To divide save money on contract price save provide

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Unformatted text preview: B Fundamental Balance Fundamental Impose high enough risk incentive to get contractor do Impose high job efficiently – within the specifications of the contract E.g. Incentive to finish on time, incentive to stay within E.g. budget E.g. better team assignment, equipment provision, mgmt E.g. Impose low enough risk to have reasonably low bid Impose low Impose according to contractor ability to tolerate Impose Derivative Results of Risks I: Accountability/Monitoring Accountability/Monitoring Consider parties A and B in an agreement Consider A is contractor; B is owner is The greater the risk on party A The The more incentive on party A to manage this risk The The less incentive on party B to manage this risk The More incentive on A to monitor the relevant factors More so B can’t claim the risk is responsible for a problem More incentive on B to make sure that A’s means of More risk management falls within the agreement management E.g. that not “cutting corners” or otherwise cheating to E.g. shield from risk Derivative Results of Risks II: Impact on Construction Timing Impact Both parties must agree on cost to move forward Both In general, more risk on one party, less that party is In willing to move forward More risk on contractor, the longer will delay construct. More Given uncertainty, contractor will charge more up front Given Owner doesn’t want to pay a huge amount up front Owner As uncertainty is lessened in design, prices converge As Owner can expedite – by paying higher price (risk Owner premium) to contractor or by shouldering risk Remember; delay can have major costs – but so can Remember; wrangling over change orders! Note on Change Orders Note Changes contract (cost/schedule/scope/etc.) Changes Can lead to costs beyond contract specification Can Anticipated costs incorporated in “contingency” Anticipated Often 1-3% on top of agreed upon price Often Often only paid for additional direct costs Often Big problem if disruption in work Big Source of very large risk Source Contractual Risk ontractual Ris Allocation Allocation RISK SHARING METER Modified from Kerzner, 2000 0% Lump-Sum (Fixed Price) Fixed-Price w/ Economic Price Adjustments Fixed-Price Incentive Cost-Plus Incentive Cost-Plus Award Fee Cost-Plus Fixed Fee OWNER’S RISK CONTRACTOR’S RISK 100 % Cost-Sharing 0% RISK Allocation Cost-Plus Percentage 100 % Cost Versus Price for Lump Sum Cost b{ $10,500 a }c $10,000 } $10,300 $9,500 Final Price (Price is fixed at $10,300) Final Cost a = If final cost is $9,500, contractor profit is $800 (8.42%) b = If final cost is $10,000, (as expected), contractor profit is $300 (3%) c = If final cost is $10,000, contractor loss is $200 (-1.9%) Image by MIT OpenCourseWare. Macomber, 1989 Lump Sum (“Fixed Price”) Lump Contractor required to achieve the project at Contractor the negotiated contract value All risk of cost, schedule fall on contractor All The owner knows the actual cost of the The project before it begins Minimizes risk for the owner if the project is Minimizes well estimated, contractual documents accurate and project clearly defined High incentive for contractor to finish High Early (so can move on to other jobs) Early Low cost (so can make a profit) Low Lump Sum Lump Required for many public projects Required Good for some well-defined projects Good Good price competition in commodity metric Good Bad for ill-defined projects Bad Adversarial relationship over responsibility and Adversarial payment for of changes High contractor risk means typically start late High Very different from typical meaning of “Fixed fee”! Very Ways to Save Money: Effect on Owners Effect Helps: Efficiency within construction Helps: Best teams Best Appropriate equipment Appropriate Careful management Careful Quality workmanship (to avoid risk of rework) Quality Hurts: Cutting corners, distortion, charge orders Hurts: orders Substitution of materials Substitution Distortion of quantities used Distortion Distortion of progress Distortion Cost Versus Price for Cost Plus Cost (Price = cost plus 5%) $11,025 } c b $10,000 }a } $10,500 $9,975 $9,500 Final Price $10,500 Final Cost a = If final cost is $9,500, contractor profit is $475 (5%) b = If final cost is $10,000, contractor profit is $500 (5%) c = If final cost is $10,500, contractor loss is $525 (5%) Image by MIT OpenCourseWare. Macomber, 1989 Cost Plus Fixed % Cost Owner is paying the actual cost plus a fixed Owner percentage Contractor agrees to do his best efforts to Contractor achieve the work Contractor shoulders very little risk Contractor Typically select contractors based on reputation Typically and comfort (service rather than commodity) Cost Plus + Fixed %: Advantages Cost Maximum flexibility to the Owner Maximum No fighting over change orders – contractor gets No paid for any extra work required Permits to collaborate at the early stages of Permits the project Minimal negotiation time Minimal Minimal fear of commitment by contractor Minimal Only have to pay for what actually costs Only If manage closely, can save money vs. fixed-price If save vs. Cost Plus + Fixed %: Disadvantages Cost Owner shoulders all risk Owner Little incentive to reduce costs and overtime salaries Little can even increase costs Cost unknown until contract completes Cost Owner needs to oversee construction closely Owner Speed up slow crews Speed Identify management problems Identify Contractors have incentive to grow scope, price Contractors Terr...
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This note was uploaded on 07/25/2012 for the course ECON 111 taught by Professor King during the Spring '12 term at CSU Bakersfield.

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