What is a Lump sum contract or Fixed price contract
Lump sum contracts are the most favourite contract (procurement) type used in the construction industry. Also known as fixed-price contracts. Because in these contracts, the contract price is fixed and agreed at the initial stage. In industry, this contract type is recognizing as one of the safest contract types for clients. But the Contractor’s responsibility and risk are very high in fixed-price contracts.
Let me explain the main advantage and disadvantages of lump sum contracts (fixed-price contracts).
lump sum contract advantages and disadvantages
What are the advantages of a lump sum contracts?
- Client’s risk is minimal.
- Fewer variations
- The Client can arrange capital according to the payment plan.
- Contractors cash flow is predictable.
- The tendering process is more transparent and impartial.
What are the Disadvantages of lump sum contracts?
- Contractors risk is high (ill productivity and mismanagement can lead the project into a loss)
- Improper details and specs in the design can lead to project disputes.
- Delays in the Client’s financing can delay the project as well.
- The design should be complete and available before the pre-contract process.
- Procurement time can be high.
For more insight, See our explainer video also for more insight.
More insight on lump sum contracts /fixed-price contracts
What are the Contractor’s tasks and responsibilities of lump-sum/fixed-price contracts
In fixed-price contracts, the Contractor is evaluating the value of work as per the documents available. Mainly price will determine based on specifications and the drawings.
Moreover, the Contractor should request any missing information or documents before submitting the price. If not, the Client expects the contactor to allow a budget for all this missing information. After evaluating and reviewing these documents, the Contractor is agreeing to complete the works without exceeding the agreed fixed price. Under a lump-sum agreement, it is the responsibility of a contractor to implement the appropriate work. He should also offer suitable resources and techniques to accomplish the task.
Below are the features of lump sum contracts
The primary condition of this contract type is that, agreed budget should not alter (without any changes to the design or specs). Also, the quality and the standard of the project should keep according to the documents provided at the tender stage( quality cannot deviate without prior approval of the Client). These are all the critical characteristics of the fixed-price contracts. But the Contractor is providing the rates and quantity breakdown for the fixed price.
Design changes and specification changes
Client and client’s representatives will intensively check design and specification at the construction stage. In lump-sum contracts, the contractor can’t change specs or design without proper approvals. But the contractor can propose design change as a value engineering option. Based on contractual terms, contractors may charge eligible percentage fees from saving offered from value engineering option.
The payment process of fixed price contracts/ Lump sum contracts
Contractor and client agree on a project program before commencing the works. Project milestones will decide based on the project program. Concerning this program, A payment schedule will agree between both parties. Upon successful completion of each milestone, the client will release the agreed amount based on the payment schedule.
In some exceptional cases, The Client may agree to pay additional compensation for the early completion of the project.
Fixed price contracts/ Lump sum contracts -Additional tips
Apart from the fixed price, The Client may also be agreed to pay fluctuation of the material costs separately. But the losses due to low productivity and losses due to material delays should be bare by the contractor.
But lump sum contracts can also create large disagreement and entitlements from contract documents. The following are general factors that can arise:
When the holder creates or notes an order variation bidding from the contractor, the price citation can become unclear. The holder may also submit the plea that the required variation was initially controlled under contract requirements. To formulate particular contract clauses mentioning the method to control the order variation are necessary.
Additional benefits of fixed price contracts
Lump-sum contracts may consist of early achievements return for the contractor. These early achievements can create the highest revenue for the project holder.