What is the best way to price construction contracts?

There are several ways to price construction contracts. In this article, Duncan Cotterill Partner Julia Flattery discusses the best options

There are various ways for calculating the price of construction works. When considering which type of pricing is most appropriate for your project, you should also consider the contractual implications. The most common forms of pricing mechanism and the impact each has on your projects are discussed in more detail below.

Lump sum

This is also referred to as ‘fixed price’ – but don’t be deceived. Fixed price/lump sum contracts mean that there is an agreed price for the works stated in the contract, not that the price is not subject to increase during the build.

A lump sum/fixed price contract can be preferred by principals/clients/owners, as it arguably provides the best cost certainty at the outset. On the other hand, this may mean that clients pay more for the works than would be if payment was based on the actual works carried out. This is because the agreed price is based on what the contractors anticipate it will cost to carry out the project and, generally speaking, is not reduced if the works actually cost less (other than where this is due to an agreed reduction in scope).

Measure and value

This pricing mechanism works on the basis that the works are paid for monthly, based on an assessment as to what quantity of works have been carried out during the preceding month. The contract contains agreed rates for the works and the monthly invoice is based on multiplying the quantity of works by those agreed rates.

The price is therefore based on the agreed rates and not the actual cost to the contractor of carrying out the works. There is therefore risk to both parties if this mechanism is used. The contractor needs to ensure that the agreed rates reflect the likely costs that they will incur. The principal/client/owner has to assess whether the rates proposed by the contractor are an honest reflection of the cost that will be incurred. Contractors are not necessarily obliged to disclose their margins in their supplied rates.

The measure and value pricing mechanism can be useful, where the design will not be sufficiently finalised prior to the contract being entered into and therefore it will not be possible to calculate a mutually acceptable lump sum. The parties should always strive to have as finalised design as possible in advance of works being commenced. However, in some circumstances, this is simply not possible, due to factors such as time pressures requiring the contract to be entered into prior to finalisation.

Cost reimbursement

This is also referred to as cost-plus or charge-up. Under this pricing mechanism, the contractor charges the actual cost incurred in carrying out the works, plus an agreed percentage for margin and overheads. The contractor usually has to provide evidence when claiming payment as to the costs incurred during that payment period.

This type of contract has become more prevalent in recent years due to the uncertainty around the increasing costs of materials, plant and labour. Arguably, it provides a fair price for principals/clients/owners, as they are only paying the actual cost of the works carried out by the contractor plus the agreed margin and overheads. However, the disadvantage is that there is no certainty as to what the cost of the project will be at the outset.

This pricing mechanism also tends to be used where the nature or scope of the work cannot be adequately defined due to time pressures or uncertainties as to the completed project.

A variation on this mechanism is to use a target price approach. This sets a target price at the outset that the contractor is to aim to achieve for the works. If the works come in below this target price, then the cost saving is shared between the parties to acknowledge that the contractor has carried out the works either more efficiently or more innovatively, to reduce the overall cost.

If the works come in over this target price, then the cost increase is also shared between the parties (although usually there is a cap on the increase that the contractor has to bear). This mechanism provides an incentive on the contractor to seek to achieve the best possible price for the works and also provides the principal/client/owner with some degree of price certainty.

Conclusion

It is important to consider which is the best form of pricing mechanism for you and the project. Legal advice should be obtained to assist with this decision and drafting the contract to achieve the required objectives. Contact our construction law team to find out more.

This article is provided by Duncan Cotterill, a full-service law firm with offices in Auckland, Wellington, Nelson, Queenstown and Christchurch. If you have any questions relating to this article, please contact your local Duncan Cotterill advisor duncancotterill.com

Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.