Lump sum contract
Lump sum contract is typically used in building construction projects in which quantities are exactly measured.
Typically used with Design-Bid-Build method of project procurement.
A lump sum contract, sometimes called stipulated sum, is the most basic form of agreement between a supplier of services and a customer. The contractor agrees to provide specified services for a specific price. The customer agrees to pay the price upon
completion of the work. Or the customer will pay according the schedule of payment. In developing a lump sum bid, the builder will estimate the costs of labor and materials. Then add to it a standard amount of overhead and a normal amount of profit.
Most of the builders add their profit 12%-16% of the total project cost. This amount of profit may be enhanced according to builder assessment of risk. If the actual cost of the project increases than the estimated amount, then builder’s profit will be reduced. If the actual costs decreases, the builder gets more profit. The cost to the owner will be the same in both cases. But In actual practice, the costs that exceed the estimated amount, results in the disputes between the client and the builder. Or the builder will use the low grade materials to complete the work in the same profit.
The lump sum contract may contain a section that contains unit price of items. Unit Price is often used for those items that have indefinite quantities, such as pier depth. A fixed price is established for each unit of work.
Following are some of the features of the lump sum contract.
- Builder is free to use any resources and processes to complete work.
- Contractor or builder is responsible for proper work performance.
- Work must be very well defined at bid time..
- Owner’s financial risk should be low and fixed at outset.
- Builder has greater chances of more profit.
Requirements of lump sum contract
- Good project definition is required for lump sum contract.
- Lump sum contract requires complete plans and specifications setting and directions in enough detail to enable a contractor to carry them out.
- Stable project conditions are necessary.
- Effective competition is necessary when bidding.
- There should be much longer time to bid and to award lump sum type of project.
Advantages of lump sum contract
- Low financial risk to Owner.
- High financial risk to Contractor.
- Know cost at outset.
- Minimum Owner supervision related to quality and schedule.
- Contractor should assign best personnel due to maximum financial motivation to achieve early completion and superior performance.
- Contractor selection is relatively easy.
Disadvantages of lump sum contract
- Changes in lump sum contract are difficult and costly.
- Early project start is not possible because of need to complete design before bidding.
- Contractor is free to choose lowest cost means, methods, and materials consistent with the specifications. Only minimum specifications will be provided.
- If the owner is not able to write the desired specification, then he should expect that the contractor will use the lowest suitable grade materials. This will increase the profit of the contractor.
- Hard to build relationship. Each lump sum project is unique.
- Bidding is expensive and lengthy in lump sum contract.
- Contractor may include high uncertainty within each Schedule of Value item.
TYPES OF CONSTRUCTION CONTRACTS by Gary Michael Smith, Esq.
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