Unless you are building something big and complex like a new sports stadium or a large industrial project, you likely won’t see this type of contract as an SMB contractor. Guaranteed Maximum Price (GMP) contracts are similar to fixed price contracts but differ in that you will work closely with the owner in the design phase to help them understand project costs.
If you do encounter a project where the owner wants to bring you in during the design development phase in hopes to minimize (and fully understand) their costs at the onset, here is what you need to know.
Key Takeaways
- Before agreeing to this type of contract, ensure that all drawings, specifications and site-specific information is known. It is imperative to know the thorough scope of work as any additional costs will shrink your profitability.
- Costs included in a GMP contract are: direct costs, general conditions, contractor markup, contingency and allowances.
- As you will assume more financial risk, GMP contracts are at times hard to negotiate than T&M or Cost-Plus contracts.
- GMP contracts provide a strong potential for profitability if the budget is created accurately.
What is a GMP Contract?
A guaranteed maximum price (GMP) contract sets the maximum price for a project. Often called a construction manager at risk contract, the contractor is responsible for any costs above the project limit. This limits the risk for the owner but puts your potential profits on the line if there are unforeseen costs that exceed the project limit. Because of these risks, GMP contracts are used when there is a well-defined scope of work.
You must be diligent in tracking all costs alongside your initial estimate as any unforeseen costs will not be reimbursed by the owner. However if the project’s scope is modified due to owner changes or unforeseen site conditions, the GMP will be adjusted and the owner will be responsible for paying for the additional costs. These change orders will outline modifications to the project scope and clearly define the contractor’s liability or the owner’s obligations. Note: Be ready for all your costs to be transparent to the client. All direct costs (labor, materials and equipment) and indirect costs (markup for overhead and profit) will be viewed by the owner so they can reimburse them.
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Pros + Cons of GMP Contracts for Construction
Pros
- You will have greater control over the construction process because you will be responsible for managing the costs and schedule.
- Some GMP contracts (as described above) can provide shared savings or other incentives which can lead to further profit.
- Since these contracts put more risk on contractors, you can typically charge a higher fee.
- You will have some influence on design/approach as the owner will typically involve you earlier on in the project.
- There is the possibility to create trust with your owner due to the open-book nature of proceedings, which will in turn hopefully lead to more projects.
Cons
- You must carefully review the specifications as not all costs are considered the owner’s responsibility. If these costs are not accounted for (or an allowance set) this could eat into your profit.
- Your cost tracking must be meticulous both to receive compensation from the owner and to ensure that you stay below budget.
- Change orders are highly contested in this type of contract as all costs should have been accounted for in a GMP contract. Arguing over existing or unknown conditions can be a difficult process.
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Uses for a GMP Contract
An owner often brings in a contractor earlier on in the design development process so you can advise on the costs of the project. You will have the opportunity to work with the architect and design team to scope out any specific items the owner may want in the drawings.
Traditionally used for larger and more expensive projects, GMP contracts are typically used for projects that employ a design-build scope or one in which the owner will hire a construction manager to monitor the progress and stay on top of the budget.
For example, a GMP contract is good for projects where you have worked with the architect before and can be a partner in the design-build process. You will be able to use your expertise to advise on the constructability of the project during the design phase so that when you come to the construction phase, you can run a more cost-effective project. This will mean more upfront costs to the owner, but spending smart money in the beginning of the project will allow you to be more integrated in the construction documents and lead to less unforeseen details and conditions throughout the project.
How Mitigate Risks on GMP contracts
To prevent future disputes over change orders or scope of work, it is critical to fully comprehend all construction documents that contribute to the scope of work. From understanding the drawings, specifications and assessing any site risks, you will create a clearly defined scope of work. It is also critical to outline how changes to the project will be handled, whether owner directed or site impacted and how it affects the cost and schedule. A change will directly impact the maximum price, so you must insert language in the contract that protects you in case of any changes. The GMP is a set number but can be flexible if the correct language is inserted.
While the most simple type of GMP simply sets a fixed maximum price for the contract, there are two modifications that you can add to GMP contracts to further protect you from financial risk.
- Escalation clause: If the market is unstable, this clause allows for the GMP to be adjusted due to potential increases in materials or labor costs. This will allow for an increase in the GMP so you can protect your bottom line.
- Shared savings: This inclusion can allow for a shared savings between you and the owner (either as a lump sum or pre-agreed percentage). If the final cost of the project falls below the GMP. This can create an incentive for you to finish the project below cost as you will gain more profit.
How a GMP Contract Affects Cash Flow and Profitability
Following the creation of the budget and the GMP (which sets your profit margin), as mentioned above, cost tracking is critical with a GMP contract. Your budget details the costs you have in play for each line item and it is critical to manage these costs every pay app. If changes to the project scope don’t change, you are at most risk for any cost changes, so it is imperative to stay under (or at) budget for each line item. You must trust that your pre-construction team has fully reviewed the drawings because you are beholden to that number throughout the construction process.
The client/owner is not obligated to share any financial savings if the cost comes below the GMP, but most owners will insert a clause to incentivize contractors to perform work below budget. Unlike fixed-price contracts which stipulate a set price for projects, the owner will reimburse you up to a threshold, or GMP. But like fixed-price contracts, you are on the hook for any overages, unless a formal change order is agreed upon.
Common Issues with GMP Contracts
Since GMP contracts are reimbursable and you share your finances with the owner, contingency amounts on line items can be confusing. If you budgeted $10 for stone and the actual cost is only $8 (you budgeted $2 for contingency as you weren’t certain about anything from labor to material cost or needed to rent equipment to assist the stone contractor), explaining this extra $2 expense can be tricky. Instead of putting a contingency per line item, it’s smart to list out all contingencies on a separate line item.
Change orders will also be a point of friction throughout the project as the owner is operating on that total maximum price you presented to him/her (taking into account all situations and costs) for completing the project. As such, when presenting a change order to the client you need to ensure that you have the appropriate backup explaining the reason for the change and what it wasn’t accounted for in the previous budget.
Lastly, trust can also be an issue with GMP contracts as owners may think that you are inflating costs at the onset when providing the GMP. On the flip side, the openness of finances can feel like an infringement on your privacy as a contractor.