Construction Pricing and Contracting

8.
Construction Pricing and Contracting

8.1 Pricing for Constructed Facilities
Because of the unique nature of constructed facilities, it is almost imperative to
have a separate price for each facility. The construction contract price includes
the direct project cost including field supervision expenses plus the markup
imposed by contractors for general overhead expenses and profit. The factors
influencing a facility price will vary by type of facility and location as well.
Within each of the major categories of construction such as residential housing,
commercial buildings, industrial complexes and infrastructure, there are smaller
segments which have very different environments with regard to price setting.
However, all pricing arrangements have some common features in the form of
the legal documents binding the owner and the supplier(s) of the facility.
Without addressing special issues in various industry segments, the most
common types of pricing arrangements can be described broadly to illustrate
the basic principles.
Competitive Bidding
The basic structure of the bidding process consists of the formulation of

detailed plans and specifications of a facility based on the objectives and
requirements of the owner, and the invitation of qualified contractors to bid for
the right to execute the project. The definition of a qualified contractor usually
calls for a minimal evidence of previous experience and financial stability. In
the private sector, the owner has considerable latitude in selecting the bidders,
ranging from open competition to the restriction of bidders to a few favored
contractors. In the public sector, the rules are carefully delineated to place all
qualified contractors on an equal footing for competition, and strictly enforced
to prevent collusion among contractors and unethical or illegal actions by
public officials.
Detailed plans and specifications are usually prepared by an

architectural/engineering firm which oversees the bidding process on behalf of
the owner. The final bids are normally submitted on either a lump sum or unit
price basis, as stipulated by the owner. A lump sum bid represents the total
price for which a contractor offers to complete a facility according to the
detailed plans and specifications. Unit price bidding is used in projects for
which the quantity of materials or the amount of labor involved in some key
tasks is particularly uncertain. In such cases, the contractor is permitted to
submit a list of unit prices for those tasks, and the final price used to determine
the lowest bidder is based on the lump sum price computed by multiplying the
quoted unit price for each specified task by the corresponding quantity in the
owner's estimates for quantities. However, the total payment to the winning
contractor will be based on the actual quantities multiplied by the respective
quoted unit prices.
Negotiated Contracts
Instead of inviting competitive bidding, private owners often choose to award

construction contracts with one or more selected contractors. A major reason
for using negotiated contracts is the flexibility of this type of pricing
arrangement, particularly for projects of large size and great complexity or for
projects which substantially duplicate previous facilities sponsored by the
owner. An owner may value the expertise and integrity of a particular
contractor who has a good reputation or has worked successfully for the owner
in the past. If it becomes necessary to meet a deadline for completion of the
project, the construction of a project may proceed without waiting for the
completion of the detailed plans and specifications with a contractor that the
owner can trust. However, the owner's staff must be highly knowledgeable and
competent in evaluating contractor proposals and monitoring subsequent
performance.
Generally, negotiated contracts require the reimbursement of direct project cost

plus the contractor's fee as determined by one of the following methods:
1. Cost plus fixed percentage

2. Cost plus fixed fee
3. Cost plus variable fee
4. Target estimate
5. Guaranteed maximum price or cost
The fixed percentage or fixed fee is determined at the outset of the project,
while variable fee and target estimates are used as an incentive to reduce costs
by sharing any cost savings. A guaranteed maximum cost arrangement imposes
a penalty on a contractor for cost overruns and failure to complete the project
on time. With a guaranteed maximum price contract, amounts below the
maximum are typically shared between the owner and the contractor, while the
contractor is responsible for costs above the maximum.
Speculative Residential Construction

In residential construction, developers often build houses and condominiums in
anticipation of the demand of home buyers. Because the basic needs of home
buyers are very similar and home designs can be standardized to some degree,
the probability of finding buyers of good housing units within a relatively short
time is quite high. Consequently, developers are willing to undertake
speculative building and lending institutions are also willing to finance such
construction. The developer essentially set the price for each housing unit as
the market will bear, and can adjust the prices of remaining units at any given
time according to the market trend.
Force-Account Construction
Some owners use in-house labor forces to perform a substantial amount of

construction, particularly for addition, renovation and repair work. Then, the
total of the force-account charges including in-house overhead expenses will be
the pricing arrangement for the construction.

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8.

Construction Pricing and Contracting

The basic structure of the bidding process consists of the formulation of

Detailed plans and specifications are usually prepared by an

Instead of inviting competitive bidding, private owners often choose to award

Generally, negotiated contracts require the reimbursement of direct project cost

1. Cost plus fixed percentage

Speculative Residential Construction

Some owners use in-house labor forces to perform a substantial amount of

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