How contractors are affected by guaranteed maximum price contracts

Drive-thru:

  • A guaranteed maximum price (GMP) project sets a maximum fee for contractors as the cost of performing the job plus an agreed-upon profit rate.
  • GMP contracts encourage more collaboration in construction projects, but also present some risks to contractors.
  • There are several ways for contractors to manage risk under a GMP, with one of the best being investing in technology to help manage the process.

Construction contracts can take many forms, with the ultimate goal of protecting project owners, contractors, and subcontractors. One such contract is the guaranteed maximum price (GMP), which project owners often see as most attractive.

On the contractor side, some in the industry say a primary benefit of GMP projects is that they encourage more collaboration in the early stages—thus ensuring the adequate outlining of the scope of work, cost, and timeline. Others say contractors assume too much risk with a GMP.

As with most things, a GMP brings benefits and drawbacks, so understanding the process is crucial. Here’s an overview of how GMP contracts work, the risks involved, and what they mean for contractors.

How GMP contracts work

A GMP project sets a maximum fee for contractors as the cost of performing the job plus an agreed-upon profit rate. Contractors must cover cost overruns, but project owners or clients are reimbursed for cost under-runs. Essentially, a GMP places a limit on what a contractor is paid, regardless of the actual project cost.

A GMP places a limit on what a contractor is paid, regardless of the actual project cost.

Under a GMP, there’s a possibility that project owners can save money if the project costs less than what the contractor estimated. Owners and contractors may want to decide in advance how to handle savings—for instance, they might share it. Agreeing to share savings could encourage contractors to look for efficiencies and keep costs down.

What’s included in a GMP?

A GMP usually includes a “schedule of values,” contingencies and allowances.

The schedule of values is a breakdown of a project’s estimated costs and a contractor’s profit into line items for specific aspects of the project. The contractor and owner will decide whether the GMP will apply for each line item or for the total price.

Contingency amounts are included in the schedule of values to give the contractor leeway in case the cost of any line item is exceeded. The contingency is used to cover unforeseen costs not caused by a contractor’s negligence.

Allowances refer to amounts that are set aside in the contract to cover decisions that owners have to make about certain aspects of the project. The allowances are usually used for materials rather than profit or overhead.

Contractor risk with GMP

Contractors assume most of the risk in a GMP agreement, but there are several ways to manage that risk. Contractors can charge more for their work or pass on the risk by offering GMP contracts to any subcontractors involved. In all scenarios, the best way to manage risk is to accurately and precisely estimate costs to avoid any overruns. Using software for job costing can help with more exact estimates.

Contractors can charge more for their work or pass on the risk by offering GMP contracts to any subcontractors involved.

How change orders are handled in a GMP

The process for handling change orders—whether it’s to increase the GMP or change the timeline—should be addressed in a contract, including how changes are initiated, agreed to and implemented. Dispute resolution is another key aspect of a GMP contract to cover situations where contractors and owners can’t agree on a price.

Cost reporting to project owners

Being transparent about actual costs can help project owners understand where there may be savings. It also helps contractors and project owners build a solid working relationship. Contractors should work to provide ongoing communication and accurate cost reporting, and many often rely on software to provide accurate reports.

GMP offers many benefits to contractors and project owners, but it’s important for contractors to also understand the risks. GMPs encourage more collaboration and organization, and accurate job costing and transparent reporting can keep projects running smoothly and protect your bottom line, so you can move on to the next big thing.

Sign up. Stay fueled.