Lump Sum Construction Contracts: A Comprehensive Guide to Fixed-Price Contracting

Construction lump sum contracts are known to be clear and straightforward. 

The contractor quotes a fixed price for the entire scope of work. It covers the expected project costs and the contractor’s fee. Likewise, the client commits to settle the predetermined amount per the agreed payment project schedule. 

No administrative bureaucracies or complex line item calculations for either party. 

What happens when the actual costs exceed the budget? Who bears the cost overruns? 

Suppose the project owner asks for alterations to the original construction project design. Will the lump sum contract remain valid?

Our quick guide explores the dynamics and best practices for a lump sum contract. Further, we compare lump sum contracts to cost plus contracts and guaranteed maximum price contracts to identify scenarios where lump sum contract is most appropriate. 

Let’s get to it!

Overview of a Lump Sum Contract in Construction Projects

A lump sum contract also called a stipulated sum contract or a fixed price contract, occurs when the contractor agrees to complete the project's scope at a preset price. 

Think of it like ordering a 3-course meal from a menu. The diner already knows the final price upfront and expects to settle it afterward. 

For instance, a project owner can agree to a $40 million fixed fee for the entire project regardless of the actual costs. The stipulated sum contract is set before the start of the project, usually at the formation or negotiation stage of the construction contract.

Key Features of a Lump Sum Contract

The two distinctive features of lump sum contracts are a straightforward objective and a clear scope of work. The goal is to set a lump sum price for the final project cost and contractor’s fee, creating a sense of transparency and predictability. Second, the clear scope of work in the lump sum contract will have elaborate details regarding the following:

• Project description, deliverables, and schedules
• Detailed inputs specifications
• Narrative about the current site conditions
• An outline of the applicable quality standards and expectations
• Roles and responsibilities of all parties to the construction contract
• Project alteration protocols
• Payment terms and schedules
• Legal and contractual terms and conditions

Further, the fixed price in a lump sum contract is payable using any of the following schedules:

• Deposit and final payments
• Completion-based payments
• Milestone-based payments
• Time-based payments
• Progress payments
• Retainage

The elaborate scope of work facilitates a mutual understanding by all stakeholders regarding the project requirements. It creates a basis for accurate cost estimates, effective project planning, and prompt risk management in a lump sum contract.

Advantages of Lump Sum Contracts

The clear scope of work and straightforward objectives make lump sum contracts a favorite for civil engineers, architects, and commercial and residential contractors when bidding for construction projects. A study by CoConstruct, a builder trend company analyzing 38,000 construction projects between 2018 and 2020 in the United States, indicates that up to 80% of projects in the United States construction industry use this type of contract. 

Still, contractors must weigh the pros and cons of each type of contract before opting for lump sum contracts for their next project bid. Check out the advantages of lump sum contracts below: -

Facilitates Strategic Cost Management

An established contractor with strategic partnerships with suppliers and subcontractors can leverage their accessible cash flow, economies of scale, and good business relationships to lower their actual costs, resulting in a higher profit margin.

For example, a construction company may purchase equipment for long-term project requirements and save on unused hours when leasing. A streamlined and efficient cost structure is an invaluable competitive edge, enabling contractors to place lower yet profitable bids and win more projects. 

No Quantification of Individual Project Costs

Contractors using lump sum agreements need not measure or document the items constituting the fixed sum. Such work measurements only become necessary due to unexpected costs and extra items not considered in the original lump sum contract. Such additional costs could be due to rising material costs, unfavorable site conditions, labor shortages, and equipment breakdown. 

Accordingly, the administrative burdens of accounting for intricate items do not exist in a lump sum contract. Both owners and contractors can track changes in complex lump sum projects and streamline the payment process. 

Limited Client Involvement

Contractors with portfolios featuring lump sum contracts demonstrate their ability to work independently and exceed client expectations. See, lump sum contracts leverage on client trust. The contractor assumes full responsibility for cost management. 

The absence of an itemized breakdown eliminates the possibility of micromanaging the professionals or calling impromptu meetings to query project spending. Instead, the contractor works independently to deliver the entire project within budget and manage client expectations. 

Effortless Planning and Execution

By quoting a fixed amount in lump sum contracts, both owners and contractors know the total cost and markup beforehand. They can prepare accurate budgets and plans, anticipating the project deliverables and remuneration.  

Motivates Speedy Execution of the Construction Project

Beating deadlines is crucial for construction contracts with razor-thin margins. It frees the contractors to bid for more projects amidst stiff competition and fewer opportunities. Likewise, a contractor who knows their expected profit margin will use innovative strategies to attain early completion of work. 

The Drawbacks of Lump Sum Contracts

Despite the significant benefits of lump sum contracts, it is essential to recognize the pitfalls associated with these construction bids. 

Limited Project Scope Flexibility

Changing the well defined project scope without incurring extra costs. Indeed, a contractor seeking to alter or add anything to the original design must engage in fresh negotiations with the client. The talks or unplanned changes may result in disputes, project termination, and the selection of a competitor for proper job execution. 

Significant Contractor Risk

Lump sum contracts with a high risk of cost overruns are detrimental to the contractor since the contractor bears full responsibility for the scope of work. Hence, it is prudent to take up insurance against these unforeseen events and factor the premiums into the provisional sum. 

Quality Concerns in lump sum construction contracts

Contractors working on projects with low profit margins or maximum amounts are inclined to cut corners to minimize overhead costs. In turn, they compromise the project quality to complete the essentially assigned construction contract on or below budget. 

Unrealistic Project Schedules/Time Constraints

Since lump sum contracts have well defined scopes and predetermined amounts, the contractor agrees to complete the work fast. There is no room for addressing unexpected safety or quality concerns. 

Lump Sum Contracts vs. Cost Plus Contract vs. Guaranteed Maximum Price Contract

Cost plus contracts and guaranteed maximum price contracts (GMP) are common construction contracts and popular alternatives to lump sum contracts. In contrast, the intricacy of unit price contracts makes them less popular in the industry. The contractor must know and quote the unit price for all cost centers.

Then, would you opt for them in your next construction bid? How do cost plus and GMP contracts compare to lump sum contracts?

Cost Plus Contract 

A cost plus construction contract is quite similar to a lump sum agreement. The project owner agrees to reimburse the contractor for the actual costs plus a fixed price. Hence, it cushions the contractor from unexpected spending due to variations between quoted and actual costs. 

In our illustration above, the contractor only quotes their maximum amount, independent of the actual cost. That way, they can tally the individual items upon completion of work, substantiate them with proper documentation, and get a reimbursement for any additional costs. 

Cost plus contracts are further classified as follows:

• Cost plus fixed fee contract compensates for actual costs and provisional sums for the contractor’s profit.
• Cost plus incentive contract pays the actual costs and a minimum or maximum fee upon completing the project at an agreed date and within a target cost. 
• Cost plus award contract reimburses the contractor for the actual cost, the preset contractor’s fee, and an additional amount for attaining specified metrics in the scope of work. 
• Cost plus percentage contract tags the contractor’s fee to a percentage of the actual costs. 
• Cost sharing contract pays for a portion of the project costs with no added fee. 

Contractors should opt for cost plus contracts if the project extends over an extended duration, making it difficult to estimate the overall scope of work in advance. Indeed, it is applicable where contractors must begin construction before finalizing the specifications to beat a tight schedule. 

Hence, the client assumes more risk for escalating indirect costs and other construction expenses. On the downside, besides the cost plus incentive contract, the remaining cost plus options lack motivation for cost savings and efficiency. Moreover, the cost plus percentage contract is prohibited by federal government agencies since it encourages wastage and has higher risks for fraud. 

Guaranteed Maximum Price Contract

As the name suggests, the guaranteed maximum price contract (GMP) is a construction agreement whereby the quoted price is the highest actual cost a contractor should incur to complete the project. By setting the highest price, these contracts protect the client from reimbursing exorbitant project costs to inefficient or untrustworthy contractors. 

When faced with the dilemma of choosing between a lump sum contract and a GMP construction contract, the contractor should use the following checklist:  - 

• Do you prefer working on construction contracts that welcome innovative ideas? If so, opt for GMP contracts. 
• Can you estimate the project costs associated with the scope of work while at the bidding stage? For example, how much materials or labor costs will you need for this type of contract? If so, it makes lump sum contracts an ideal choice for you.
• Is there a high chance of exceeding the predetermined price set at the beginning of the project? If so, then opt for the GMP contract. 

Best Practices for Using a Lump Sum Agreement in Construction Projects

Finally, contractors should observe best practices when using lump sum contracts. These approaches assist in mitigating risks, enhancing project clarity, accurate cost estimations, effective project planning, timely project completion, and managing client expectations. Here are some examples of best practices applications in construction projects:

• Prefabricating modules and off-site assembly to improve on precision, quality control, and speedy construction of bridges
• Using advanced technologies like Building Information Modeling (BIM) to improve efficiency in planning, coordinating, and communicating with manufacturing plant construction teams for warehouses
• Embracing lean practices like Kaizen continuous improvement, value stream mapping, 5S Methodology, and the pull planning approach to minimize labor costs, waste, and downtimes while streamlining processes for optimal project efficiency
• Partnering with industry experts to share resources and expertise while mitigating risks associated with lump sum contracts
• Liaising with a construction attorney when conducting a comprehensive risk assessment to predict and prepare for such risks as weather-related delays, supply chain disruptions, skilled worker shortages, and economic downturns
• Using aerial monitoring tools to conduct site inspections for a commercial office complex construction project
• The project owner and contractor agree to discuss status reports detailing the achieved project milestones and current and upcoming tasks for a residential building project

Final Thoughts

Lump sum contracts are popular and an excellent choice for small, short, or straightforward construction projects that are easy to describe and complete. The contractor is paid a fixed sum based on a clear scope of work and a straightforward objective. Also, the contractor evaluates lump sum contracts compared to other common construction contracts like GMP contracts and cost plus contracts, before bidding for construction projects. Better still; they should strive to maintain best practices and exceed client expectations.