Procurement methods in Construction Industry

Contract

The word as ‘Contract’ in human activities is so general under legal contest. In construction, the main important thing is that work information is enough to carry out the works though Contract also can be seen every projects.

The reason behind to include the contract is for helping to parties to overcome the situation where something goes wrong then no parties are willing to accept the fault or consequence of the problem.

A formal contract incorporating the terms described in the tender may be sent to the successful bidder for execution.

Contract types

The following are the various types of contracts,for execution of civil engineering works:

1. Lump Sum or Fixed Price Contract
2. Measurement contract
3. Turnkey Contract
4. Design and Build
5. Cost Plus Contracts
6. Unit Price Contracts
7. Time and Material Contracts
8. Item rate contract
9. Percentage rate contract
10. Labour contract
11. Piece-Work agreement
12. Target Contract

1. Lump Sum or Fixed Price Contract

Under a Lump Sum or Fixed Price Contract, the contractor agrees to perform the work specified and described in the contract for a fixed price. The price of a fixed contract can only be changed upon the execution of a change order, under which the owner and the contractor either

(1) Agree for the contractor to perform additional work that falls outside the scope of the original work for an agreed         upon extra compensation or

(2) Agree to remove certain work from the original scope of work and reduce the price of the contract in proportion          to the work that the contractor no longer has to perform.

These types of contracts are appropriate when a clear scope and a defined schedule have been reviewed and agreed upon.

Advantages:

1. Lower financial risk to Employer.
2. Higher financial risk to Contractor.
3. Minimum Owner supervision related to quality and schedule.
4. Contractor has higher incentive to achieve earlier completion and better performance.
5. Contractor selection is relatively easy.

Disadvantages:

1. Changes difficult and costly. (but it usually is)
2. Need to substantially complete design prior to bidding.
3. Contractor inclined to choose lowest methods / materials to comply with specification.
4. Hard to build relationship.  Each project is unique.
5. Bidding expensive and lengthy.
6. Contractors may include high contingency within each Schedule of Rate item

2. Measurement contract

Measurement contracts (sometimes called “re-measurement” or ‘measure and value’ contracts) contains a Bill of Quantities ( BOQ ) provided by the employer or its consultants,  can be used in situations where the design (or type of works) can be described in reasonable detail, but the amount cannot. The contractor will quote against each BOQ item and enter a unit rate or unit price to build up the total contract price on basis of those BOQ quantities. During the construction period, the actual quantity of works executed under each BOQ item will be jointly measured and valued at the quoted rate for interim payment purpose.

A measurement contract might also be appropriate on projects where the design has not been completed in sufficient detail for bills of quantities to be produced.

It should be possible to describe the works in sufficient detail to determine a programme and to obtain rates from tenderers. Generally tenderers rates will be based on drawings and approximate quantities.

The actual contract sum (sometimes called the ‘ascertained final sum’) cannot be determined when the contract is entered into, but is calculated on completion, based on “re-measurement” of the actual work carried out and the rates tendered.

Measurement contracts can allow an early start on site, before design is complete, and they can allow changes to be made to the works relatively easily. However, there is inevitably some risk for the client as the cost of the works is not known. In effect, the client is taking the risk for any ‘unknowns’, and whilst this can result in competitive prices from contractors, the level of uncertainty for the client means that measurement contracts are rare other than on civil engineering projects.

3. Turnkey Contract

A turnkey contract is a business arrangement in which a project is delivered in a completed state. Rather than contracting with an owner to develop a project in stages. The developer is hired to finish the entire project without owner input. The builder or developer is separate from the final owner or operator, and the project is turned over only once it is fully operational. In effect, the developer is finishing the project and “turning the key” over to the new owner.

This type of arrangement is commonly used for construction projects ranging from single buildings to large-scale developments.

• Difference between lump-sum contract & turnkey contract

Under a traditional lump-sum contract, the owner agrees to pay the developer to complete a project that is built to the owner’s specifications. The owner is given many opportunities to make decisions throughout the project, and to make changes as needed. In a turnkey contract, the owner is generally left out of the building process entirely as the developer handles all decisions and problems related to construction.

A contract of this kind may also be used in the residential home building industry. With a turnkey agreement, a builder or developer completes both the construction and the finishes in the home before turning it over to the homeowner. The homeowner is often offered a chance to select finishes, including curtains, paint colors and carpeting.

 4. Design and Build

Design and Build procurement works on the basis that the main contractor is responsible for undertaking both the design and construction work on a project, for an agreed lump-sum price.

Design and build projects can vary depending on the extent of the contractor’s design responsibility and how much initial design is included in the employer’s requirements. Nevertheless, the level of design responsibility and input from the contractor is much greater on design and build projects than a traditional contract with a contractor’s designed portion.

Adequate time must be allowed to prepare the employer’s requirements (the employer usually appoints consultants to facilitate this), as well as time for the contractor to prepare their proposal and tender price. It is vital that the proposal matches all of the employer’s requirements before any contract is entered into.

The employer has control over any design elements of the project that are included in their requirements, but once the contract is let responsibility over design passes to the contractor, so the employer has no direct control over the contractor’s detailed design.

The contractor can carry out the design in a number of ways. Often they will appoint their own consultants or use their own in-house team. It is also common practice for the contractor to take on the employer’s consultants and continue to use them to complete the detailed design under what is known as a novation agreement.

Other Features of Design and Build Procurement

• As design and construction can be carried out in parallel, the overall programme time of design and build projects can be shorter. However this depends on how much design the contractor is responsible for.
• There is reasonable certainty over costs because the contract price is known at the outset. Provided the employer does not order changes during the construction of the work, the contractor will be obliged (subject to the conditions) to complete the project for the contract sum. If the employer does require design or specification changes during the construction period, the contractor advises as to the effect this may have on costs or additional time needed.
• Design and Build is a relatively low risk procurement option for the employer, in terms of cost and time. There can be a risk related to design and quality, particularly if the employer’s requirements were not properly gathered and if insufficient time went into examining the contractor’s proposal.

5. Cost Plus Contracts

The Cost Plus Contract is a type of a construction contract under which the owner agrees to pay the complete cost of the materials and labor needed to needed to build the project along with a fee for the contractor’s overhead and profit. This contract type is favored where the scope of work is highly uncertain or indeterminate and the type of labor, material, and equipment needed to build the project is also uncertain in nature.

This type of contract involves payment of the actual costs, purchases or other expenses generated directly from the construction activity. Under this arrangement, complete records of all time and materials spent by the contractor on the work must be maintained. Cost Plus Contracts must contain specific information about certain pre-negotiated amount (some percentage of the material and labor cost) covering contractor’s overhead and profit. Costs must be detailed and should be classified as direct or indirect costs.

There are multiple variations for Cost plus contracts, and the most common are:

• Cost Plus Fixed Percentage Contract– Compensation is based on a percentage of the cost;
• Cost Plus Fixed Fee Contract– Compensation is based on a fixed sum independent the final project cost. The owner agrees to reimburse the contractor’s actual costs, regardless of amount, and in addition pay a negotiated fee independent of the amount of the actual costs;
• Cost Plus Fixed Fee with Guaranteed Maximum Price Contract– Compensation is based on a fixed sum of money. The total project cost will not exceed an agreed upper limit;
• Cost Plus Fixed Fee with Bonus Contract– Compensation is based on a fixed sum of money. A bonus is given if the project is finished below budget, ahead of schedule, etc.;
• Cost Plus Fixed Fee with Guaranteed Maximum Price with Bonus Contract–Compensation is based on a fixed sum of money. The total project cost will not exceed an agreed upper limit and a bonus is given if the project is finished below budget, ahead of schedule, etc.; and
• Cost Plus Fixed Fee with Arrangement for Sharing Any Cost Savings Contract– Compensation is based on a fixed sum of money. Any cost savings are shared with the buyer and the contractor.

The Cost Plus Fixed Fee construction contract is more predictable than Cost Plus Fixed Fee Percentage Construction Contract because the contractor’s fee for overhead and profit is, as its name suggests, predetermined. Regardless of what the cost of construction ultimately amounts to, the contractor’s fee remains the same. Conversely, the Cost Plus Fixed Percentage Construction Contract provides more variability with respect to the amount of the contractor’s fee because it is directly linked to the cost of construction, which in these types of arrangements is inherently unpredictable. In fact, the Cost Plus Fixed Percentage Construction Contract arguably incentivizes the contractor to not keep the costs low because its fee increases with the cost of construction.

The Cost Plus with Guaranteed Maximum Price Contract seeks to eliminate some of the risks associated with Cost Plus Contracts in that it caps the owner’s overall financial exposure. Thus, while the contract price is to be determined based on the cost of construction and the contractor’s fee, owner’s costs are capped at a certain amount.

These types of Cost Plus Construction Contracts are oftentimes grouped with bonus contracts, built-in contingencies, or cost savings contracts which incentivize the contractor to complete the project with agreed targets regarding schedule, quality, and budget in exchange for additional compensation on the project.

6. Unit Price Contracts

Unit Price Contracts are based on anticipated quantities of items which are counted in the project in addition to their unit prices. The final price of the project depends upon the quantities required to carry out the work. Generally, these types of contracts are suitable only for construction and supplier projects which involve accurate identification of different types of items, but not their numbers, in the contract documents. These types of contracts are oftentimes used on excavation projects.

7. Time and Material Contracts

Time and Material Contracts are usually preferred if the project scope is not clear, or has not been defined. The owner and the contractor must establish an agreed hourly or daily rate, including additional expenses that could arise in the construction process. The costs must be classified as direct, indirect, mark-up, and overhead. Sometimes the owner might want to establish a cap or specific project duration to the contractor that must be met, in order to have the owner’s risk minimized.

8. Item rate contract

For this contract, contractors are required to quote rates for individual items of work on the basis of schedule of quantities furnished by the client’s department.

9. Percentage rate contract

In this form of contract, the client’s department draws up the schedule of items according to the description of items sanctioned in the estimate with quantities, rates, units and amounts shown therein.

10. Labour contract

This is a contract where the contractor quotes rates for the item work exclusive of the elements of materials which are supplied by the client’s Department.

11. Piece-Work agreement

This is that for which only a rate is agreed upon without reference to the total quantity of work to be done or the quantity of work to be done within a given period.

12.Target Contract

This is the type of contract where the contractor is paid on a cost-plus percentage work performed under this contract. In addition, he receives a percentage plus or minus on savings or excess effected against either a prior agreed estimate of total cost or a target value arrived at by measuring the work on completion and valuing at prior agreed rates.

Selection of suitable contracts for construction

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