Invoices for contractor time and materials services, computed by the contractor, display earned labor and equipment hours and material quantities plus incidentals, multiplied by the appropriate rate(s). Hours and dollars are then distributed to customer purchase orders and work orders. Unfortunately, manual invoices produced every two weeks or once a month present project costs and progress too late to inform the project team of tasks that are behind schedule or over budget.
Fixed price or lump sum contracts
Projects with many engineered drawings/specifications, a well-defined scope of activities for each contractor, and good start and finish expectations match up nicely with fixed price or lump sum contract types.
Payment terms differentiate fixed price from lump sum. Fixed-price contracts typically have progress payments based on agreed-to benchmarks like percent complete. Once the contractor and owner agree that a benchmark has been achieved (successfully meeting all contractual requirements), payment is calculated.
Lump sum contracts differ in that the project duration is typically much shorter and a single payment is made upon final acceptance of the work.
Sub-species of fixed price and lump sum contracts are designed to focus contractor efforts to deliver completed work on a particular, clearly stated objective like delivery date and time. Other incentives might be designed to emphasize daily progress, daily availability of requisite labor and supervision, availability of specialized equipment (such as monster cranes), and other project specific variables that make unusual contributions to overall project success.
Unit price contracts
While of limited use in North America, unit price contracting is common in Europe. A unit price contract is the agreement between a contractor and an owner that virtually any work activity can be described in standard man hours. For example, a butt weld of two 20-foot sections of 3-inch 304SS Sch10 pipe, at grade in daylight, will always take the same crew skills and hours.
The owner and contractor must agree on the standards since they form the basis of the contractor’s bid for work. Once standard man hours are agreed to, competitive bidding begins. Each bidder is asked to propose a crew rate for classes of work (like piping or electrical) that is their specialty. The contractor will also be asked to bid a discount or premium to standard man hours effectively stating their appetite for work.
Each base price is subject to conditions, which is where it can get complicated. Remember, the base rate assumed the work was performed at grade, in daylight. If the work was performed above-grade then additional resources (man lift, scaffolding) can be required that a contractor needs to also be compensated for. In a well-written unit price agreement there will be hundreds of base rates each with many conditions modifying the base price. The final number of rates plus conditions can reach into the tens of thousands. Once the unit price rate schedule is established for a class of work, the hardest part of the unit price contracting battle is complete.
Unit price contracts have great traction in other parts of the world because a well drafted unit price contract shifts most, if not all financial incentive, to the contractor. He will always be paid the same amount per activity, regardless of how productive his crew is each day. On the other hand, contractors can maximize their profits by putting their very best crews on unit price jobs and their less capable guys on time and materials work. That works out well for the owner with the unit price contract.
When unit price contracting is in use, owners are somewhat freed from controlling contractor time and attendance. The owner can focus on evaluating the quantity of units produced each day and their quality. Needless to say, unit price contracts are difficult to get in place. Once in place they are easy to use.
Combining multiple contract types
Because work types dictate contract types, a single contractor might have time and materials, fixed price and unit price work going on simultaneously at one site. Plant owners can control contractor “cross-dipping” by calculating total contractor work hours at each shift. The hours worked on time and materials are allocated to dollar rate work and deducted from total hours. Remaining hours are allocated to lump sum or unit price work at zero dollar rates. Lump sum and unit price effort is compensated on a benchmark basis or units completed basis. By controlling the total, plant owners can control the pieces.