Two pricing models are used In construction contracting. One is the time and materials (T&M) model and the other is the firm fixed price (FFP) model. As the American economy has changed, so has the common means of project pricing in construction. The more common T&M pricing is being replaced by FFP pricing to control spending and budgetary compliance. The impact on the construction industry has been substantial.

Definition

A firm fixed price contract sets a specific price for the completion of the project. The amount agreed to for the specifications listed in the contract is all that is required to be paid by the customer to the contractor. The contractor is locked into only the specifications for the cost, and the customer is locked in to the price listed for the work specified. This is different from a T&M contract in which the price quote is simply an estimate and overages may occur and need to be paid by the customer. A T&M agreement for construction can be a budget-killer and accounting nightmare for the customer.

Benefits

There are significant benefits for the customer and potential benefits for the contractor. But the majority of the benefits lean toward the customer. This isn't to say that the FFP contract is a foolish venture for the construction contractor because the profit is incorporated into the set cost for the project. And if the contractor manages to realize certain efficiencies during the execution of the project, the savings adds to the profit.

Risks

Unlike a time and materials (T&M) contract, a firm fixed price contract is inflexible. An FFP contract must be very precisely planned, and all contingencies accounted for because it will not allow for compensation for unforeseen incidents. Where a T&M contract would allow for additional labor, materials and equipment costs, an FFP will not. The rigidity presents significant financial risk to the contractor. A contractor who does not carefully calculate the costs and contingencies can sustain a devastating financial loss.

Misconceptions

The agreed price does not remain binding when the customer introduces additions or changes to the original specifications. The contract must be renegotiated and recalculated to account for the costs of the modification. The price and the specifications are linked. If the specifications are changed, the price must also change. Without modifications, the price remains intact even when unforeseen delays occur. Of course, the remedy to that is contingency clauses that allow compensation for unforeseen costs.

Warning

When considering an FFP construction contract, the customer must be realistic in the cost figures during the competitive bidding process. The acceptance of an unrealistically low price could lead to failure in project completion and other very costly legal problems. Make sure the contractor is not cutting corners and ignoring statutory building requirements to keep the bid amount down and to produce additional profit. If the contractor's estimate is so unrealistically low that he loses money, he may go bankrupt and the customer will be left with an uncompleted project. In submitting a bid, the contractor must try to predict possible expense increases and delays that could affect the bottom line. Failure to carefully and realistically consider the costs may lead to financial catastrophe and serious legal problems.

Source:

Business Dictionary

Acquisition Central: FAR 52.216-9 Fixed Fee---Construction.