PM101-4 (Part 1) Fixed Price or Time and Material: Is Your Project Doomed?
Robert Trajkovski, altPMP BSEE MSE Ph.D(ABD)
Billion Dollar Project Leader| Director of Capital Projects | Helping Companies Execute Their CAPEX Goals into Reality
One of the biggest contributors to Project failure is the contract that is signed between the owner and the GC(General Contractor). Failure happens whether the contract is fixed price(FP) OR Time and Material(T&M)?
Why? Did You Make Too Good of a Deal With Your General Contractor?
Owners believe that contracts are tools for controlling risk. Most owners believe that they can transfer the project risk to the GC and completely remove it from themselves. In reality, this never happens. GCs are not in the business of losing money.?
Most owners who execute large complex projects are international companies with large capital. Most GCs, let's say mid-size companies, are in the business of selling a service to the client. Their costs are variable and the more effort they have to put in the more it costs them.? ?
When a client comes to the GC and says that they are not completely finished with a detailed design BUT would like a proposal that is fixed price, what the GC hears is that the scope of work(SOW) is not set but you want a price to hold me accountable. In other words, the client wants the GC to perfectly predict the total cost with imperfect information.
Let's step away for a moment...
Imagine I was in the pencil-making business. You come to me with a new design for a pencil that is not fished. With my experience and many estimating tools, I believe that I can make these pencils for you for a $1. BUT because the design is not complete there is a risk to me committing to the $1. I know that you are 90% complete but there is a 10% chance you will make the pencil fancier. My proposal will not be for $1. It will be a fixed price of $1.30. Ten cents will cover the improvement and 20 cents will cover the profit and extra work due to the 10% that is not defined.?Noticed that I bumped the price 30% even though you claimed that you were 90% done.
As we talked about in a previous article this is the biggest problem with owners not meeting their cost or schedule, or both, is not having finished the design.?
The moral of that little diversion is that a GC MUST adjust their price because of the unknown risk posed by not having a finalized design.
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Now what happens when we agree on the price and you decide that you will add a fancy pencil holder with a smiley face? I must adjust my price since my SOW has changed. The final design is different from what was used to develop the proposal. I must resubmit the revised proposal to cover my costs.
Sometimes this process goes very bad for the GC
I have seen a process GC do a fixed-price contract for a process that was not completely designed. The process was still being designed while the building was being constructed. This was done to meet an aggressive schedule date.
I believe that the GC lost money doing the project. A loss of lots of money. The people who negotiated the contract should have known better. But eagerness to get into a new line of business probably has left a bad taste in their mouth. It was difficult for the process GC to adjust the price and justify that the change was not covered in the contract.
A fixed, lump sum, contract should only be used once the final design is completed and there are minimal changes that can occur.
With this in mind...what about Time AND Material contracts? We will leave this to part 2.
My four cents...
?Links to previous PM Series of articles are shown below: