4.

Contracts and Pricing

Arrangements

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S. Zwierzchowski
University of Calgary MEng Program in Iran

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 Issues and Underlying Principles
Opening Discussion

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 Issues
n At a basic level how is it ensured that the
owner and the contractor/supplier perform
their obligation and responsibilities?

n What contract pricing arrangement minimizes

the financial risk to the owner?

n What contract pricing arrangement minimizes

the financial risk to the supplier/contractor?
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 Issues
n What contract pricing arrangement provides
the best incentive for contractor/supplier
performance and quality?

n Does the type of contract price arrangement

affect the number of bidders for a given
project procurement?

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 Contracts

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 What Is a Contract
n A set of promises and obligations between
two or more parties that is enforceable under
the law

n Written or verbal or a mix

n Complex contracts consist of many documents

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 Contracts Enforceable Under the
Law
n Breach of Contract
n Not fulfilling a promise or obligation required
under the contract
n Non-defaulting party can recover damages
incurred because of the breach or obtain
other remedies to mitigate the breach through
the courts

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 Contracts - Termination
n Contract is brought to an end by:
n Performance
n Mutual agreement
n Frustration
n Breach
n Operation of the law

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 Project Procurement
Contracts

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 In General
n Projects concerned with the construction of
infrastructure and the procurement of plant
and equipment tend to have high values and
a large degree of complexity
n Contracts can be complex and extensive
n Promises and obligations are defined in many
documents

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 Master Agreement
n In the body or in schedules or through
references to other documents would define
n general scope of work to be performed
n the price and price arrangement for the work,
payment terms
n overall schedule
n key schedule milestones
n general terms and conditions

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 Other Documents Forming the
Contract
n Documents, drawings and datasheets
defining technical requirements
n Change orders
n Inspection and test plans and procedures
n Correspondence
n Meeting minutes, and on.
n Unless explicitly stated otherwise, the
documents, correspondence, and meeting
minutes used in the bidding process
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 Contract Pricing
Arrangements

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 Pricing Arrangements
n Fixed Price (Lump Sum)
n Fixed Price with Price Adjustments
n Unit Price
n Time and Materials/ Unit Rate
n Reimbursable with Fixed or Percentage Fee
n Target Price
n Reimbursable with Incentive Fees

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 Fixed Price (Lump Sum)
n Contractor/supplier is paid a fixed price for a
defined scope of work or a defined equipment
specification
n Included is overhead and profit
n Contractor/ supplier can incur a loss
n Costs are greater than price

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 Fixed Price (Lump Sum)
n Scope of work must be accurately and
completely defined
n Extra charges by the contractor for scope
changes
n Each change requires negotiation
n Rules must be defined in contract
n Relative to other price arrangements, fixed
price requires greater effort to define work
scope and technical requirements
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 Fixed Price (Lump Sum)
n Contractor assumes the risk associated with
the price of the work
n Variations in labor and material costs
n The need for extra labor beyond what was
estimated
n Technical difficulties in meeting defined work
scope and technical objectives
n Contractors/suppliers add a contingency to
price
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 Fixed Price (Lump Sum)
n Contractor is motivated to reduce costs
n Contractors profit is increased
n Contractor has no incentive to incur additional
costs
n such as schedule acceleration through
overtime
n providing greater quality in the work or
equipment than the minimum required to meet
contract requirements

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 Fixed Price with Price Adjustment
n Similar to straight fixed price except
n Adjustments can be made to the price over
time if some of the contractor/suppliers costs
change
n Normally be used to offset the effects of
inflation or price volatility in a commodity
n Increases in labor and material costs
n Method or formula defined in the contract
using published statistics for inflation
n Reduces the contractors/suppliers risk
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 Unit Price
n Each unit of work/equipment/material provided at a
fixed price
n Exact quantity of units not specified and may not be
known with certainty
n Price for each unit will cover the contractor/suppliers
direct costs plus overhead and profit.
n Contractor/supplier assumes the price risk on a per
unit basis
n Owner/purchaser assumes the price risk for
variations/increases in the quantity of units required.

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 Unit Price
n Examples:
n supply and installation of racking on a per module

basis
n supply and installation of lighting on a per fixture basis

n manufacture and supply of valves

n manufacture and supply of pressure vessels

n supply and installation of piping on a per length basis

n excavation on a per volume basis

n Still important to accurately and completely define the

requirements and specifications for each unit.

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 Time and Materials/Unit Rate
n Contractor is paid for the amount of time
required of labour and other resources
n Hourly, daily or weekly rates per labour
category or per chargeable resource item
such as equipment and tools
n Senior engineer; drafter; master electrician;
journeyman welder; and on
n Cranes; excavators; scaffolding; and on.

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 Time and Materials/Unit Rate
n Rates include overheads and profits
n Rates fixed for the contract
n Contractor assumes price risk relative to
costs associated with the rate increasing
n Schedule of rates is included in the contract
n Cost of materials and other expenses at cost
plus a percentage markup
n A type of reimbursable contract

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 Time and Materials/Unit Rate
n Disadvantage
n The contractor has no incentive to quickly
complete the work
n The longer the contractor must work on the
project, the more money the contractor earns
n Advantages
n The quality of work can be high
n The scope of work, technical requirements,
and design do not have to be defined in detail
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 Reimbursable with Fixed or
Percentage Fee
n Similar to a time and materials contract except
the contractor is paid for actual costs
Advantages and disadvantages the same
n In addition, a fee that is a percentage of the
actual costs to cover overhead and profit is paid
n could be a fixed fee
n Contractor bears no price risk whatsoever
n Administration is very difficult
n actual costs incurred by the contractor must be
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documented and verified
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 Target Price Contract Types
n A form of reimbursable contract but with an incentive
based on total costs that the contractor charges for
the work.
n If the costs are below the target price, contractor is
paid a percentage of the difference as a bonus.
n If the costs are above the target price, contractor is
only paid a portion of the difference
n Costs can either be fixed rates or can be the actual
costs incurred
n Administratively rates are easier to work with and than
trying to determine the actual costs.

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 Reimbursable with Incentive Fees

n Contractor is paid for the actual costs

incurred or according to rates established for
the work provided.
n The contractor is paid an incentive fee based
on performance
n Schedule
n Quality
n Cost
n Other
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 Issues and Underlying Principles
Concluding Discussion

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 Issues
n At a basic level how is it ensured that the
owner and the contractor/supplier perform
their obligation and responsibilities? Through
contracts and contract law.
n What contract pricing arrangement minimizes
the financial risk to the owner? Fixed price.
n What contract pricing arrangement minimizes
the financial risk to the supplier/contractor?
Reimbursable with percentage fee.
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 Issues
n What contract pricing arrangement provides
the best incentive for contractor/supplier
performance and quality? Reimbursable with
incentive fee.
n Does the type of contract price arrangement
affect the number of bidders for a given
project procurement? Yes, some
organizations will not undertake fixed price
contracts because of the risk of financial loss
in performing the work.
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