quote before the change work starts. Also you can make the sub-contractor daywork rates for specialist labour, plant and materials part of the pricing summary for the whole of the tendered package
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With regard to the cost plus reimbursement, it is unlikely that your proposed arrangement will incentivise your sub-contractor to work efficiently. His effort will always be related to the time available and the money he can earn rather than the task. There will always be temptation for them to prolong the task if the day rate is profitable. To enable you to manage this, the minimum you will need is a mechanism to cap the time and money available for the sub-contractors work for the entire operation before you start. Even then this will take very close control to prevent abuses.
Personally I would opt for the former as it will enable you to manage the activities of the sub-contractor by variation instructions and provide ownership via an audit trail.
Cheers Greg Tripp
Greg,thanks for the comments. As the PM for this task, I have tried to nail the scope down as much as possible and also tried to write the tender documentation to give us as much flexibility as possible within the contract without incurring huge costs. When I wrote the schedule of rates I couldn’t add any provisional sums purely because we do not know the nature of the future changes just that future changes are likely as a result of the client changing the design and some incomplete designs for interfacing packages. I did try to create a slush fund by over egging my cost estimates before client sign off (~15% extra) but the bids are coming back around this over estimated figure.
The client is trying to reduce all financial risk at the moment, often at the cost of missed opportunities. The thing that will concern my client with allocating extra costs to the fixed price option is knowing how much to allocate is difficult to calculate because of the amount of unknowns and so it would still carry some risk. Plus the additional cost are difficult to justify now whereas the costs are much more tangible and acceptable when part of a change request.
I too am concerned about incentives to the sub-contractor in the day rate contract and so I am looking and sharing the cost savings and over spends (I don’t think the subby will sign up to shared over spends!). Another option is an additional sum for completion under budget. My preferred contractor seems to be very reliable and they have been invited to tender due to doing a good job on other Skanska project and if they do ‘take the piss’ I will recommend that they are removed from the approved list of sub-contractors for Skanska UK – so it is in their interest to do a good job. Also this package may be increased to ~£2m as a variation if the initial phases of the contract are completed to high a standard. If the subby does not do a good job then this variation will be turned into a separate package and retendered.
I will also be tasking my construction managers to monitor their progress against pre-identified KPIs with penalties to the sub-contractor if they are not met.
Greg, I think the Client will side with you and go with the fixed cost option but will not alloacte additional costs from the cost plan but rather tell us to minimise the changes through proactive management and early warnings. However the Client won’t recognise that most of the additional costs will be a result of their future decisions and changes to specification!
Gary,
I echo Greg’s comments about the cost-plus scenario. We used a contractor on day work (not the same but similar in essence) and there was no motivation for them to complete the work at any sort of rate. At the earliest opportunity the subby loaded the task up with plant and operatives and charged an extortionate rate for the pleasure. We controlled the day work by putting on one of the construction managers as their sole supervisor – essentially cracking the whip!
It may be worth taking in to account the extra supervision that will be required with the cost-plus scenario. I may be going out of my commercial depth here, but would a target-cost package be suitable?
Thanks Chris. The plant contractor has allocated a number of manpower days and plant days to each task and will deploy these resources on site. This should removed the risk of him overloading resources and overcharging as we can hold him to account saying ‘you specified you only need this number of resources for this task, why are you using XX?’. This adhering to the proposed method and rates will be a KPI used for QA during the task and will allow us non-SMEs to identify inefficiencies on-site. Since the tender is competitive, I am confident that their proposed costs and methods are efficient – I just need to hold them to their tender returns!
The only comment I have from our place is to pick up on the early warnings bit at the end of your first response above Gazza.
I agree with your sentiment – EWNs only seem useful within the (narrow) remit of the contract terms. The subbies here are pretty good at spotting stuff that was out of scope. And it is incredibly difficult to fully define a tight scope in a mechanical installation job. I struggle to think how you could ever get a tight scope in a groundworks/plant contract.
The EWNs do seem to prove useful when holding the subbies feet to the fire with regards to their programme. We seem to have reached an equilibrium where their delays are counterbalancing extra work from our foggy scope. The upshot is everyone is slightly unsatisfied but at least no-one is seeking compensation from anyone else.
Not sure if that helps…. it seems useful to stay on friendly terms and not resort to firing off too many EWNs.
Gary,
I think if you have done all the background work and defined the scope tightly as possible then go with the fixed cost. Who will be running the subbies’ work? Like Mark points out, without someone ensuring that they are motivated it seems like cost plus is a great way for they to print money.
Gary, This is a great discussion. I would avoid cost plus like the plague. Are there no other options available? If the client changes the scope then he needs to be prepared to pay for the risks. This will keep him in check and prevent scope creep in a accountable way-I am used to DE&S where you get a new key player every 12 months and everyone has a good idea.
You can still use site instructions for minor changes along the way and these can be independently assessed if you so wish. If you are going out to a competitive tender be aware of subbies under-bidding and then hammering you for variations.