Construction Project Delivery Methods
By Larry Watkins, Esq. (AR)
When planning your construction project, it is essential that you decide early which project delivery method is best suited for the size, complexity, and risk for your project. Further, the second most important consideration is the pricing structure for the project contract. Too often, owners do not properly consider delivery and pricing early in the project, which means that one of the most important decisions affecting project success is continually ignored at worst or blindly accepted later at best. This article is discusses what the delivery and pricing options are, how each has benefits and drawbacks, and why choosing the right combination is critical.
Project Delivery Methods
There are three ways for an owner to procure a project. These are called project delivery methods. They are design-bid-build, construction manager, and design-build.The chart below graphically illustrates the construction project delivery methods discussed in this section:
In a design-bid-build delivery method, the owner contracts with a design firm to provide 100% complete design plans and specifications for bidding. This delivery method enables the owner to competitively bid the project. After accepting a bid, the owner then separately contracts with a construction company to build the project according to the plans and specifications. At the end of the day, the owner has a design contract with the design firm and a construction contract with the contractor. Historically, this delivery method arose in the industry via federal and state government procurement. The government’s rationale was that bidding reduced corruption with government contracts, but bidding requires 100% complete plans and specifications to ensure the bidders all have the same detailed information. Over the last decade, however, government agencies began realizing that a one-size-fits-all delivery method approach for large or complex projects could result in schedule delays and cost overruns – the evidence of course is the proliferation of cost plus, design-build, and public private partnerships statutes for government projects.
Design-bid-build has value, but it is primary purpose, as stated above, is for public projects. Beyond the benefits of having a complete design and competition in bidding, Design-bid-build has drawbacks. First, in principal, does it make sense that the architect or engineer for the owner completely controls the project and costs when the design cost is usually 1% to 3% of the total project cost? The contractor should have early input into the feasibility of the construction and early suggestions to reduce costs – since the contractor’s scope of work typically accounts for 90% to 95% of the total project costs. Second, design-bid-build only works well for small, conventional projects, such as a public school facility or an office building. A complex design for a large project takes an enormous amount of time, and many of the bidding contractors will inevitably provide different prices and design deviations because they believe the design contains problems or will not agree to be liable for a system that it had no role in designing. In short, the design is too complicated to standardize it for bidding – comparing apples to apples.Conversely, the owner will end up comparing apples to oranges.
Third, if an engineer designs a complex project requiring equipment that cannot be procured or a facility that cannot be built, the change orders will pour in. Competition in bidding will not have the effect of limiting costs. Fourth, who will be liable? If the contractor cannot make the complex project function, is the problem with the design, construction, or both? Fifth, and this is often not considered because owners and public agencies assume they are entitled to a cost-free proposal, many contractors will not bid on a large, complex project. Why? The short answer is money. For a large, complex project, the cost to the contractor just to develop and submit a bid ranges from $100,000 to over $1,000,000. To the contractor, that means spending up to $1,000,000 to bid with a low probability of obtaining the contract (e.g. a 20% chance if there are 5 bidders). Sixth,the schedule will be longer as design-bid-build projects cannot be fast-tracked (overlapping design and construction). In sum, the design period must first begin and end, then the bidding period must begin and end, and after that the construction period must begin and end. The owner’s overlapping design and construction by fasttracking saves months on conventional projects and years on large, complex projects.
In a construction manager delivery method, an owner typically contracts with the construction manager to act as its agent. The construction manager (“CM”) manages all aspects of the design, purchasing, and construction. The design professionals, major suppliers, and prime contractors each contract directly with the owner, and none of them has contractual privity with the owner’s CM. The value here lies in the owner having a professional on its staff as CM to manage a project the owner cannot or does not wish to manage – regardless of complexity. The owner saves a GC mark-up because the contracts are all between the owner and various contractors. Further, the CM can fast-track the project, additionally providing early input for the project to reduce costs, schedule durations, and constructability issues.
The drawback is that the CM is only an agent of the owner. First, the CM has little or no liability for design defects, construction problems, cost overruns, or schedule delays. Second, the CM does not typically have much decision-making authority, which causes a multitude of problems when important project issues arise. Third, this delivery method places a large coordination burden on the owner because the owner must contract with all of the prime contractors – the CM has no contracts with anyone except the owner. The owner must therefore be prepared to dedicate staff to the project for procurement, especially if the CM does not have the authority to enter into contracts for the owner.
There are two additional models in the CM project delivery method category: CM at Risk and EPCM. CM at risk means that the CM is liable for cost overruns and schedule delays – that is the risk part. This mitigates some of the problems above, but not all of them. EPCM is relatively new in the industry. EPCM means engineering, procurement, and construction manager. In essence, EPCM makes the CM also responsible for the project’s design and purchasing. This takes much of the administrative burden off the owner and the CM becomes liable for engineering and procurement issues. However, the EPCM company’s liability will be very limited, and if there are schedule delays design/construction defect issues, just like the design and construction problems in design-bid-build, the CM and construction contractor will engage in finger-pointing ad infinitum.
In the traditional design-build delivery method, the design-builder contracts directly with the owner and is solely responsible for all design, purchasing, construction, costs, schedule, and performance. This primary benefit of the contractor’s sole responsibility for all aspects of the project enables the owner to take a hands-off approach. The owner only needs to turn the key when the project is finished (hence the term “turnkey” that is used in connection with design-build and EPC). There are, however, two main drawbacks.First, precisely because the contractor is taking all project risks short of financing – design, purchasing, building, cost, schedule, and performance – the contractor charges a risk contingency premium. This contingency increases the contract price initially, but arguably decreases the total project costs in terms of elimination of duplicated design efforts, fast-tracking, schedule delays, cost overruns, and disputes. Disputes affecting the owner or project are extremely rare because the design-build contractor is liable to the owner everything. Second, the owner has little or no control over the project after the contract is signed – a drawback if the owner either desires to change a design or construction.
EPC is a delivery method that falls into the design-build category. Here, as with traditional design-build, the contractor is solely responsible for the EPC portions of the project, but, unlike traditional design-build, the EPC contractor is also liable for the timely production performance of the project. As discussed more thoroughly below, the EPC contractor guarantees the production output’s quality and quantity. You should be careful not to confuse EPC with EPCM. EPCM firms do not have the performance, cost, and schedule liability that EPC contractors have because EPCM firms are agents for the owner and provide only professional design, purchasing, and management services to the owner. The EPCM firm does not build or construct the physical project.
Contract Pricing Structure Options
Beyond the three primary project delivery method alternatives, there are four price structures from which to choose for the construction contract: fixed price, fixed unit price, cost plus, and cost plus with a guaranteed maximum price (GMP). To avoid cost overruns, the owner must determine early in the project– prior to design or contract signing – how it will structure the contract price.
The most common structure is fixed price, which means the construction contract has a single price for the entire scope of work, regardless of the amount or type of work. Fixed price contracts are normally the owner’s preferred choice because the contractor is liable for cost overruns. Fixed unit price contracts require the owner to pay the contractor a fixed cost for each unit of work produced (e.g., cubic foot of concrete). Fixed unit price contracts work well for projects that have little need for extensive engineering plans and specifications – such as a 50 mile road resting on good soil and encountering few obstructions. In cost-plus contracts (also called cost reimbursement), the owner pays the actual, invoiced costs plus a contractor fee. Cost-plus is ideal for projects that have such an accelerated schedule that, even though extensive design is required, construction cannot wait for design completion. For example, leading up to World War II, the US federal government used cost-plus to rapidly build a large number of military facilities on the East Coast and West Coast. Contractors unwilling to take risks on complex projects may also insist on cost-plus pricing (e.g. LNG or nuclear projects). The cost-plus with GMP contract maintains the reimbursement structure of the cost-plus pricing, but the contractor is liable for cost overruns if the construction cost exceeds the contractor’s GMP. To stay competitive, the contractor cannot increase the GMP too high above the market rate.
In theory, a party could use any one of these price structures for any of the project delivery methods, but some price structures do not pair well with certain delivery methods. For example, a design-build delivery method would not work well with the fixed unit price projects, which would not require any contractor design. In other words, why pay a premium for design-build if there is no design or complex construction? For another example, a design-bid-build delivery would not work well with cost-plus pricing. Recall that with design-bid-build the plans and specifications will be 100% complete, allowing the contractor to provide a competitive, fixed price. If an owner were to use cost-plus pricing with design-bid-build delivery, the contractor would have a blank check to complete the project construction without any cost overrun risk – defeating the purpose of design-bid-build and disregarding the value of cost-plus pricing on projects that must commence construction without a complete design.
Typically, certain delivery methods are paired with specific pricing structures. Design-bid-build delivery is nearly always paired with a fixed price contract, but this delivery can also be paired with a fixed unit price contract. CM pairs well with all four pricing structures. Design-build is very compatible with fixed price, cost-plus, and cost-plus with a GMP.
In conclusion, although there are many combinations of project delivery methods and pricing structures, the right combination for your project mitigates schedule delays, cost overruns, and quality & performance shortfalls. Choose the best combination intentionally and wisely.*
*The information in this article does not constitute legal advice and is for general educational purposes only.