If your project has a clear and well-defined scope of work and the designer has provided a completed set of construction drawings and specifications, a lump sum contract (also called fixed price) contract may be mutually beneficial for both you and the owner.
- Lump sum contracts are simple, but there are risks for both owners and contractors.
- This type of contract offers very limited flexibility in terms of any changes or variations.
- Contractors must spend the time and money early during pre-construction to properly estimate the project.
In this Article
What is a lump sum contract?
In a lump sum contract, a price is presented to the owner to complete the project for a fixed amount — no more or less. All labor, material, subcontractors, and equipment costs are included in this fixed price and you, as the contractor, are not required to perform any additional work beyond the originally agreed upon scope of work.
Using the scope of work (construction drawings, specifications, owner’s requested schedule, etc.) you’ll estimate the cost of the project plus your markup (overhead & profit).
Uses for a lump sum contract
Lump sum contracts are risky for more complex projects, or those who require a lot of demolition before you can fully understand site conditions. On the other hand they are great when used for projects that are:
- Simple in nature
- Have a clear set of construction documents (full set of plans, designs, specifications and schedule)
- Or (if lucky) with an owner who agrees to a certain percentage of contingency as they don’t want to have as much oversight
All in all, this type of contract is best used for projects that have a low risk of unforeseen problems.
How a lump sum contract affects profitability
First and foremost, proper preconstruction is essential for lump sum projects. You should not enter into a lump sum contract without a complete understanding of the drawings, site conditions, material lead times and other potential drawbacks. It’s vital to spend ‘smart money’ prior to the construction being started so you don’t end up spending ‘dumb money’ trying to fix any errors.
It’s also incredibly important to come in at or below the lump sum price. You should include some padding in your numbers along with a generous contingency in order to protect your bottom line. Anything from site conditions to market conditions (labor shortages, price escalations, etc.) can negatively impact the bottom line and must be best estimated in the contingency to protect your profit.
- Make sure you call each material manufacturer to understand the lead times and costs for expediting.
- Speak to the landlord about site access and any after hours work. Asking subcontractors to work off hours due to noise will increase costs exponentially.
If the preconstruction work is done correctly, the hope is that your profit margin stays as originally defined prior to starting the contract. If done poorly (which can include anything from miscalculating material lead time and expediting, incorrect material counts, a lack of site knowledge or existing conditions, etc.) your bottom line suffers as you will be forced to eat into your profit to cover up for the errors. Some of the things to consider to maximize profit include:
- Labor cost: Communicate with subcontractors so that they understand the schedule constraints and make sure to account for overtime.
- Material cost: Include accurate counts for everything, from raw to finish materials and ensure the prices are good for long lead times. If not, you’ll need to think about material escalation clauses to cover increases.
- Overhead: Take into account general administrative costs, insurance and any other site administration needed
What is a Variation?
A ‘variation’ is anything that impacts the plan, design errors or commissions to specification changes by the owner and their consultants. Variations will impact the project cost and potentially trigger disputes in the project.
Variations aren’t always bad. Beneficial variations (like a reduction of scope) can save both the owner and the contractor time and money. From decreasing material quantities to removal of scope, a variation must be clearly outlined as this changes the project scope. Following this, a change order or an amendment to the contract should be issued which redefines the project scope and deliverables.
Common issues with lump sum contracts
Though this type of contract can be simple, there are a number of issues that can arise that can impact both you and the owner. Two of the major ones that contractors need to protect themselves against are:
- Delays: You must protect yourself against delays that are out of yours or the owner’s control by inserting clauses into the contract. This can cover anything from material shortages to landlord delays, etc.
- Cost fluctuations for labor and materials: These are not typically considered in this type of contract as price is given to the owner as a fixed price in lieu of per unit. To price fluctuations, you can and should increase your margins to cover these inevitabilities.
To reduce these common issues and to reduce the risk of contract disputes, make sure to insert clear language that protects you and your bottom line.
Further Reading: 8 Types of Construction Contracts
Jarone started his construction career working for a commercial general contractor in Los Angeles, before transitioning to being an Owner’s Representative for the past eight years. Jarone has led multiple projects and has been integral in cross-departmental communication and implementation of processes with design, leasing, planning and facilities/operations teams. From preconstruction, which included dealing with landlord work letters, General Contractor interviews, bidding and scope buyout, to construction and managing the General Contractor and other vendors, to eventually punch and close out, Jarone has consistently delivered projects on time and within budget.