Contracting approaches

Contracting approaches will vary based on the characteristics of the contracting parties, risk appetites, decisions made on scope of work, and degree of project scope definition.

Contract differences based on payment terms

The figure below shows how scope definition and risk can vary for various contract payment types. The more effort that the owner puts into scope definition the more likely a lump sum / fixed price contract can be achieved. Such a contract places more risk onto the contractor and less onto the owner. If less scope definition has been achieved then contractors will more likely only accept day rate or time and materials types of contracts. Such T&M contracts place more risk onto the owner, as there is no upper limit on project costs.

It should be noted that there can be different interpretations or gradations of what a lump sum or fixed price contract entails. Some contracts allow for escalation increases due to increases in costs of labour or commodities (often called a firm price contract), others incorporate incentives or fees in addition to the fixed component, while others allow for no increases at all (often called a simply a fixed price contract). Even under fixed price contracts owners can be liable for contract price increases due to approved scope increases or force majeure claims.

Inexperienced owners can often attempt to place more risk onto contractors by insisting on lump sump contracts in the absence of proper scope definition. Where scope definition requires more work to be fully defined, a partial release of funds or preliminary phase development contract can be advantageous. In such an approach, a contractor is paid a certain amount to do investigations, detailed project planning, and preliminary design work, etc., in order to more fully define project execution phase costs and risks. A separate approval is then obtained to proceed with the remaining work on the project. Such ‘gated’ approaches are often recommended by experienced project management organizations.

Contracts based on scope of work

Contracts can also be discussed based on the particular scope of work included within the contract. Owners may decide to manage all work on a project themselves, or decide to contract out a portion or all of the particular project. The figure below describes some of the differences between these approaches.