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AACE INTERNATIONAL CONTRACTING FOR CAPITAL PROJECTS

The major advantage of a reimbursable cost contract is time, economy;


since a contract can be established during the early stages of • contractor may assign its “second division” personnel to
a project. This type of contract presents a disadvantage to an the job, make excessive use of agency personnel, or use
owner, however, since poor performance by the contractor the job as a training vehicle for new personnel;
can result in increased costs and because final costs are the • owner carries most of the risks and faces the difficult
owner’s responsibility. Further, the final or total investment decisions; and,
level is not known until the work is well advanced. • biased bidding of fixed fees and reimbursable rates may
not be detected.
Reimbursable cost contracts can contain lump-sum elements,
such as the contractor’s overhead charges and profit, which Target Contracts
is usually preferable to calculating these costs on a percent- Target contracts are intended to provide strong financial incen-
age basis. Reimbursements may be applied to such items as tive for the contractor to complete the work at minimum cost
salaries, wages, insurance and pension contributions, office and within minimum time. In the usual arrangement, the con-
rentals, and communication costs. Alternatively, reimburse- tractor starts work on a reimbursable cost basis. When suffi-
ment can be applied to all-inclusive hourly or daily rates for cient design is complete, the contractor produces a definitive
time spent by engineers on the basis that all office support estimate and project schedule for owner review, mutual nego-
costs are built into these rates. This form of contract is gener- tiation, and agreement. After agreement is reached, these
ally known as a fixed-fee or reimbursable-cost contract, and become targets. At the end of the job, the contractor’s reim-
can be used for both engineering and other office services as bursable costs are compared with the target and any saving or
well as for construction work. overrun is shared between the owner and the contractor on a
prearranged basis. Similarly, the contractor qualifies for addi-
Such arrangements give the owner greater control over the tional payment if it completes the work ahead of the agreed
contractor’s engineering work, but reducing the lump sum upon schedule. The main appeal this form of contract has to
content of the contractor’s remuneration also reduces its the contractor is that it does not involve competitive bidding
financial incentive to complete the work economically and for the target costs and schedule provisions.
speedily. Further, it lessens the owner’s ability to compare
and evaluate competitive bids, since only a small percentage Requirements
of the project cost is involved. Finally, it is possible that the
“best” contractor may not quote the lowest price. • a competent and trustworthy contractor;
• quality technical and financial supervision by the owner;
Requirements and,
• competent estimating ability by the owner.
• a competent and trustworthy contractor;
• close quality supervision and direction by the owner; Advantages
and,
• detailed definition of work and payment terms covered • flexibility in controlling the work;
by lump sums and by all-inclusive rates. • almost immediate start on the work, even without a
scope definition;
Advantages • encourages economic and speedy completion (up to a
point); and,
• flexibility in dealing with changes (which is very impor- • contractor is rewarded for superior performance.
tant when the job is not well defined), particularly if new
technology development is proceeding concurrently Disadvantages
with the design;
• an early start can be made; • final cost initially unknown;
• useful where site problems such as trade union actions • no opportunity to competitively bid the targets;
like delays or disruptions may be encountered; and, • difficulty in agreeing on an effective target for superior
• owner can control all aspects of the work. performance;
• variations are difficult and costly once the target has
Disadvantages been established—contractors tend to inflate the costs of
all variations to increase profit potential with easy tar-
• final cost is unknown; gets; and,
• difficulties in evaluating proposals—strict comparison of • If the contractor fails to achieve the targets, it may
the amount quoted may not result in selecting the “best” attempt to prove that this was due to owner interference
contractor or in achieving the lowest project cost; or to factors outside the contractor’s control; hence, effec-
• contractor has little incentive for early completion or cost tive control and reporting are essential.

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