Procurement methods in construction are essential to establishing clear terms for project delivery, cost control, and risk allocation between clients and contractors. Selecting the right procurement strategy helps manage project risks, cost, and quality expectations. Here’s a look at some of the primary procurement types—Cost-Plus, Open Book, Fixed Price, and Target Cost.
1. Cost-Plus
As the name suggests, in a Cost-Plus contract, the contractor is reimbursed for all project costs, including labour, materials, and overhead, plus an additional fee or profit margin. This fee could be a percentage of the total cost or a fixed fee. The client essentially pays for actual costs plus an agreed margin. This approach often applies when the project’s scope isn’t fully defined, allowing flexibility for adjustments. Cost-Plus contracts pose a risk of budget overruns for the client if there are delays or inefficiencies. The lack of a fixed budget means there’s less incentive for the contractor to keep costs low. Contractors face limited risk since they are reimbursed for all costs. However, they must maintain transparent record-keeping, and disputes can arise if costs are questioned by the client.
2. Open Book
Open Book contracting promotes transparency by allowing clients to see the contractor’s actual costs. It’s often used alongside other pricing models, such as Cost-Plus or Target Cost. Contractors keep detailed records and share them with the client, building trust and enabling collaboration on cost-saving measures. The project’s total cost is determined in real-time, with both parties involved in budget reviews. Open Book can lead to higher-than-expected costs if the client does not actively participate in cost control. Additionally, since prices fluctuate based on market conditions, unexpected increases in material costs can affect the project. While Open Book enhances trust and dialogue between the parties, it will also require extensive administrative effort. Contractors may also face client pushback on legitimate costs, leading to potential disputes over budget increases.
3. Fixed Price
In a Fixed Price or Lump Sum contract, the client and contractor agree on a predetermined price for the project, regardless of the actual time or materials used. This is one of the most straightforward procurement methods. The contractor is responsible for completing the project within the agreed budget. Any cost overruns are typically the contractor's responsibility unless scope changes are authorized by the client. While this model provides cost certainty, the client may still face risks if the scope isn’t well-defined. Any changes to the project scope can lead to additional costs and project delays. The contractor carries the bulk of the financial risk, as they must complete the project for the agreed price. Unexpected challenges, such as labour shortages or rising material costs, can erode profitability. A contractor will price such risks into their price, which the client accepts for early price certainty, although the risks may not materialise.
4. Target Cost
In a Target Cost contract, the client and contractor agree on a target budget, and savings or overruns are shared based on a pre-agreed formula. This promotes collaboration between parties to manage costs effectively. Both the client and contractor work closely to manage costs against the target. If the project costs are below the target, both share the savings. Conversely, if costs exceed the target, both share the additional expense. If the target isn’t realistic, costs may quickly exceed budget expectations. Clients may also experience delays as contractors attempt to reduce expenses to avoid penalties or loss. Contractors have a vested interest in managing costs but may face financial strain if overruns occur. The model requires effective collaboration and communication to ensure both parties agree on cost-saving initiatives.
Each procurement method offers unique advantages and challenges, impacting cost control, risk, and collaboration. Selecting the right method requires careful consideration of project complexity, risk tolerance, and collaborative goals between client and contractor. Should you require more information about the pro’s and con’s of different procurement routes, please contact me Peter.Searle@ba4cs.co.uk
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