ENGR 301

Engineering Management
Principles and Economics
Lecture 2A
Project Delivery Methods and
Contracts
Dr C.J. Willis, CAPM, P.Eng 1
Project Delivery Methods
Traditional

Phased

Fast Track

Dr C.J. Willis, CAPM, P.Eng 2

Project Delivery Methods

• Traditional
All build activities start after all design work is
completed

Dr C.J. Willis, CAPM, P.Eng 3

Project Delivery Methods

• Phased
Design and build phases overlap, but for each
activity, Build starts after Design ends

Dr C.J. Willis, CAPM, P.Eng 4

Project Delivery Methods

• Fast Track
Design and Build phases overlap. For each
activity, Build starts before Design is finalized

Dr C.J. Willis, CAPM, P.Eng 5

Characteristics

Traditional
• Longest overall project duration
• Suitable for using a Single contractor

Dr C.J. Willis, CAPM, P.Eng 6

Characteristics

Phased
• Shorter overall duration
• Suitable for using multiple contractors;
requires PM

Dr C.J. Willis, CAPM, P.Eng 7

Characteristics

Fast Track
• Shortest overall duration
• Suitable for using multiple contractors,
requires PM
• Very difficult to manage
• Inadequate design and schedule

Dr C.J. Willis, CAPM, P.Eng 8

 CONTRACTS: Learning Objectives
After this lecture learners will:
1. Understand the project development cycle
2. Understand what is a contract and its
components
3. Understand the difference between direct and
indirect cost
4. Have an appreciation of the different contract
types
References
Engineering Management Principles and
Economics, custom Pearson e-book
Dr C.J. Willis, CAPM, P.Eng 9
 Why do we use Contracts?

• Describe the scope of work

• Define the project’s duration
• Specify the amount and method of payment
• Set control mechanisms
• Manage and allocate risks
• Assign responsibilities and obligations

Dr C.J. Willis, CAPM, P.Eng 10

 What is a Contract?
• A contract is an agreement between the owner and the
performing organization to execute a defined scope of
work
– A mutually binding agreement that obligates the seller to
provide the specified product and obligates the buyer
(owner) to pay for it.
– A contract is a legal relationship subject to remedy in the
courts
• The owner chooses the type of contract
– Done according to the nature of the facility or product

Dr C.J. Willis, CAPM, P.Eng 11

 What is a Contract?
• Contracts may be Verbal or in writing .
• Only time a contract must be in writing is a
contract for the sale of land.

Dr C.J. Willis, CAPM, P.Eng 12

 Proof of the Existence of a Contract

• An offer was made.

• An offer was accepted.
• There was mutual agreement.
• There was consideration.
• The subject matter of the contract is legal.
• Both the owner and seller have the capacity to
enter into agreement.

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 Things that are usually specified in a
Written Contract
• The names of the parties involved in the contract along
with their addresses.
• The scope of work that is covered by the contract.
• The period of the contract.
• The contract price and the method and terms of
payment.
• The language and source of law governing the contract.
• A listing of other documents that are considered as
being part of the contract
– Engineering drawings and specifications.

Dr C.J. Willis, CAPM, P.Eng 14

 Contract Types

• Contract type refers to the approach of the

owner of a project with respect to payment for
the service or product provided by the seller
• Who selects the contract type and what is the
basis of the selection?

Dr C.J. Willis, CAPM, P.Eng 15

 Types of Contracts

1. Lump sum contract

2. Unit price contract
3. Cost + Fixed Percentage Contract
4. Cost + Fixed Fee Contract
5. Cost + Fixed Fee + Profit Sharing
6. Cost + Fixed Fee + Sliding Fees

Dr C.J. Willis, CAPM, P.Eng 16

 Lump Sum Contract
• Lump sum contracts are used for projects such as
building projects where it is possible to compute
accurate quantities of work prior to construction.
• For a lump sum contract, a contractor quotes one
single price which covers all work and services
required by the contract plans and specifications.
– In this contract type, contractors provide a single quoted
price for the entire job based on a complete set of plans and
specifications.

Dr C.J. Willis, CAPM, P.Eng 17

 Lump Sum Contract

• The lump sum price quoted by a contractor not only

includes the contractor’s direct costs for labour,
equipment and materials; but also all indirect costs
such as project and home office overheads.
• In addition, the lump sum price quoted by the
contractor must also include profit.

Dr C.J. Willis, CAPM, P.Eng 18

 Lump Sum Contract

• In lump sum contracts the scope of the

projects must be well defined
• Contractor usually sets higher mark-up to
account for risk
• Payment is made to the contractor
according to percentage of work complete
• All risk is shifted to the contractor

Dr C.J. Willis, CAPM, P.Eng 19

 Lump Sum Contract
• A major advantage associated with using the lump
sum contract type is that the price quoted is
usually assumed to be a guaranteed price for the
work
• Based on this the owner has a fairly good idea of
how much to budget for the project

Dr C.J. Willis, CAPM, P.Eng 20

 Lump Sum Contract
is not flexible!
• The major disadvantages associated with using the lump sum
contract type include:
– The owner is required to have detailed plans and
specifications complete before bidding and construction can
commence. [Traditional delivery]
– There is little or no flexibility to make design changes or
modify the contract based on changed conditions.
– Any deviation from the original plans and specifications
must be handled as a change order, which leads to the
potential for litigation and considerable wrangling over the
cost of contract changes.

Dr C.J. Willis, CAPM, P.Eng 21

 Unit Price Contracts
• Unit price contracts are used for work where it is not
possible to calculate the exact quantity of materials that
will be required
– such as highway construction projects and projects requiring extensive
excavation and backfilling.
• In this type of contract, the project is broken down into work
items that can be characterized by units such as m3, m2 and m
as well as piece numbers (e.g. 16 window frames).
• The engineer estimates quantities for the various work items
and the contractor quotes the price by unit for each work item
using the quantities estimated by the engineer as a guide.

Dr C.J. Willis, CAPM, P.Eng 22

 Example of Unit Price Contract

Item Description Unit Quantit Rate Amount

No. y ($) ($)
1 Provide for and apply prime coat m2 2,780 4 11,120
to stabilized surface and shoulders

2 Provide and place asphaltic m2 1,900 6.50 12,350

concrete on carriage way
3 Provide and install traffic signs No. 7 40 280
4 Provide for an apply road m 1,060 3 3,180
markings to road surface
Contract Price $26,930

Dr C.J. Willis, CAPM, P.Eng 23

 Unit Price Contracts
• The total price for a work item is computed by
calculating the product of the price-per-unit quoted by
the contractor and the quantity estimated by the
engineer.
• At the time of tendering, the total contract price is
determined by summing the total prices for the
various work items.

Dr C.J. Willis, CAPM, P.Eng 24

 Unit Price Contracts
• In unit price contracts, progress payments for
the contractor are based on precise
measurement of the field quantities placed.
• When the actual quantity associated with a
work item differs from the estimated
quantity (i.e. the quantity used for
tendering) by more than 10%, the unit price
for that work item is normally renegotiated.

Dr C.J. Willis, CAPM, P.Eng 25

 Unit Price Contracts

• The disadvantages associated with the use of unit price

contracts include:
– The true contract price is not known until the project
is completed.
– Unit price contracts are susceptible to being
manipulated via unbalanced bidding for profit and
unbalanced bidding for front end loading.

Dr C.J. Willis, CAPM, P.Eng 26

 Unit Price Contracts

• Unit price contracts are best used when the

design responsibility remains with the owner
or the design is completed during construction.
• For the contractor, this has lower risk than
lump sum

Dr C.J. Willis, CAPM, P.Eng 27

 Cost + Fixed Percentage Contract

• In this form of the Cost Plus contract type the

contractor is reimbursed for all direct expenses for
labour, materials and equipment, as well as indirect
expenses such as overhead.
• In addition, the contractor is paid a percentage of the
reimbursable cost as his / her fee.

Dr C.J. Willis, CAPM, P.Eng 28

 Cost + Fixed Percentage Contract
• Example:
– The owner and contractor have agreed that the contractor
will receive a fixed percentage of 7% of the reimbursable
cost.
– If the reimbursable cost is $1,000,000, the contractor will
receive 7% of $1,000,000, i.e. $70,000 as his/her fee.
– If the contractor uses more expensive materials and
techniques, and increases the reimbursable cost to
$2,000,000, then his/her fee doubles to $140,000
• Best for contracts with new technology
• Not recommended for time limited projects
• Risk shifted more towards the owner

Dr C.J. Willis, CAPM, P.Eng 29

 Cost + Fixed Fee Contract

• The contractor is reimbursed for all direct expenses for

labour, materials and equipment, as well as indirect
expenses such as overhead.

• The contractor receives a fixed fee for his expertise, which

is essentially a profit or markup.

• The fixed fee is paid regardless of the fluctuation of the

reimbursable cost component and is usually established as
a percent of an originally estimated total cost figure.

Dr C.J. Willis, CAPM, P.Eng 30

 Cost + Fixed Fee
Example:
• A project’s total cost is estimated to be $77,000,000 and the
owner and contractor have agreed that the contractor’s fixed fee
will be 1% of this estimated cost, i.e. $770,000.
• If the actual reimbursable cost is $50,000,000 the contractor will
still receive a fixed fee of $770,000.
• If the actual reimbursable cost increases, the contractor’s fixed
fee remains as $770,000.
• This form of the Cost Plus contract type gives the contractor an
incentive to get the job done as quickly as possible.
• Contractors may tend to use expensive reimbursable materials
and methods to expedite the completion of the project.
• Owner risk only in direct cost
• Contractor can lose profit if project is delayed

Dr C.J. Willis, CAPM, P.Eng 31

 Cost + Fixed Fee + Profit Sharing

• This form of the Cost Plus contract type provides a

reward to the contractor who controls costs, keeping
them at a minimum.
• In this formula it is common to specify a target
price for the total contract. If the contractor brings
the job in under the target, the savings are divided or
shared between the owner and the contractor.
• It is common for the contractor to share or receive
25% of the under-run of the target.

Dr C.J. Willis, CAPM, P.Eng 32

 Cost + Fixed Fee + Profit Sharing
Example:
• It is agreed that the contractor’s fixed fee will be
$1,700,000 and profit sharing will be 25% of the savings to
the contractor and 75% of the savings to the owner.
– The target price for the project is estimated at $17,000,000.
– If the contractor completes the project for $16,500,000, the
contractor will be reimbursed $16,500,000 plus a fixed fee of
$1,700,000 plus 25% of $500,000.
– If the contractor is able to complete the project for $15,000,000
instead, the contractor will be reimbursed $15,000,000 plus a
fixed fee of $1,700,000 plus 25% of $2,000,000
• The contractor is motivated find ways of saving costs
during construction.
• If the contractor finished with cost overrun, no penalty
• Contractor tends to finish with cost savings to increase profit
at an agreed %

Dr C.J. Willis, CAPM, P.Eng 33

 Cost + Fixed Fee + Sliding Fee
• This form of the Cost Plus contract type not only provides a
bonus for under-run (savings) but also penalizes the contractor
for overrunning (exceeding) the target price.
• The amount of the sliding fee increases as the contractor falls
below the target and decreases as he / she overruns the target
price.
• A formula for calculating the contractor’s sliding fee based on
a sliding scale is
 
Sliding Fee = R (T – A)
 
Where T = target price
R = base percent value
A = actual cost of construction
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 Cost + Fixed Fee + Sliding Fee
• Example
• The target price for a project is set as $17,000,000
• The contractor’s fixed fee is agreed as being
$1,700,000.
• In addition, the base percent value for profit sharing is
5%.
• If the contractor completes the project at an actual cost
of $15,000,000, the sliding fee will be:
• Sliding fee = 0.05($17,000,000 – $15,000,000) =
$100,000
• The contractor’s total fee will be: $1,700,000 +
$100,000 = $1,800,000
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 Cost + Fixed Fee + Sliding Fee

• If the contractor completes the project at an actual

cost of $19,000,000, the sliding fee will be:
• Sliding fee = 0.05($17,000,000 – $19,000,000) =
–$100,000
– This means the contractor will be penalized an amount
of $100,000)
– Note: The penalization is for +$100,000
• The contractor’s total payment will be:
$1,700,000 – $100,000 = $1,600,000
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 Cost + Fixed Fee + Sliding Fee

• Contractor will be penalized for cost

overrun and rewarded for cost savings
• Risk of cost overrun distributed between the
owner and the contractor

Dr C.J. Willis, CAPM, P.Eng 37

 Provisions for Risk Allocation
• The total contract price is the primary mechanism that
reflects the allocation of risks among the parties to a
contract.
• A contract usually contains a number of provisions that
assign responsibility for covering the costs of possible or
unforeseen circumstances.
• The following is a partial list of responsibilities with
concomitant risks that can be assigned to contracting parties
through contract provisions:
– Force majeure
– Indemnification(Insurance)
– Occupational safety and health of workers
– Suspension of work
– Liquidated damages
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