Home Contract Practice Lump Sum Contract | Advantages and Disadvantages

Lump Sum Contract | Advantages and Disadvantages

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Lump Sum Contract

What is a Lump Sum Contract?

Firstly, We have to understand what is a Lump Sum contract. If you are working in the construction sector, then you would surely hear the popular term ‘Lump Sum Contract.’ However, In the Construction industry, we know a lump sum contract is a fixed price contract. The Client (Owner) pays a fixed amount for the scope of works. In the Contract document, we should specify the scope of works and contract type as a lump sum contract. There are many advantages and disadvantages of lump sum contract in construction.

Further, a fixed-price contract is the most basic form of contract type between the Contractor and the Client.

 The Client is duty-bound to pay the price upon completion of the work or as stated by the agreed schedule of payment. The main advantage of a Lump Sum contract is that both parties have knowledge of the scope of the work and the total amount associated with it before they start the project. Therefore, we usually use this type of contract when we have defined the scope of works accurately without ambiguity.

Once the Contractor signs the contract, he is legally bound to finish the work within agreed fix total cost mention in the agreement. Therefore the Contractor has the majority of the risk. But the Contractor completes the job under the agreed total amount; then, he makes an additional profit from the contract.

What are the conditions?

We usually use this type of contract to reduce the contract administration costs in the project. But we can not use this type of contract for every single project. So let’s discuss the conditions for using the lump sum contracts.
  1. The project should be having with well-defined work scope,
  2. Stable conditions – unlikely changes of the original scope of works (Variations) and delays,
  3. the project with a short duration.

Let’s discuss the advantages and disadvantages of lump sum contract.

Advantages

  • It is suitable for cost control.
  • We know the total amount of cost at the beginning.
  • It may reduce financial risk to the Client (Owner)
  • It may reduce the time which is required to deliver the project.
  • Accounting related to the lump sum contract is low-intensive.
  • The selection of the Contractor is not hard.

Disadvantages

  • The Contractor’s risk is very high.
  • Additional changes in scope (Variations) might be difficult and costly.
  • The Contractor bids higher because of the higher financial risk.
  • The Contractor may decide which materials and methods. Then he may use even the lowest quality of materials, methods (Techniques), and equipment.
  • The tendered price might include high-risk contingency; a competent contractor might not be interested in bidding to avoid the high risk.

The Categories of the lump sum contracts

We can divide Lump sump contracts into three categories according to specific needs.

1. Firm Fixed-Price contract (FFP)

FFP contract is an easily manageable contract. In this type of fixed-price contract, The Contractor has to finish the construction within an agreed amount and time. The Contractor has to cover any additional costs due to poor performance. We can see that FFP contracts commonly used in government or semi-government projects. Because of the scope of work is every possible detail outlined. Most of the buyers prefer this type of contract because they know the price early. The price does not change unless there is a change in the scope of work. (No Variations)

2. Fixed Price Incentive Fee contract (FPIF)

FPIF contract is also a fixed-price contract similar to the FFP contract. But the FPIF contract additionally includes an intensive fee. Then, the Contractor can earn an additional amount (Bonus) for finishing early or achieving defined performance criteria such as quality.

3. Fixed-Price with Economic Price Adjustment Contract (FP-EPA)

If the performance period is multi-year long, The specialist advises going a Fixed-Price with Economic Price Adjustment contract. It is a fixed-price contract with a provision clause that protects the Contractor due to changing conditions, such as cost increases. The EPA clause should be related to a reliable finance index. Then the Contractor can adjust the prices/rates referring to the finance index. (Price fluctuations)

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