Lecture 6-Delivery Systems Payment&Award

7/28/2019 Lecture 6-Delivery Systems Payment&Award

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Project Management Course

Alberto De Marco 1

Project Management

Delivery systems

Payment &Award

Instructor:

Alberto De Marco

IV School of Management EngineeringDept. of Production Systems and Business Economics

Preliminaries

Long- term project calendar and groups


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Alberto De Marco 2

Interview

John Stewart, former McKinsey & Co. director

Project organization

When does a usual business needs a projectmanagement organization?

What are the cost and benefits of project

management organization

RISK/KNOW

HOW

100% CONTRACTOR

100% OWNER

TRADITIONAL DBB

DESIGN/BUILD

TURN-KEY

B.O.T.

CM at RISK

Delivery systems - Summary

AGENCY CM


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Alberto De Marco 3

Project Organization Outline

9 Project Management Organizations

9 Contract Organization9 Project Delivery Systems

Payment Schemes Time&Material

Unit prices

Cost plus kinds

Guaranteed Maximum Price

Lump-sum

Award Methods Bidding

Negotiation

Key Idea for Saving: Risk Sharing

Different parties have ability to manage ortolerate different types of risk Owner (or big contractor) often better: Geotechnical

risk, weather risk

Contractor better: Risk of slow teams, equipmentquality, procurement, quality of supervision

Divide risks within an agreement to Save money on contract price

Provide incentive to contractors to finish early, inbudget, good quality


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Fundamental Ideas Contractors are often highly risk averse

Recall risk premiums: Contractor willing to pay owner(charge less for contract) if owner takes on risk if have to

For risks that contractor cantcontrol, may be willing topay a risk premium to owner to take over

Contractor here will lower costs if owner assumes certain risk(essentially, paying the owner a risk premium)

For risks that contractors cancontrol, cheaper for a

contractor to managerisk than to pay a risk premium

Fundamental Ideas II

Structure contract so that

Risks contractor can better handle are imposed on

contractor (i.e. contractor will lose $ if dont control)

To be competitive, will have to managethese Risks owner can better handle are kept by owner

Risk can be better handled by A vs. B heremeans that the risk premium that would becharged by the A for taking on this risk issmaller than would be charged by B


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Alberto De Marco 5

Risk allocation

RIS

K/KNOWH

OW

100% CONTRACTOR

100% OWNER

TRADITIONAL DBB

DESIGN/BUILD

TURN-KEY

B.O.T.

CM at RISK

AGENCY CM

??? payment

Fundamental Balance

Impose highenough risk incentive to get contractor do

job efficiently within the specifications of the contract

E.g. Incentive to finish on time, incentive to stay withinbudget

E.g. better team assignment, equipment provision, mgmt

Impose lowenough risk to have reasonably low bid

Impose according to contractor ability to tolerate


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Alberto De Marco 6

Derivative Results of Risks:

Accountability/Monitoring

Consider parties A and B in an agreement

The greater the risk on party A

The more incentive on party A to manage this risk

The less incentive on party B to manage this risk

More incentive on A to monitor the relevant factorsso B cant claim the risk is responsible for a problem

More incentive on B to make sure that As means of

riskmanagementfall within the agreement

E.g. that not cutting corners or otherwise cheating toshield from risk

Derivative Results of Risks:

Impact on Construction Timing More risk on contractor, the longer will delay construct.

Given uncertainty, contractor will charge more up front

Owner doesnt want to pay a huge amount up front

As uncertainty is lessened in design, prices converge

Owner can expedite by paying higher price (risk

premium) to contractor or by shouldering risk

Remember; delay can have major costs but so canwrangling over change orders!


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Alberto De Marco 7

Note on Change Orders

Changes contract (cost/schedule/scope/etc.)

Can lead to costs beyond contract specification

Anticipated costs incorporated in contingency

Often 1-5% on top of agreed upon price

Often only paid for additional direct costs

Big problem if disruption in work Source of very large risk

ontractua s

Allocation

100 %RISK Allocation

Lump-Sum (Fixed Price)

0 %

100 %

CONTRACTORSR

ISK

0 %

OWNERSRISK

RISK SHARING METERModified from Kerzner, 2000

Fixed-Price w/ Economic Price Adjustments

Fixed-Price Incentive

Cost-Plus Incentive

Cost-Plus Award Fee

Cost-Plus Fixed Fee

Cost-Sharing

Cost-Plus Percentage


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Alberto De Marco 8

Project Organization Outline9 Project Management Organizations


Payment Schemes Time & Material

Unit prices

Cost plus


Lump-sum


Negotiation

Time&Material Contract price = Value of work + material*(1+%fee)

Price of working hour according to unionized prices oragreed upon on contract

%fee represents contractor overhead

Work Specialized worker 75 $/h ; 50 hours Worker 50 $/h ; 100 hs

Material Equipment rental 5,000 $ Construction commodities3,000 $ 30% overhead

Contract value: 75 * 50 + 50 * 100 + (5,000 + 3,000) * 1.3 = 19,150


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Alberto De Marco 9

Time&Material

Risk on owner

Actual contract value defined at the end

Small works (repair & maintenance)




Payment Schemes9 Time & Material

Unit prices

Cost plus


Lump-sum


Negotiation


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Alberto De Marco 10

Unit Price Contract Agreement on the price chargedper unitbetween thecontractor and the owner If project is complex, it needs a detailed list of activities (bill of

quantities) If project is linear/homogeneous, it can be described by one

unit price which includes the amount of work packages e.g.: unit price per foot of completed tunnel, unit price per ft3 of

poured concrete

Interesting example of risk sharing Owner: risk for uncertainty in quantity

Contractor: risk for unit price (efficiency, procurement) Contractor overhead must be integrated in the unit price Necessity of an owner presence on site to measure the

actual quantities (quantity surveyor) Typically renegotiate if quantity 20% off

Quantity influences price b/c economies of scale

Unit prices

Activities:

Footings 80 $/sq ft

Columns 1,550 $/unit

Scheduled quantities: Footings 100 sq ft

Columns 9 units

Contract initial value:

80 * 100 + 1,550 * 9 = 14,750


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Alberto De Marco 11

Unit Price Contract Highly dependent on the accuracy of the

estimation of the quantities given by theOwner/Designer Risk of unbalanced bidding

If contractor believes actual quantity will differ, caseincrease and/or decrease the unit price

Contractor can make profit because payment is based onactual quantities but he can also lose money in the same

wayA contractor can be excluded if its bid is very

unbalanced

The total cost for the owner can be greater thanplanned

Example: Pile Driving

Too risky to just charge fixed price

Geotechnical uncertainties make length of piles

uncertain

Piles can be highly expensive

Risk allocation

Price risk more under contractor control (efficiency,crew and equipment selection): to contractor

Length out of contractor control: to owner

Owner must precisely monitor length used


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Alberto De Marco 12




9 Unit prices

Cost plus


Lump-sum


Negotiation

Cost Plus Kinds

Cost plus fixed %

Incentive cost plus types:

Cost plus fixed fee

Target cost plus incentive fee

Guaranteed maximum price


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Alberto De Marco 13

Cost Plus Fixed %

Owner is paying the actual cost plus a fixedpercentage

Contractor agrees to do his best efforts toachieve the work

Contractor shoulders very little risk Typically select contractors based on reputation

and comfort (servicerather than commodity)

Cost Vs. Price for Cost + Fixed %

Macomber, 1989


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Cost Plus Fixed % - Example Estimated cost 100,000 $

Fixed % fee 8 % Contractors Return on Cost ROC = 8%

Actual contract value at completion Situation A

Actual cost 90,000 $

Price = 90,000 *(1+8%) = 97.200 $ Situation B


Price = 110,000 *(1+8%) = 118,800

ROC = 8.0 %

ROC = 8.0 %

Cost Plus + Fixed %: Disadvantages

Contractors have incentive to grow scope, price! Owner shoulders all risk

Little incentive to reduce costs and overtime salaries

can even increase costs Cost unknown until contract completes

Owner needs to oversee construction closely Speed up slow crews

Identify management problems

Terrible with turnkey delivery type!


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Alberto De Marco 15

Cost Plus + Fixed %: Advantages Maximum flexibility to the Owner

No fighting over change orders contractor getspaid for any extra work required

Permits collaboration at early project stages Minimal negotiation time

Minimal fear of commitment by contractor

Only have to pay for what actually costs

If manage closely, can save moneyvs. fixed-price

Applicability

Requires sophisticated owner to manage

Use if the pricing could not be performed in anyother way and if it is urgent

Emergencies (civil, military) Examples

Either scope or construction method unknown e.g. historic building renovation with unknown cond. Unknown technologies

Confidential projects (limit public knowledge)


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Alberto De Marco 16

Incentive policy

Owner needs to incentive contractor to

reduce cost

May reduce speed of work because contractordoesnt use overtime, extra equipment, etc.

Cost Plus Fixed Fee (Fixed Fee)

Cost may vary but the fee remains firm The fee is independent of the duration of the

project Like Cost + fixed % except some shared risk

Less time risk: High incentive to finish early Less risk of contractor

Growing size of project to make more Cutting corners to make a buck


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Alberto De Marco 17

Cost Plus Fixed Fee Example Estimated cost 100,000 $

Fixed fee 8,000 $ Estimated Return on Cost ROC = 8%



Price = 90,000 + 8,000 = 98.000 $ Situation B


Price = 110,000 + 8,000 = 118,000

ROC = 8.9 %

ROC = 7.3 %

Target Cost Plus Incentive Fixed Fee

Target cost 100,000 $

Fixed fee 8,000 $

Saving/extra cost share 30% Estimated Return on Cost ROC = 8%



Price = 90,000 + 10.000 * 0.30 + 8,000 = 101,000 $

Situation B Actual cost 110,000 $ Price = 110,000 - 10.000 * 0.30 + 8,000 = 115,000

ROC = 12.2 %

ROC = 4.5 %


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Alberto De Marco 18




9 Unit prices

9 Cost plus


Lump-sum


Negotiation

Guaranteed Maximum Price or GMP

Variation of the Cost Plus a Fee but GMPcan be a cap on costs

After a certain point, the floor or ceiling,

the contractor assumes any additional costs Best: GM Shared Savings: Below Guaranteed

Maximum, savings shared (60-30% or sliding) Very good for turnkey, well-defined scope


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Alberto De Marco 19

GMP with Incentive Fixed Fee GMP 112,000 $

Target cost 100,000 $

Fixed fee 8,000 $

Saving share 30% Estimated Return on Cost ROC = 8%

Actual contract value at completion Situation A (savings) = cost + incentive fixed fee

Actual cost 90,000 $ Price = 90,000 + 10.000 * 0.30 + 8,000 = 101,000 $

Situation B (extra costs) Actual cost 110,000 $ Price = 110,000 + 8,000 = 118,000 > 112,000 $

ROC = 12.2 %

ROC = 1.8 %

Cost Versus Price for GMP

Macomber, 1989


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GMP: Advantages

Permits easier financing

Can fast-track

Owner keeps savings below GMP

Often can get started quickly on construction

Particularly if contractor already involved w/design

Contract may be higher than for fixed price b/cdesign often not complete when contract set

GMP: Disadvantages

Contractors may still spend lots

Owner must monitor contractor spending

Bad if unclear scope after GMP agreed to (mustrenegotiate)

Just as for C+FF, quality may be sacrificedwhereas without GMP, cost and/or schedulewould have increased


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9 Unit prices

9 Cost plus

9 Guaranteed Maximum Price

Lump-sum


Negotiation

Cost Versus Price for Lump Sum

Macomber, 1989


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Lump Sum (Fixed Price) Contractor required to achieve the project at

the negotiated contract value All risk of cost, schedule fall on contractor The owner knows the actual cost of the

project before it begins Minimizes risk for the owner if the project is

well estimated, contractual documentsaccurate and project clearly defined

High incentive for contractor to finish Early (so can move on to other jobs)

Low cost (so can make a profit)

Lump Sum

Required for many public projects P3 also

Good for some well-defined projects

Good price competition in commodity metric Bad for ill-defined projects

Adversarial relationship over responsibility andpayment for of changes

High contractor risk means typically start late Very different from typical meaning of Fixed fee!


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Alberto De Marco 23

Ways to Save Money:

Effect on Owners

Helps: Efficiency within construction Best teams

Appropriate equipment

Careful management

Quality workmanship (to avoid risk of rework)

Hurts: Cutting corners, distortion, charge orders

Substitution of materials Distortion of quantities used

Distortion of progress





9 Unit prices

9 Cost plus

9 Guaranteed Maximum Price

9 Lump-sum

Summary


Negotiation


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Alberto De Marco 24

Conclusion When market is not very good, clients insists on

fixed price bids whereas when the project offersare numerous, it is more difficult to obtain thoseconditions

The contract type choice must depend on:The accuracy of the estimation

The ultimate cost known since the beginning or at

least the maximumThe desired risk

If quick completion of work is wanted

What payment scheme would you

choose?

RISK/KNOW

HOW

100% CONTRACTOR

100% OWNER

TRADITIONAL DBB

DESIGN/BUILD

TURN-KEY

B.O.T.

CM at RISK

AGENCY CM

?

?

?

?


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Alberto De Marco 25

Summary

Relative Costs of Construction Contracts

E= contractor's original estimate of the direct job cost at the time of contractaward

M = amount of markup by the contractor in the contract

B = estimated construction price at the time of signing contract

A = contractor's actual cost for the original scope of work in the contract

U = underestimate of the cost of work in the original estimate (with negativevalue of U denoting an overestimate)

C = additional cost of work due to change orders

P = actual payment to contractor by the owner

F = contractor's gross profit

R = basic percentage markup above the original estimate for fixed fee contract

Ri = premium percentage markup for contract type i such that the totalpercentage markup is (R + Ri), e.g. (R + R1) for a lump sum contract, (R + R2)for a unit price contract, and (R + R3) for a guaranteed maximum cost contract

N = a factor in the target estimate for sharing the savings in cost as agreed uponby the owner and the contractor, with 0 N 1.

Chris Hendrickson, 2000


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Alberto De Marco 26

Original Estimated Contract Prices


Type of Contract Markup Contract Price

Lump sum M = (R +R1)E B = (1 + R + R1)E

Unit price M = (R + R2)E B = (1 + R + R2)E

Cost plus fixed % M = RA = RE B = (1 + R)E

Cost plus fixed fee M = RE B = (1 + R)E

Guaranteed max cost M = (R + R3)E B = (1 + R + R3)E

Owners Actual Payment with

Different Contract Provisions


Type of Contract Change Order Payment Owner's Payment

Lump sum C(1 + R + R1) P = B + C(1 + R + R1)

Unit price C(1 + R + R2) P = (1 + R + R2)A + C

Cost plus fixed % C(1 + R) P = (1 + R)(A + C)

Cost plus fixed fee C P = RE + A + C

Guaranteed max cost 0 P = B


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Alberto De Marco 27

Contractors Gross Profit with

Different Contract Provisions


Type of Contract Profit from Change Order Contractor's Gross Profit

Lump sum C(R + R1) F = E - A + (R + R1)(E + C)

Unit price C(R + R2 F = (R + R2)(A + C)

Cost plus fixed % CR F = R (A + C)

Cost plus fixed fee 0 F = RE

Guaranteed max cost -C F = (1 + R + R3)E - A - C



9 Contract Organization

9 Project Delivery Systems

9 Payment Schemes

Award Methods

Competitive Bidding

Cap

Negotiation


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Bidding method A contractor is selected by the lowest price

proposal, in market competition

Fixed price - low bid is win-lose

Typically associated with lump-sum contract

Qualifications critical

Variants: multi-parameter bidding

Low bid plus arithmetic combination of other factors

Low bid divided by ranking of other factors

Bidding Main Variants

Contractor is competitively selected based on

Qualification and price proposal

Time and price proposal

Qualification, time and price proposal

Design and price proposal


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Bidding Tradeoffs Time provided to bidders to review documents

Too long: Construction delayed

Too short: Bids low-quality because too little time to review contract

docs (incorporate high risk premium or unrealisticallylow)

Few bidders willing to participate

Bid countToo many bidders: Scare away best contractors

Too few bidders: Bid not competitive

Bidding Tradeoffs

Advantages Can get good price

Transparency

Disadvantages Can set up win-lose situation

Competitive pressures can eliminate profit from bidTry to make up with change orders, cutting corners

Can lead to dispute-oriented relationships

Insufficient consideration of design before pricing


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Issues with Bids Low bidders can be unreliable

Prequalify aggressively!

To allow for fast-tracking may bid early (30%)

Dont try to force delivery from low bid

Growing Frequency: innovative bidding method

Pressure for lowest bid can create

Cutting corners

Low-quality personnel

Bad feelings

Bidding Process

A/E oversight typical

Publicity (specifies qualification requirements)

Provide bid documents

Typically include fair cost estimate, sample contract

Answer RFIs

Pre-bid conference

Explain scope, working conditions, answer

questions, documented in writing)


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Public vs. Private Bidding

Public Bidding

Must be publicly advertised (posting in newspapers,

public building, etc.)

Qualification occurs after submission of bids

Typically 60 day period in which can submit bids

Private Bidding

May be by invitation only

Qualification occurs before submission of bids

Qualifications Common items for qualifications

Bonds/Insurance (bid, performance, payment)

Safety record

Reputation

Financial strength Total/Spare capacity

Licensing

Background in type of work

Experience in local area/labor market

Management system (QA, planning, estimation, control)

Interest, adaptability shown


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CAP

A fixed price (lump-sum) is set by the owneragainst which contractors propose a level ofquality and options for the project

Negotiation

Typically selected based on reputation, qualifications

Typically used for two cases

Very simple

Use trusted, familiar party

Very complex/big

Get contractor involved in design, start work early

Requires relatively savvy owner

Evaluate proposals, monitor performance

Important even for DBB for post-bid changes


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Negotiation Considerations

Can get win-win because of differences in

Risk preferences

Relative preferences for different attributes

Goal is to find a Pareto optimal agreement

Key skill in negotiation: Ability to find win-win

options

Conclusion

Scope

Delivery system

Payment scheme

Award method


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Business cases

Documents

Lecture 6-Delivery Systems Payment&Award