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Financial Management and Accounting for the Construction Industry

Reproduced with permission. Originally appeared in Financial Management and Accounting for the Construction Industry. © 2015 LexisNexis Matthew Bender.

 

Introduction to Construction Finance | Contract Types | Contract Acquisition | Contracting Methods

 

Introduction to Construction Finance

Construction is one of America’s largest industries and plays a major role in the American economy. However, unlike many other large industries, the construction industry is highly fragmented, with several hundred thousand contractors in the United States ranging in size from one-person operations to multi-billion dollar international corporations. The level of management sophistication also varies significantly. Business methods are influenced by these facts and other variables, such as regional practices, market conditions, competition, and labor considerations.

Industry Participants

The construction industry participants include architects and engineers who design the structure; trade contractors (often referred to as specialty or subcontractors) who construct the structure according to the design; suppliers who supply the materials, component parts, and equipment; and general contractors, construction managers, or heavy construction contractors who perform portions of the work and coordinate the work performed by the specialty contractors.

The structures produced by this team include residential and commercial buildings, roads, bridges, tunnels, and every other type of facility that is affixed to land. The trade contractors, general contractors, construction managers, and heavy construction contractors are often collectively referred to as “construction contractors,” and this group is commonly thought of as the construction industry. Architects and engineers provide professional services, and suppliers are either manufacturers or distributors of manufactured products. There is no question, however, that all of these business entities and others play an important role in the construction process. 

Owner

The owner holds legal title to the structure that is to be constructed. An owner may be an individual, a corporation, a partnership, or a governmental entity.

The owner’s role in the construction process begins with the conception of the project. The owner then contracts with other industry participants who carry out the design and construction. How and with whom these contracts will be initiated and the contract terms depend on the owner’s experience with the construction process, the owner’s specific requirements for the project (i.e., time, budgetary, or legal constraints), and personal preferences. Often the owner will engage financial consultants, facility planners, architects, engineers, construction managers, or other consultants to assist in this decision-making process. Once these decisions are made and contracts are entered into, the owner’s continuing responsibility is to monitor the progress of the project and fulfill contractual duties, such as providing access to the site and paying the contractor in accordance with the contract terms.

Architect and Engineer

The architect, engineer, or both contract with the owner to design the structure and to provide related services as required by the owner. In building construction, the design is typically done by an architect; however, in other types of construction, an engineer usually has design responsibility. In either event, the design professional usually engages other specialists to assist in specific areas of the design process. These individuals include electrical, structural, mechanical, soils, and other engineering specialists and various other consultants. 

The services performed by the design professional differ from project to project. In the case of building construction, for example, typical services include the following:

(1) Construction documents. These documents are necessary to negotiate or solicit contractor bids and implement the construction process. Construction documents comprise the complete detail drawings, written detail specifications, and the contract provisions including the general conditions.

(2) Bidding or negotiating. The design professional may assist the owner in obtaining bids for or negotiating the construction contract.

(3) Construction phase. In some cases, the design professional may represent the owner during the construction phase. Typically, the design professional’s responsibility is to ensure that work advances according to the plans and specifications and the related terms of the contract. Other responsibilities may include reviews of the construction process, approval of change order requests, and approval of progress payment applications.

The scope of the design professionals’ services can be increased or decreased to suit the owner’s needs. Depending on the type of work and the agreed-on scope of required services, the design professional’s fee is usually determined in one of the following ways:

(1) Percentage of construction cost based on estimated or actual cost;

(2) Fixed fee, including or excluding expenses;

(3) Multiple of direct personnel expense (i.e., professional staff expense payroll multiplied by an agreed-on factor to cover overhead and profit); or 

(4) Hourly rates for each professional or class of professionals. 

General Contractor

The general contractor contracts with the owner to construct the structure in accordance with the plans and specifications developed by the design professional. The terms of this contract may call for a fixed price, a cost-plus-fee arrangement, or some derivation of these methods as discussed more fully in § 1.04. The owner selects the general contractor based on competitive bids, negotiations, or both. 

Some general contractors perform certain portions of the work (trades) with their own labor force and subcontract the remaining trades to specialty contractors. Others subcontract all trades. 

Whether or not the general contractor performs any trades, it is the general contractor’s responsibility to manage the entire construction process.

Construction Manager

The construction manager (CM) functions as a business consultant or partner to the owner, acting on behalf of the owner as an agent providing consulting resources throughout the entire construction process. As the owner’s agent, the CM may engage trade contractors or, alternatively, may engage a general contractor who will subcontract with the trade contractors.

The general contractor usually performs the construction for an agreed-on price or pricing formula, which includes the construction costs and the contractor’s profit. The CM, on the other hand, receives a fee for services provided and reimbursement for specified costs. The owner pays the general contractor or the trade contractors.

The general contractor generally begins work after the design phase is complete, while the CM is typically involved in the design phase. The CM’s role in the design phase is to work with the owner and the design professionals to give them the added advantage of the CM’s practical construction experience.

Construction managers may be used in any situation, but frequently are used if a construction project must be completed in a compressed time frame and the “phased” construction process is necessary. In a phased construction project (frequently referred to as “fast track” construction), portions of actual construction are started before the design phase is complete. For example, as soon as the building site is selected, the site work can be started and, as soon as structural design is complete, the excavation, foundation, and structural steel work can start.

The preceding paragraphs provide a general description of the theoretical role of the construction manager. In practice, however, a CM’s responsibilities vary and may include the following:

(1) The CM contracts with the general contractor or subcontractors rather than the owner.

(2) The CM guarantees a lump sum or maximum price for the construction project.

(3) The CM is not involved in the design phase.

Heavy Construction Contractor

Heavy construction contractors build highways, bridges, tunnels, and other infrastructure type works. Given the type of work, they are frequently engaged by federal, state, and local public sector owners. They perform these types of projects as a prime contractor in a manner similar to a general contractor except that they typically perform all or a significant portion of the work with their own work force. They also work as a subcontractor for private sector owners and CM firms where their specialty is needed—for example, excavating and placing deep foundations for high-rise buildings.

Subcontractor

The subcontractor is often referred to as a trade or specialty contractor, because the subcontractor typically performs a particular segment (trade) of the total construction project. The subcontractor, as the name suggests, enters into a contract (subcontract) with the primary contractor, which is typically a general contractor or a heavy construction contractor. If a construction manager is used, the owner generally contracts with the subcontractor.

Subcontractors specialize in one or more of a wide variety of trades, which include the following: 

Acoustical
Architectural
 woodwork
Cabinets
Carpentry
Caulking
Ceiling
Concrete
Curtain wall
Demolition
Drywall
Electrical

Excavating
Fence
Fire protection
Flooring
Glass
HVAC
Insulation
Landscape
Marble
Masonry
Mechanical
Painting
Paving

Plumbing
Reinforcing steel
Rigging
Roofing
Sheet metal
Sprinkler systems
Structural steel
Tile and terrazzo
Voice and data
 communication
Waterproofing
Welding
Windows


This list is by no means complete, and there is considerable overlap in some of the trades.

The terms of the subcontract can vary as is the case with general contracts, but the fixed-price type is most prevalent. The subcontract will typically follow the terms and conditions of the contract between the general contractor and the project owner. 

The subcontractor typically purchases the necessary materials and equipment and performs the work with the subcontractor’s own labor force consisting of skilled tradesmen and supervisory personnel. It is not unusual, however, for the subcontractor to engage a second-tier subcontractor to perform a certain portion of the required work.

Supplier

The term “supplier” refers to all the business entities supplying the components, parts, and materials used in the construction project and the machinery, equipment, and tools used by the contractors. Suppliers can be manufacturers, distributors, leasing companies, or others.

The contractor generally uses a purchase order to document its agreement with a supplier. In some cases, a supplier may agree to supply all of the goods for a set price, which may be subject to adjustments based on the time of delivery. In other cases, the supplier will agree to deliver only at the price in effect at the time of delivery.

Contract Types

General contractors and subcontractors perform their work under several different types of contracts. The type of general contract used in a given situation is generally based on the owner’s preference; likewise, the type of subcontract used is generally based on the general contractor’s preference.

The discussion of the various contract types that follows is applicable to the general contractor/owner relationship and the general contractor/subcontractor relationship. When reference is made to contractor and owner, it is meant to apply to both relationships.

Fixed-Price

A fixed-price contract is sometimes referred to as a lump-sum or stipulated-sum contract. This type of contract obligates the contractor to perform the work required by the contract for a fixed dollar amount. This type of contract permits the owner to fix the exact cost of construction in advance and, therefore, helps to minimize the owner’s construction cost risk. On the other hand, the contractor must commit to the price of the work in advance and, thus, is subject to performance and productivity cost risk. 

The price is established through the process of estimating the cost of each work segment required by the contract. The contractor, therefore, must be able to accurately estimate the quantities of material required, the labor, the equipment necessary to install the materials, and the time the job will take. Since the price will be based on the estimate, the contractor’s estimating skills are crucial. Other factors that increase the contractor’s risk include weather conditions, site conditions, labor problems, and the potential for escalation in the cost of material, equipment, supplies, and labor. 

The contract generally provides the contractor with some protection against certain risks. For example, a contract may provide relief for certain types of unanticipated soil or other site conditions or for delays caused by worse than anticipated weather conditions. As contract provisions differ, so do the corresponding risks assumed by the contractor.

To enable the contractor to estimate the work accurately, the owner must provide all of the contract documents including the detailed plans and specifications. The contractor relies on these documents, and the owner bears responsibility for the documents’ accuracy. The risk that they are inaccurate or incomplete lies with the owner, although the owner may have recourse against the design professional in certain cases.

Another potentially more significant risk that the owner bears is that the contractor will not complete the project, and the remaining amount unpaid under the contract is not sufficient to compensate a new contractor. The owner can obtain protection against this risk by requiring payment and performance bonds.

Payment under fixed-price contracts is based on progress as determined by design and/or engineering estimates of percentage of completion, generally on a monthly basis. The owner normally withholds a percentage (retention) from the amount calculated. This withholding is intended to provide an incentive to the contractor to complete the project and to protect the owner if the contractor defaults. Before the project is started, the contractor and the owner agree to a schedule of payment amounts for each segment of the project, the sum of which equals the total contract amount. This schedule (frequently referred to as a payment breakdown or schedule of values) becomes the basis for progress payments. At each billing date, the contractor and owner estimate and agree upon the percentage of each work segment that has been completed and payment is made on that basis.

The contractor and owner have different objectives in the payment process. First, in establishing the payment breakdown, the contractor generally strives to have the maximum realistic amount of the total contract allocated to the trades that are scheduled for completion in the early stages of the project. This process is referred to as front-end loading. The contractor’s objective is to have billing ahead of expenditures to eliminate the negative cash flow, which would otherwise be created by the billing cycle and the retention withholding. In theory, front-end loading should not add to the owner’s cost, because if the contractor was not able to keep cash flow even through this method, the contract price would have to include an amount to compensate the contractor for the cost of financing the work. Nonetheless, the payment breakdown is often established after the contract is awarded and, therefore, the owner has an economic incentive to prevent front-end loading or, at least, to keep it to a minimum. Second, the same cash flow considerations come into play in establishing the periodic percentages of completion. The contractor has an incentive to present the highest realistic percentage of completion, and the owner has the opposite incentive. 

The contractor’s understanding of construction progress and the costs incurred enable the contractor to deal with the questions of physical completion. The owner, who may not be technically capable of challenging the contractor, generally engages the design professional or another professional to represent the owner in negotiating the payment breakdown and the periodic percentage of completion estimates.

The amounts withheld from each billing (retention) are generally paid to the contractor at contract completion. Many contracts, however, provide for reductions of retention at one or more predetermined project milestones. For example, a contract might provide for a 10-percent retention until the project is 50 percent completed, whereupon it is reduced to 5 percent until the project is completed. In some cases, the contractor is permitted to substitute interest-bearing securities, such as municipal bonds, for cash retention.

Cost-Plus-Fee

Under a cost-plus-fee contract, the owner agrees to reimburse the contractor for the costs incurred and pay the contractor an established fee. The fee can be a set amount (fixed fee), or it can be a variable amount based on the total cost of the project, other factors, or both. In practice, the variable fee method is used less frequently because of the significant risk to the owner. The fixed fee is generally based on the cost estimate, project duration, or both. Most fixed-fee contracts provide for a fee adjustment if the projects completion date is extended or if the scope is expanded for reasons beyond the contractor’s control. 

In a cost-plus-fee contract, the owner bears substantial risk, and the contractor bears very little. In a fixed-price contract, the risk bearing is reversed. This raises the question of why an owner would enter into a cost-plus-fee contract. At one time, cost-plus-fee contracts were frequently used in fast-track construction because, without a complete design, a fixed-price cannot be determined. Since construction management has come into use, the lack of a complete design is seldom the justification for the use of cost-plus-fee contracts. Cost-plus-fee contracts are used if accurate estimates are impossible because of unstable or unpredictable project site conditions or other factors. For example, cost-plus-fee is common in renovation work if the structure is old and “as built” drawings do not exist. In these cases, the contractor would be reluctant to quote a fixed price and, if so, the price would include substantial contingency amounts. 

A cost-plus-fee contract requires a high degree of trust on the owner’s part, because the contractor’s efficiency, skill, and honesty can have a significant impact on the project’s total cost. This type of contract also requires the owner to work a lot harder to protect the owner’s interests. In cost-plus-fee contracts, the contractor is reimbursed for costs incurred based on the contractor’s submission of a billing together with the supporting documents required by the contract, which, in almost every case, the owner has the right to audit. The fee is paid based on a contractually established schedule that is generally based on time, progress toward completion, or costs incurred.

Cost-Plus-Fee with a Guaranteed Maximum

A cost-plus-fee with a guaranteed maximum contract is the same as a cost-plus-fee contract except that the contractor guarantees completion at a total cost less than or equal to an established amount. Frequently, this type of contract also provides that if the project is completed at less than the maximum price, the contractor and owner share the savings on a predetermined basis. This arrangement is intended to provide an incentive to the contractor to save costs. In terms of risk, a cost-plus-fee with a guaranteed maximum contract falls between a fixed-price and cost-plus-fee contract. 

To obtain this type of contract, an owner has to furnish the contractor with the same detailed contract documents as would be necessary for a fixed-price contract. Given the need for these documents in either case, the owner generally chooses a guaranteed-maximum format in those instances in which the owner believes that the obtainable guaranteed maximum price is the same as, or close to, the obtainable fixed-price price. Thus, the owner has the advantage of predictable cost plus the potential for savings. For this reason, some owners often view the guaranteed-maximum contract as the better of these two choices. Others do not use guaranteed-maximum contracts for fear that the obtainable maximum price would be significantly higher than the obtainable fixed-price price, and the savings, if any, would not make up the difference. 

In fast-track construction, the owner and the contractor may agree to start the project on a cost-plus-fee basis with the understanding that a guaranteed maximum price will be established when contract documents are complete or substantially complete.

Unit-Price

Under unit-price contracts, the owner pays the contractor a set amount for each unit of work. This contract type is common in highway and utility construction. For the most part, unit-price contracts are used if the number of units (quantity) cannot be accurately determined at the start of the project. Although the exact number of units is not determinable, the contract generally provides an estimate of the units. This enables the owner to compare competitive bids by multiplying the contractor’s unit price times the estimated units. Unit-price contracts typically contain a provision to adjust the unit price if the number of units varies from the estimate by more than a designated amount. The economy of scale requires this price adjustment, because the cost of material purchases and labor efficiency can vary as quantity changes. 

A unit-price contract is similar to a fixed-price contract, because the unit price is fixed, and the contractor bears the risk of properly pricing the units. However, the contractor bears the risk of improperly estimating the quantities required in a fixed-price contract, but not in a unit-price contract. The owner is afforded unit-price protection, but cannot determine the total cost, because the number of units is unknown. Thus, there are also similarities to the cost-plus-fee contract. 

In the unit-price contract, the contractor bills the owner based on the number of units put in place. The owner’s protection is afforded through owner or his agent’s physical inspection of the work. In many cases, the owner advances a stipulated sum to the contractor at the start of the project. This advance is intended to cover the cost of the contractor’s initial preparation (mobilization) for the project. A contractor may improve cash flow by front-end loading, which is bidding higher unit costs for those items that are completed early in the construction process and lower prices for items to be completed later. Unit-price contractors may also attempt to gain an advantage through an “unbalanced bid.” For example, if a contractor believes that the owner’s quantity estimate for a particular item is less than the amount that will actually be required, the contractor may bid a higher unit cost for that item. The total estimate for all items is maintained by lowering the unit cost for another item or items for which the contractor believes that quantity estimates are accurate or higher than the amounts that will actually be required. 

Contract Acquisition

A contractor acquires a contract through the competitive bid process or through negotiations with the owner. The owner makes this choice based on preference, any legal restrictions, and the advice of the owner’s design professional or other consultants. The methods of contract acquisition apply to general contractors, subcontractors, and construction managers. 

Before delving into the specifics of negotiated and competitive bid contracts, it is imperative to understand the chief differences: A negotiated contract offers the owner the greatest flexibility in terms of decision-making based on contractor qualifications, whereas a competitive bid contract is primarily concerned with meeting specifications. In addition, negotiated contracts offer a business partnership that is aimed at achieving the owner’s objectives, while competitive bids offer an owner-to-builder relationship that is predicated on the contract terms and building to specification.

Negotiated Contracts

Negotiated contracts are established through discussions between the owner or owner’s representative and the contractor. Contracts are frequently negotiated if the design details are not available and a cost-plus-fee contract is used. Fixed-price, unit-price, and guaranteed-maximum price contracts can also be negotiated; however, negotiation for these contracts is not as common. The decision to negotiate is sometimes based on an owner’s perception that a negotiated contract results in a higher quality of work. In part, this perception stems from the owner’s ability to make a selection based solely on the experience and qualifications of the contractor and, in some cases, specific individuals within the contractor’s organization. In addition, in a negotiated contract, some perceive that the contractor is less likely to cut corners because the contractor is not faced with competitive bidding pressure. This perception is obviously strongest if a cost-plus-fee contract is used and weakest, although not completely without merit, if a fixed-price contract is used.

Competitive Bid Contracts

The competitive bid process is the most frequently used method of contracting. A competitive bid contract is an owner-to-builder relationship that is predicated on the contract terms and building to specification. In the private sector, owners tend to select this method when price is the key concern. With few exceptions, the law requires competitive bidding for public work. 

Competitive bidding requires that the owner solicit bids from more than one contractor. Owners solicit bids by providing the contractors with the contract documents and requiring that bids be submitted in a specific format, within a specific timeframe or on a specific day. In most cases, the contract is awarded to the lowest “responsible” bidder. In public sector work, generally the lowest bid must be accepted. For non-public sector work, however, the owner may choose to award the contract to other than the lowest bidder based on other factors, such as the contractor’s experience and the owner’s previous dealings with the contractor. The method of award should be established at the time bids are solicited. The estimating process is costly to the contractor and necessitates the need to have a full understanding of the award process in advance. Some owners feel that contract award based on factors other than the low bid may result in fewer bidders, less price competition, or both. 

Contractor bids are solicited in an “open” or “closed” bidding process.

Open Bid

In the open bid process, the owner invites, usually by advertisement, all qualified contractors to participate. Each owner sets specific qualifications. Qualifications may be as simple as having a license or having the ability to furnish bid and performance bonds, or it may involve meeting financial or experience requirements. In the case of public work, for example, many states and local jurisdictions have established pre-qualification agencies, which apply varied criteria in qualifying contractors to bid either specific projects or within certain capacity limitations relating to the size of individual projects and/or the amount of work on hand. 

The open bid process is typical for public sector work and, with few exceptions, the contract is awarded to the lowest bidder. Private-sector owners rarely use the open bid because control over the selection decision is greatly reduced, and there is little, if any, corresponding benefit.

Closed Bid

In the closed bid process, which is also referred to as “select bidders” or “short-list,” only those contractors selected by the owner are permitted to bid. Owners most frequently develop their short list based either on their experience or on recommendations from their design firm or others. In some cases, owners will request statements of qualifications as part of this process. 

Regulations generally preclude public-sector owners (i.e., federal, state, or local government agency) from using the closed bid to avoid potential issues relating to contractor selection. On the other hand, the closed bid is almost always the private-sector owner’s choice. The private-sector owner has the right to exercise preference and is not required to justify the selection. 

Contracting Methods

Once an owner has decided to undertake a construction project, it must be determined as to what contracting method will best serve the owner’s needs. Contracting methods refer to the manner in which the team of industry participants is assembled. In public work, regulations or law often mandate the contracting method or severely limit the choices available. However, in private work there are no limitations, and the choices are numerous. The following pages give an overview of basic contracting methods. Alternative methods are, for the most part, derivations of these basic methods. 

Traditional

In the traditional method of contracting, the owner engages a design professional to prepare the plans, specifications, and other contract documents. These documents are used to solicit bids from, or to negotiate the contract with, a general contractor who will be responsible for constructing the project in accordance with the contract documents. Typically, the owner also engages the design professional to observe the construction process and monitor the performance of the contractor. The general contractor engages subcontractors to perform specific portions of the work. The general contractor and the subcontractors purchase materials, equipment, and the like from suppliers, as the following illustrates.

From the owner’s perspective, the advantages and disadvantages of the traditional method of contracting include the following.

Advantages

(1) The design professional and the contractor are each selected separately. Thus, the owner may make each choice based on individual merit. 

(2) Because complete design documents are available before the construction contract is executed, the owner can use a fixed-price, unit-price, or guaranteed-maximum-price contract. Thus, the owner can take advantage of price competition and determine the total cost of construction in advance. 

(3) The design professional and the general contractor are independent and, therefore, each provides some control over the other.

Disadvantages

(1) A disadvantage to the independence between the design professional and general contractor is that separate contract terms, and priority differences that are inherent between a designer and builder, can create a communication gap. In the traditional role, the owner must manage this gap properly as the owner has full responsibility over both, separate parties.

(2) Construction costs cannot be quantified until the design phase is completed and the construction contract is obtained.

(3) Except for fast-track cost-plus-fee contracts, construction activity cannot start until complete design documents are available. Thus, the duration of the total project could be longer than it might be if other methods of construction were used.

Construction Management

The concept of construction management was developed as a response to the needs of owners. In the traditional method of contracting, the owner contracts with a design professional to observe the construction process. Some owners believe that the design professional’s role in the construction phase does not provide adequate protection, because the design professional generally does not have sufficient expertise in construction. Construction management can provide an alternative or a supplement to this role of the design professional by having a construction contractor, who is not performing the work, observe the construction process. At the same time, the construction manager can also administer the work, thus eliminating the need for a general contractor. Except for contractual differences, this arrangement is similar to a cost-plus-fee contract in which the general contractor subcontracts everything. In addition to the management role during construction, the construction manager participates in the design phase. The construction manager’s role in the design phase includes assessing design feasibility, developing interim cost estimates, and recommending design alternatives.

The term “construction management” is used to describe a variety of different contracting methods, but in its pure form, the owner engages a construction manager as the owner’s representative or agent. The construction manager works with the design professional throughout the project and assists the owner in selecting the construction team. The team may include a general contractor who, in turn, contracts with some or all of the trade contractors or the construction manager who may manage the trade contractors. In either case, the construction manager performs as the owner’s agent and the owner is party to the contracts, as the following illustrates.

The construction manager’s authority to manage the contractors comes from the construction manager’s position as the owner’s agent. Thus, the trade contractors, by their contract, must accept direction from the construction manager as if the construction manager were the owner.

From the owner’s perspective, the advantages and disadvantages of the construction management method of contracting include the following.

Advantages

(1) The construction manager’s construction experience is beneficial to the design process. 

(2) In fast-track construction, construction management can mitigate risk. 

(3) The construction manager does not guarantee a fixed price or maximum price. Therefore, the construction manager has no incentive to cut corners, which could have a positive effect on the quality of construction.

Disadvantages

(1) The advantage that a construction manager does not have an incentive to cut corners can also be a disadvantage. The construction manager is not as likely to be as cost conscious as a general contractor with a lump-sum contract.

(2) The owner does not have the benefit of total cost protection in advance of construction. In other words, the construction manager does not take financial responsibility for the total cost of the project as a general contractor does in a fixed-price, unit-price, or guaranteed-maximum contract.

Design-Build and Turnkey

Under the design-build method of contracting, the owner enters into one contract for the design and construction of the project. Theoretically, various types of contracts, such as fixed-price, cost-plus, etc., can be used for design-build projects. In entering into a fixed-price design-build contract, the owner is committing to a purchase price for a project that has not been completely designed but which generally includes sufficient design and specification documents upon which contractors can make a responsive bid.

However, the design-build method is also used for unique and complex projects. In these instances, the potential design/contractors are required to submit proposals that include extensive preliminary design data as well as cost estimates or fixed prices. The preparation of these proposals requires a significant effort and investment by the proposing firms. The owner’s task of evaluating the proposals is also difficult.

In recent years, design-build has become much more common. In fact, various federal and state agencies are now using design-build because they believe they can complete their projects in a more timely, cost efficient, and less litigious manner. Many industry observers predict that this trend will continue and some even believe that design-build will grow to become the most prevalent method for certain types of construction. 

The turnkey method is the same as the fixed-price design-build method except that the turnkey contractor also provides some portion, or all of the construction period financing. 

From the owner’s perspective, the advantages and disadvantages of the design-build method of contracting include the following. 

Advantages

(1) The owner enters into only one contract and deals with only one party. 

(2) Fast-track construction is facilitated and projects are completed earlier partly because communication between designer and contractor is internal and common disputes between designer and contractor in other construction methods are eliminated. 

(3) Cost savings can be achieved in some cases, particularly if the work duplicates prior projects. 

(4) The proposal process provides the owner with design alternatives.

Disadvantages

(1) In other methods, the design professional is independent of the contractor, and this independence provides some control over the process. Since these controls are absent in design-build, product quality is more difficult to control. 

(2) It is difficult to compare competitive proposals because the designs vary. The lowest price may not be the best deal, and the highest price may not represent the best product.

Job Order Contracting

Under this approach one contract is issued for an anticipated series of facility management jobs. The job order contract is based on unit prices that are set forth in a unit-price book that is furnished by the owner and a competitively bid multiplier. The terms of the contract set forth the type of work, location of the work, design criteria, and the approximate amount of work that the contractor can expect during each year of the contract. Generally, the contract is for a one-year period with options for two to four additional years. The contract value is typically expressed as a range from a nominal minimum amount to a maximum amount and the owner is only obligated to award the minimum amount during the contract. 

The unit prices included in the unit-price book cover the cost of numerous construction tasks and activities that the owner reasonably expects may be required during the contract period. The total cost to the owner includes the cost per the unit-price book plus a multiplier, which covers the contractor’s overhead and profit. If, during the term of the contract, the owner requests work to be performed that was not included in the unit-price book, the cost of such work would be negotiated and added to the contract. 

The contractor will establish and staff a site management office after having been awarded the contract. Periodically during the contract period, the owner will request the contractor to provide estimates of the cost to perform various construction tasks. Job orders are issued to the contractor after both parties have agreed to the cost of the work. 

From the owner’s perspective, the advantages and disadvantages of the job order method of contracting include the following.

Advantages

(1) The construction work is completed in less time than under the traditional contracting method because the owner does not have to go through the normal bidding process for each job. 

(2) There are fewer contract documents because all of the job orders are negotiated and awarded pursuant to the terms and conditions included in the job order contract. 

(3) The owner should recognize cost savings because of the simplification of the contracting process and the construction management process. 

(4) Job order contracts result in higher quality construction. If the contractor does not maintain a high level of quality, the owner can elect to give future projects to another job order contractor, or award the contract using the traditional contracting method.

Disadvantages

(1) The cost of an individual project may be greater than if it was bid as separate project, especially during a period of declining prices. 

(2) The owner enters into a contract with one contractor for a minimum of one year. This contractor may not have the technical abilities to readily complete one of the projects the owner would like performed under the terms of the job order contract.