What is a fixed price contract in construction?

Written by mike broemmel
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What is a fixed price contract in construction?
Construction crane

In the construction industry--whether on a residential or commercial project--a general contractor is the individual or entity that negotiates with the owner or developer the type of overall contractual scheme that will be utilised for the project. Developers and owners of all types tend to favour what is known as the fixed price contract. Generally speaking, under a fixed price contract, the prime contractor agrees to undertake and complete the proposed construction project for a set, guaranteed price, a bottom line figure that the developer or owner can rely upon and budget around.

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Function

The process of developing what the contractor will propose as the basis for a fixed price construction contract begins with negotiations with the various subcontractors who will be involved on the project. As much as possible, the contractor will in turn attempt to obtain fixed price contracts from the various subcontractors lined up for the project. For example, in negotiations with the electrical contractor, the general contractor will attempt to illicit a capped and set price for all the electrical work associated with the proposed construction project. The overall economic climate and the health of the local construction industry dictates how readily a fixed price construction contract will be utilised across the board in a particular project.

Benefits

The most essential benefit associated with a fixed price construction contract is budget reliability for the developer or owner. Essentially, a fiscal wall is built between the developer (or owner) and the general or prime contractor. If cost overruns exist that travel upward to the general contractor, they do not pass any further, alerting the agreed-to bid on the project itself. If the general contractor is able to win fixed price contractors from all or most of the subcontractors associated with a project, he also will be in an enviable position of being able to avoid the expenses of potential cost overruns.

Cost overruns

Cost overruns of some nature are commonplace occurrences on many construction projects. If a prime contractor is able to obtain fixed contracts from the subcontractors on a project, that individual will be able to prevent those cost overruns from affecting his or her own bottom line. However, if the prime contractor is unable to negotiate set contracts with his own array of subcontractors, he runs the risk of having to absorb any cost overruns. Nonetheless, the developer or owner of the project will be protected from added expenses as the result of cost overruns.

Misconceptions

The most common misconception associated with a fixed price construction contract is that it always works to the financial benefit of the developer or owner of the property under construction. While the developer or owner can enjoy the benefit of budgeting around the set price of the prime contract, there are occasions in which a general contractor can bring the project in under budget (sometimes significantly so). When this occurs, the financial benefit accrues to the general contractor and not the developer or owner.

Alternatives

There are some variations on the theme in regard to a fixed price contract in the construction industry. The cost-plus contract involves the general contractor being paid the construction costs plus an specifically agreed upon percentage of the underlying costs. The cost plus contract with a guaranteed maximum price is similar. The prime contractor is paid a percentage fee over the costs; however, there is a maximum contract percentage that cannot be exceeded.

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