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Lump Sum Contract Advantages and Disadvantages in Construction Projects

Lump-Sum-Construction-Contract

Lump sum contract is the simplest form of contract in construction projects. It fixes the price to be paid for undertaking out the work, before the start of the contract.

One of the most basic and commonly used types of construction contract is the “LUMP SUM CONTRACT” or the Fixed Price Contract. This type of contract is often based on firm bills of quantities and drawings. A lump sum price should cover all costs, overheads, risk contingencies and profit.

A lump sum price may be called for, or a series of lump sums. This is best suited to easily defined, relatively simple constructions, involving little below-ground work. However, some quite large above-ground constructions are paid for by lump sum. Sometimes a separate section of the bill for pricing allows for the foundation work of a building to be paid for‘on measure’.

In some kinds of civil engineering works, the lump sum payment method can pose serious risks upon a contractor, causing him to add a substantial sum to his tender. This is particularly so for design-and-build or‘turn-key’ projects where the contractor has to undertake detailed design as well as construction. The employer has to pay these additional sums whether or not any risks materialize.

A disadvantage is that an employer may have to pay a high price for any alteration or addition he wants to the project because the contractor is only committed to undertaking a fixed amount of work for the fixed payment. Payments under lump sum contracts are usually made in instalments as set out in the contract according to stipulated stages of completion, or linked to a programme or activity schedule.

What is a Lump-Sum Contract?

In a Lump Sum Contract, a Fixed Price is predetermined and agreed upon, for the services rendered by the contractor. Factors such as Time, Cost, and Quantity are outlined beforehand. There is no change allowed in any of these factors throughout the execution of the project.

The basic difference between a Lump Sum contract and a Unit price contract is that the contractor submits the total project expense instead of bidding with an item-wise price list for the project.

In a Lump Sum contract, it is agreed that a “Stipulated Sum” will be paid to the contractor, for which he will execute the whole project without demanding any additional amount. This is the simplest kind of contract that exists in the construction industry, which is why it is commonly used. The Contractor can hire subcontractors for the execution of certain or all parts of the project. This is known as the contract chain.

From the Client’s point of view, Lump Sum contract is the best bet to indemnify himself from the risks involved in the project. Since no additional expense is entertained other than the Lump Sum amount which is previously stipulated, the Contractor has to bear all the risks involved with the execution of the project. Hence, there is a high risk involved on the Contractor’s end in a Lump Sum Contract. This is why it is a commonly accepted practice that the Contractor builds a bit off cushion money into the budget while predetermining the cost of the project. This works as an insurance of sorts to protect the contractor from any overruns that might happen during the execution of the project.

On the other hand, this also makes it easy for the contractor to increase his profits from the project.

Lump Sum Contract Advantages

A lump sum construction contract offers the following advantages:

  • Low risk for the owner.
  • ‘Fixed’ construction cost.
  • Minimize change orders.
  • Owner supervision is reduced when compared to Time and Material Contract.
  • Construction can start before designs are complete and any consequent changes found necessary are the contractor’s responsibility.
  • The contractor will try to complete the project faster.
  • Accepted widely as a contracting method.
  • Bidding analysis and selection process is relatively easily.
  • Contractor will maximize its production and performance.

Lump Sum Contract Disadvantages

This type of contracting has also disadvantages.

  • It presents higher risk to contractor.
  • The project needs to be designed completely before the commencement of activities.
  • Changes are difficult to quantify.
  • The Owner might reject change order requests.
  • The construction progress could take longer than other contracting alternatives.
  • Contractor will select its own means and methods.
  • Higher contract prices that could cover unforeseen conditions.

A lump sum contract is the most recognized agreement form on simple and small projects. For example, projects with a well-defined scope or construction projects where the risk of different site conditions is minimal.

When Should a Lump Sum Contract be Used?

When Should a Lump Sum Contract be Used?

A Lump Sum contract should always be used where the scope of the construction project is clearly defined. In case the scope is not clearly defined, the cost overruns might become difficult to handle leading to huge losses for the Contractor. The Contractor must ensure that all the construction drawings are provided to him in advance and that the quantities associated with each item are accurately surveyed so that he can make an informed bid for the project.

The Client might use a Lump Sum contract, where the risks associated with the project are more. A Lump Sum contract although not most transparent can help in indemnifying the Client from the risks associated with the project.

Though famed for its simplicity and ease of use, a Lump Sum contract is not always the best choice for a project. Since it involves a huge previously stipulated sum, it is a possibility that the contractor is not entirely transparent about the expenses incurred in the project. This provides the contractor, a leeway to take money away easily from the project budget and increase his margins.

Lump Sum Contracts and Government Projects

Since the risk involved for Taxpayers’ money is believed to be the minimum in Lump Sum Contracts, most of the projects undertaken by the Government involve Fixed Price/ Lump Sum Contracts. Lump Sum Contracts usually necessitates the least amount of paperwork which leads to hassle-free completion of the project by the contractor. The scope of work for Government projects is also usually straightforward and clearly laid out. Very few Government projects use Unit Price contracts as they entail numerous change orders and fluid scope of work. This can easily hinder development plans making it a risky investment.

Therefore, in cases where the scope of work is crystal clear and the work is of simple nature, the Lump Sum contract can be immensely beneficial to the contractor. However, if the scope of work is fluid in nature and the construction drawings keep changing constantly, it can quickly become a messy scenario for the contractor.

 If rightly used, a Lump Sum contract can be a boon for both the Client and the Contractor. For the project to be completed without a hitch, it is necessary to do all the calculations in advance to ensure that there are no foreseeable changes during the execution.