Addicted to False Certainty – Lump Sum Contracts

In Australia we have two main procurement methods for constructing buildings which are Lump Sum Price and Design and Build. Both involve the builder providing a lump sum contract price based on a set of tender documents which are supposed to be complete, coordinated and reflective of the intended risk apportionment of the various parties. We have been using these contract methods for years and obviously clients and banks love the promise of a fixed price.

But is this method conducive to producing quality buildings via an efficient process. Is it a methodology that is sustainable in the future? Or are we just addicted to the false sense of certainty that it eludes to?

The main problems with these fixed sum contract methods are:

No fixed price - no building contract ever has a fixed price. There are always changes and when the builder is on board the room for negotiation is virtually gone. In fact the builders will be counting on changes to increase their profits on the project. They will be looking for them. The more changes the better to extend the contract period and make claims.

Are the tender documents worthy of a fixed price ? - probably not. Design fees are the first place a client looks to save money. But if the documents are not complete, well coordinated and of good quality then the fixed price will be even more of a myth and the builders will be wringing their hands and firing up their 'variation spotting' team.  Also, if there are any ambiguities in the documents then the items are excluded or a large cost is placed against them to cover the risk. The ambiguities inflate costs and shift the risk away from the party that should be embracing it.

Us and Them - the fixed price contract is not really conducive to a cooperative arrangement between the client and the builder. Due to the very low margins, the builders' prerogatives of increasing his profits by pushing down subcontractor prices and exaggerating variations are not the same prerogatives as the client - which are keeping down costs and making sure subcontractors are producing a quality product. The contract parties are usually pulling in opposite directions. It often ends in dispute.

Tender Wastage - there are instances where a lump sum tender is issued to anywhere between 10 to 15 different builders to price. This means that there could be 15 different tender teams measuring and pricing the works, 15 different highly paid Estimating Managers pulling all the prices together, 15 different executive teams spending time refining the price, multitudes of subcontractors pricing the works and so on and so on. There is often a shared Bill of Quantities that can save on the measurement wastage but ultimately the lump sum tender process squanders the industry's resources. Plus a tender list with 15 names on it would scare off most astute builders and so the client may not have access to the best companies. All this reduces efficiencies and reduces the chances of a quality product.

It is interesting that when we recently asked two very prominent NSW Estimating Managers whether they thought that the recent cases of builders going into administration in NSW was due to the lump sum form of contract – they said that it had a great deal to do with it. Obviously this factor is heightened by the current economic climate but they both agreed that the lump sum contract puts inordinate pressure on the builders’ margins and that any errors made in the pricing of these contracts can spell disaster for the builder. The pressure is high. This is obviously why Estimators are paid very large salaries – and so they should be, if you understand the pressure they are under to win projects from suspect tender documents.

So what is the solution? When we asked a number of prominent members of the NSW building community including Estimators, Consultants and Clients they agreed that the answer is a move towards less adversarial forms of contract such as Management Contracting and Construction Management. Also, Two Stage Tendering and Guaranteed Maximum Price forms of contract are proving popular. With these contracts the builder is engaged earlier without the need for full documentation (thereby making use of their buildability knowledge), there is more effort placed in pre selection of the builders so that a very relevant and select tender list is compiled, and a partnering atmosphere is promoted rather than an ‘us and them’ regime. The efforts of the builder and all the talents of the parties involved are concentrated in achieving the project goals rather than ensuring survival commercially. This is not to say that competitive tendering is eliminated as the competition is still experienced when sourcing subcontractor prices.

The move to these contract forms will benefit the health and efficiency of the Australian construction market. They are used all over the world with continued success. When stakeholders and banks break there addiction to the false certainty of the lump sum contract, then the builders and project teams will be freed up to concentrate on project success.

By Adam Walker  AAIQS  MRICS – Director at Conduit Recruitment