Any fixed price agreement places the entire risk of completing the task within budget upon the contactor. As one elderly builder once told the writer, “With set price, I make a fortune if I am really, really good, and eat it if I am really, really bad.” Put another way, it is the ultimate test of a contractor’s business, bidding and building skill in that errors must be paid entirely from the contractor’s pocket.
The old issue of change-orders (“COs”) inevitably arises as it does in almost every project and all those comments in our other articles about COs apply equally to a fixed price contract. However, the underlying work falls within the set price and if there is trouble, it usually arises as the parties realize that the assumptions underlying the bid were in error…or the contractor discovers that its personnel, in the competitive heat of the bidding process, bid a project that is almost impossible to make profitable.
Which emphasizes the extreme skill needed in these types of projects: from the beginning to the end the contractor takes the bulk of the risk and the contractor approaching the challenge is well advised to consider the points made below:
1. FIRST ISSUE: OUTBIDDING THE COMPETITION
Fixed-price contracts are often competitively bid and most awards are based solely on price, as long as the contractor meets certain qualification criteria. The contractor's challenge is to submit a bid price that covers the work involved and provides a reasonable profit, while still bidding lower than his competitors. To do this, the contractor should systematically plan bid preparation so that the bid is considered responsive by the client, no significant requirements are overlooked, any necessary qualifications or exceptions are documented and accurate data is assembled for pricing. Included in this planning should be a detailed evaluation of work means, methods and sequencing to provide the desired product in the most economical manner.
Unfortunately, various factors can cause a contractor to adopt cost-cutting strategies, both in pre-planning and in execution, with the philosophy often being that project management personnel will have the necessary experience and ability to overcome the aggressive bid pricing and "pull it off." All too often, this risky strategy backfires in the form of cost/schedule overruns, lower quality work, lost owner confidence and disputes.
That same old contractor once told the writer that the most money he ever made in a project…was the project he refused to bid. “I saw those young idiots greedily chomping at the bit to grab that big project and knew that whoever got it was out of business by the following year. It was a trap…the owner knew no one could pull it off. I told some of those guys but they thought I was just trying to outmaneuver them. Sad.”
Remember, should there be a dispute, the owner will point out that the entire risk was on the bidders and will undoubtedly wave a bid invitation document (prepared by a firm such as ours) made especially to show the arbitrator that the bidders were warned. We spend tens of hours a year improving and expanding bid invitation documents for our clients and you may be sure, if you are a contractor, that you will not be able to plead ignorance, mistake, or lack of understanding of the risks involved. You bid: you are stuck.
The arbiter’s ruling in a recent case provided insight into how and when not to try to “pull it off.” After first underbidding the cost of the job by $600,000 and the duration of the job by two months, the contractor’s management decided to fire three superintendents and blame all problems on the owner, architect, and its subcontractors. After experiencing a cost overrun of $800,000 and filing a demand for arbitration against the owner, the arbiter denied all the contractor’s claims and ruled that the contractor must pay the owner an additional $300,000. Arbiters are not fools. They can read a contract as well as you can. They fully understand (or the owner’s attorney will make them understand) that such finger pointing is the inevitable result of bad bidding.
Once you decide to bid the project, plan on covering your own mistakes. And if you are a contractor, double…then triple check whoever is making the bid BEFORE you sign the contract.
2. SECOND ISSUE: IS THIS THE RIGHT JOB FOR YOUR COMPANY?
Contractors often pursue work without adequate consideration as to whether the contract scope truly fits their experience and capabilities. Contractors often attempt to perform a certain type of work or complete a specific type of project for the first time, and are presumably willing to accept some additional risk in order to gain specific experience and market share.
Contractors should evaluate whether they have a strategy, work process, staff experience or some type of cost advantage which provides a competitive edge. Determining whether one can be competitive is as important as any decision made throughout the execution of a project, and pursuing the right business for the firm is equally important.
Contingency planning for ill personnel, change in available financing, poor weather, unavailable materials, etc, etc. MUST be undertaken. Having “depth on your bench” and the right contacts with suppliers and inspectors is an essential part of evaluating acceptable risk.
One of the most common mistakes that we find in disputes is where the contractor assigns inexperienced and unqualified personnel to the project. Some of the common causes of such ill advised personnel assignments include situations where the executive(s) in-charge is not sufficiently qualified to assess and identify the construction personnel best suited for a particular project.
Equally disabling can be the fixed bid project, with its high risk component, requiring a builder to bleed all other projects of personnel and resources to ensure its completion, often at the expense of long term relationships with repeat customers.
3. THIRD ISSUE: THE PRESSURE OF PREPARING THE BID:
Bids are often prepared under great time pressure, which often comes from three sources:
(1) The time allowed by the client between the invitation to bid/propose and the date it is due is usually limited.
(2) A contractor is normally working on more than one bid/proposal at a time and should split his/her resources among all active invitations.
(3) The contractor is dependent on much outside information to create the bid, from prices of suppliers to availability of subcontractors, and a delay in response from any of those people can cause chaos to the timing for submission of the bid.
If a contractor is to effectively operate in this environment, he/she should have complete, established procedures to guide all but the most complex features of bid preparation. Policy planning (standard operating procedures and guidelines) should be established for use on all bid work. Planning and executing a proper bid review before submittal offers some assurance that a rapidly developed bid will be complete.
Bid errors resulting from time pressures during the bid preparation process are one of the common features in contract disputes. An excellent example from a recent case arose from a situation where the time required by the third tier contractor to prepare steel shop drawings and fabricate and deliver steel joists was not communicated to the general contractor prior to bid submission and contract award. As a result, the general based his bid pricing on an unachievable schedule, resulting in delays, acceleration and disputes. One of the most common mistakes that we see in this area is the general contractor’s failure to obtain detailed schedule commitments from its subcontractors prior to the bid. As a result, the subcontractor’s bid pricing often does not reflect the general contractor’s schedule requirements.
Equally dangerous is not creating a contingency for errors, both in terms of timeand cost. Any intelligent bidder assumes that something, sooner or later, will go wrong, and will factor that both into the prices bid and the timing provided in the contract. A year ago this writer received an odd e mail from a contractor who had been in business over thirty years: “Just want you to know…today we finished the first project in which everything went right. Was a waste: it was my sister-in-law’s apartment building!”
4. FOURTH ISSUE: THE TIME TO MOBILIZE
The time normally allowed between award of a contract and the notice to proceed date is typically short, often less than a month. Yet, during this period, a contractor should finalize most of the detailed plans associated with the project and implement actions to achieve mobilization. The contractor is also often expected to produce a detailed critical path format schedule within 30-90 days of award.
To properly meet such requirements, the contractor should have been preparing preliminary plans and formulating other actions that need only to be finalized during the contract mobilization period. During bidding, the preparation of a plan for the initial execution of the project, including commitments from subcontractors and suppliers, is usually excellent protection from the surprises associated with faulty assumptions.
5. FIFTH ISSUE: THE ROLE OF THE SUBCONTRACTORS
The contractor may choose to subcontract all work, perform all work using direct-hire forces, or use a combination of direct-hire and subcontracting. Direct-hire craft personnel may be hired under either union or open shop rules. If all work is subcontracted, the options are union, open or merit shop. These decisions are required very early in the operational planning process. In some instances, the client will have dictated the approach in the bidding documents or the contractor may have union obligations that dictate his/her mode of operation. Once the approach is selected, staff and subcontracting plans should be formulated.
But unless the contractor hires subcontractors on their own fixed bid basis, remember that the risk of failure remains largely upon the contractor. And, realistically, if the subcontractor fails to perform, the odds of collecting from them may be small since so many are over extended as it is. Thus each subcontractor and each supplier may have the power to make the fixed bid into a disaster.
In the bid stage it is always good to attempt to make timely performance dependent on prompt availability of materials and many fixed bids so provide: but none known to this writer provide that the selection of subcontractors by the contractor may excuse timely performance.
From that point of view, a fixed bid places upon the contractor what amounts to a “guaranty” of the subcontractor’s performance. Chose wisely.
6. SIXTH ISSUE: THE LOCAL LABOR FORCE
With the exception of key supervisory personnel, the hiring of the direct-hire labor force will often be handled from the location of the site, although recruiting may extend elsewhere. If the contractor intends to perform the work under union conditions, the contractor should coordinate with all involved union locals to obtain local bargaining agreements that will govern pay and work rules for each craft. Or, he/she may choose to seek a Project Labor Agreement rather than work under the separate craft agreements. Such an agreement should originate with the Building Trades, AFL-CIO, at the international level and then be signed off at the local level. Either approach requires considerable time and effort and should be started very early in the bid preparation process, since the results may affect wage hour scales and work rules which relate to crew sizing, productivity and pricing.
If the project is direct-hire open shop, the contractor should conduct a thorough area labor survey to determine availability of labor and area wage scales. If there is a labor shortage of any kind, plans should be developed to compensate for that shortage such as recruiting from areas outside the project area. A second is to establish special craft training programs. A third is to compensate for shortages by scheduling extended work days or weeks. In any case, plans should be made for personnel recruiting, screening, and training (if applicable) as part of operational planning.
in a recent power facility dispute the general contractor failed to contact the local union and identify the shortage of certified pipe fitter welders. The general contractor was then forced to use boilermaker welders at reduced productivity and greater unrecoverable costs.
Learn the local labor force issues BEFORE agreeing to any fixed price bid.
7. SEVENTH ISSUE: PROJECT CONTROLS FOR THE OWNER OR THE CONTRACTOR
On larger projects, the owner may specify a project controls system, which the contractor should adopt to interface with the owner system, or the owner may only provide performance type specifications relating to scheduling and reporting, allowing the contractor to choose the system. In either case, the contractor should plan the project control support very carefully so that adequate project controls personnel and systems capability is planned for.
Again, on larger projects, a planning exercise involving key members of the execution team should be undertaken. Detailed planning during the bid process serves the dual purpose of verifying that the schedule being proposed can actually be met, and perhaps more importantly, ensuring that key members are committed to the execution plan.
Attempting to cut or eliminate project controls (cost engineering, estimating and scheduling) costs has cost many contractors the ability to satisfy client requirements for providing accurate time and cost status and forecasts, as well as preventing adequate change controls and impact analyses.
And when dealing with a fixed price contract, which normally has a time component with penalties, the cost of saving that effort may be the profit…or more…of the entire project.
8. EIGHTH ISSUE: MATERIALS FOR THE PROJECT
Permanent materials for the project will likely be some combination of owner-furnished and contractor-furnished. On-site warehousing responsibilities for these materials may be split between owner and contractor to parallel the procurement responsibilities, but are more often assigned totally to the contractor. The contractor should develop preliminary procurement plans for materials for which he/she is responsible and a warehousing/materials control plan for assigned on-site materials management responsibilities since these functions have considerable cost implications. Having proven systems and personnel capable of managing and issuing materials for specific tasks with a minimum of surplus will probably save money.
The entire issue of impact and acceleration, with its attendant massive costs, rests upon the contractor in most fixed price bids. Thus the ramifications of failure of material (or subcontractor’s materials) to arrive or be on spec will fall entirely on the profit margin of the contractor. While clauses in the contract can give some protection, ultimately the owner will want a turn key operation in which for the fixed price the project (or portion of the project) is finished and pointing fingers at subs who did not order correctly or suppliers who cannot fill an order correctly will be treated with skepticism and contempt.
A good contractor will thus carefully monitor the subcontractor’s method of materials procurement and storage as much as its own. One contractor known to the writer was satisfied that his sub had ordered and stored the requisite material…only to discover that much of the material was then being removed by the subcontractor for another job. Sometimes the contractor has to be a policeman.
9. NINTH ISSUE: ENVIRONMENTAL PROTECTION
Environmental regulations have become very specific and significant fines may be levied against contractors for non-compliance. There are federal regulations that have national application and there may be additional state and local regulations. A contractor should have standard procedures that reference known environmental regulations and outline generic protection plans, but local requirements should be surveyed and the generic plans adapted to each site. Liability implications here go well beyond contract limits, as the enforcement of these laws can include both civil and criminal penalties.
Disposal of waste…particularly hazardous waste…may turn out to be a tremendously expensive process and many contractors, arriving in California, find to their horror that what is a minor expense in Arkansas is a major expense taking a great deal of time in the Bay Area. Thus lighting ballasts once cost one of our clients thirty thousand dollars to dispose of (five thousand to remove and transport…twenty five thousand for the fine and attorneys fees when he was caught trying to do it on his own) and delayed a project for weeks when the government closed down the project while they looked for other violations of State law.
Learn the local environmental issues and restrictions and factor them in BEFORE you make that fixed price bid.
10. TENTH ISSUE: SITE CONDITIONS
Each construction site is different and these differences have considerable cost implications. An open site with ample space for all construction activities should, if properly organized, contributes to better productivity. Procurement timing and warehousing plans are directly affected by lay-down and warehousing space available. Space and access considerations will affect decisions on on-site versus off-site fabrication. If there is inadequate site parking space, a busing plan may be required. The site configuration and its proximity to the public may put constraints on the size of the work force at any one time and thus affect the cost and schedule. Site security is also directly affected by site conditions. Those supplies that were vital to your critical path schedule and that you ordered three months ago for their complex manufacture…if stolen…may destroy your job.
CONCLUSION
Time and materials puts almost all the risk on the owner. Fixed bid puts almost all the risk on the contractor. All the above tasks exist to some extent in every construction project, but the difference is that failure to adhere to compliance with the above guidelines, in a fixed price bid, can quickly lead to contractor collapse.
One contractor from Los Angeles once wrote this writer that the fixed price bid was the only way to go for a real professional. “If I don’t know how to make a profit from what I do for a living, I should be in a different profession.”
But that man had developed a network of subcontractors and suppliers that provided mutual support and protection for him and when he sought to expand his business into Nevada he immediately ran into deep trouble that made his life “far too interesting,” as he put it, for the next year.
If you have developed the skills and contacts to make it work, fixed price contracting can be the most profitable and opens up bids that otherwise would not be available…but the main reason you will succeed, is understanding that planning ahead…and planning for unplanned contingencies…will make all the difference in your success.