1.040/1.401 project management - mit · 2019-09-12 · addendum no.1 to all prospective bidders...

Dr. SangHyun Lee

1.040/1.4011.040/1.401

Project ManagementProject ManagementSpring 2007Spring 2007

Project Organization Part 2 & 3Project Organization Part 2 & 3Payment & Award MethodPayment & Award Method

Department of Civil and Environmental EngineeringDepartment of Civil and Environmental EngineeringMassachusetts Institute of Technology Massachusetts Institute of Technology

OutlineOutline

Payment SchemesPayment SchemesFundamentalsFundamentalsLump sumLump sumUnit pricesUnit pricesCost plus percentage feeCost plus percentage feeCost plus fixed feeCost plus fixed feeGuaranteed maximum priceGuaranteed maximum priceIncentiveIncentive

Award MethodsAward MethodsBiddingBiddingNegotiationNegotiationBest ValueBest Value

Fundamental IdeasFundamental Ideas

Contractors are often highly risk averseContractors are often highly risk averseFor risks that contractor For risks that contractor cancan’’t t control, may be willing to pay a control, may be willing to pay a risk premium (charge less for contract) to owner to take overrisk premium (charge less for contract) to owner to take overFor risks that contractors For risks that contractors cancan control, may be willing to control, may be willing to managemanagerisk than to pay a risk premium (charge less for contract)risk than to pay a risk premium (charge less for contract)

Fundamental IdeasFundamental Ideas

Structure contract so thatStructure contract so that

Risks contractor can better handle are imposed on contractor Risks contractor can better handle are imposed on contractor (i.e. contractor will lose $ if don(i.e. contractor will lose $ if don’’t control)t control)

To be competitive, will have to To be competitive, will have to managemanage thesethese

Risks owner can better handle are kept by ownerRisks owner can better handle are kept by owner

Fundamental BalanceFundamental Balance

Impose Impose highhigh enough risk incentive to get contractor do job efficiently enough risk incentive to get contractor do job efficiently

–– within the specifications of the contractwithin the specifications of the contract

E.g. Incentive to finish on time, incentive to stay within budgeE.g. Incentive to finish on time, incentive to stay within budgett

Impose Impose lowlow enough risk to have reasonably low bidenough risk to have reasonably low bid

Impose according to contractor ability to tolerateImpose according to contractor ability to tolerate

Derivative Results of Risks: Derivative Results of Risks: Impact on Construction TimingImpact on Construction Timing

More risk on contractor, the longer will delay construct.More risk on contractor, the longer will delay construct.Also, in terms of costAlso, in terms of cost

Given uncertainty, contractor will charge more up frontGiven uncertainty, contractor will charge more up front

Owner doesnOwner doesn’’t want to pay a huge amount up frontt want to pay a huge amount up front

Owner can expedite Owner can expedite –– by paying higher price (risk premium) to by paying higher price (risk premium) to contractor or by shouldering riskcontractor or by shouldering risk

Remember; delay can have major costs Remember; delay can have major costs –– but so can wrangling but so can wrangling over change orders!over change orders!

Addenda and Change OrdersAddenda and Change Orders

Addenda Addenda Any changes that arise before bid opening and during the Any changes that arise before bid opening and during the bidding period become part of the bid packagebidding period become part of the bid package

Change OrdersChange OrdersAny changes that arise after the contract is signed due to:Any changes that arise after the contract is signed due to:

Different Site ConditionsDifferent Site Conditions

Errors/ Omissions in the Contract DocumentsErrors/ Omissions in the Contract Documents

OwnerOwner’’s Requirements Requirement

OthersOthers

Requires adjustments in scope, time, and cost.Requires adjustments in scope, time, and cost.

Note on Change OrdersNote on Change Orders

Changes contract (cost/schedule/scope/etc.)Changes contract (cost/schedule/scope/etc.)

Can lead to costs beyond contract specificationCan lead to costs beyond contract specification

Anticipated costs incorporated in Anticipated costs incorporated in ““contingencycontingency””

Often 1Often 1--10% on top of agreed upon price10% on top of agreed upon price

Often only paid for additional direct costsOften only paid for additional direct costs

Big problem if disruption in workBig problem if disruption in work

Source of very large riskSource of very large risk

Addenda Addenda -- ExampleExample

Source: Fisk, 2003

CITY OF PALM SPRINGSENGINEERING DIVISION

ADDENDUM NO.1

To all prospective bidders under Specifications for Re-roofing the Police Department Building, City Project No. 93-52, for which bids are to be received by the City of Palm Springs at the office of the purchasing manager at 3200 East Tahquitz Canyon Way, Palm Springs, California 92262 until 4:00 pm on Tuesday 21 March 1995.

I. The existing three bid schedules in the Specifications and Drawings for this contract have been revised. Bid schedules “A”, “B”, and “C” have been changed and revised bid Schedules have been included as a part of this Addendum No.1.

II. The Specifications as originally issued, along with revised Schedules “A”, “B”, and “C” shall be used in submitting bids, and acknowledgement of receipt of this Addendum No.1 shall be entered on Page 1 of the Bid. Failure to provide such acknowledgement shall render the bid as non-responsive and subject to rejection.

BY ORDER OF THE CITY OF PALM SPRINGS

13 March 1995 By Robert J. Rocket, PECity EngineerCivil Engineer C 28209

Change Order Change Order -- ExampleExample

Source: Fisk, 2003

E.R. FISK & ASSOCIATESP.O. Box 6448 Orange CA 92613.6448 CHANGE ORDERPROJECT TITLE: Dalles Hydroelectric Project PROJECT No.: F-409 CONTRACT NAME: w34-6759 CONTRACT DATE: 29 OCT 1990 CONTRACTOR: International Constructors, Inc.

The following changes are hereby made to the contract Documents: Construction of access bridge abutment No.1 drainage system; and Reset two penstock bearing plates. All in accordance with revised DWG S-17209 Revision 3, dated 28 August 1991.

JUSTIFICATION: Unforseen soil conditions

CHANGE TO CONTRACT PRICEOriginal Contract Price: $ 13,231,053.00Current Contract Price as adjusted by previous change orders: $ 13,257,760.00The Contract Price due to this change order will be increased by $ 14,342.00The new Contract Price due to this change order will be: $ 13,272,102.00

CHANGE TO CONTRACT TIMEThe Contract time will be increased by 21 calendar daysThe date for completion of all work under the contract will be 24 June 1992.

APPROVALS REQUIREDTo be effective, this order must be approved by the Owner if it changes the scope or objective of the project., or may otherwise be required under the term of the Supplementary General Conditions of the Contract.

Requested by: Proj Mgr – E.R. Fisk & Associates (date 28 Aug 1991)Recommended by: E.R. Fisk & Associates (date 28 Aug 1991)Ordered by: Dalles Power Company (date 02 Sep 1991)Accepted by: International Constructors, Inc. (date 09 Sep 1991)

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Lump Sum or Fixed PriceLump Sum or Fixed Price

The Owner knows the actual cost of the project before it begins The Owner knows the actual cost of the project before it begins

Contractor required to achieve the project at the Bid/NegotiatedContractor required to achieve the project at the Bid/NegotiatedContract ValueContract Value

Minimize the risk for the Owner if the project is well estimatedMinimize the risk for the Owner if the project is well estimated, , contractual documents accurate, and project clearly definedcontractual documents accurate, and project clearly defined

Lump Sum or Fixed PriceLump Sum or Fixed Price

High risk for the Contractor in case of many unforeseen problemsHigh risk for the Contractor in case of many unforeseen problems

Generally utilized with the Traditional Method & usually not posGenerally utilized with the Traditional Method & usually not possible sible with Fast Trackwith Fast Track

Usually a high incentive to finish early at low costUsually a high incentive to finish early at low cost

Cost Versus Price for Lump SumCost Versus Price for Lump Sum

Source: Macomber, 1989

} }

}B

C

A

$10,300

Final Cost

A = If final cost is $9,500, contractor profit is $800 (8.42%)

B = If final cost is $10,000, (as expected), contractor profit is $300 (3%)

C = If final cost is $10,500, contractor loss is $200 (-1.9%)

Fina

l Pri

ce

$9,5

00

$10,

000

$10,

500

Lump-Sum Contract

(Price is fixed at $10,300) Figure by MIT OCW.

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Unit Price ContractUnit Price Contract

Agreement on the price charged per unit by the Contractor to theAgreement on the price charged per unit by the Contractor to theOwnerOwner

Contractor overhead must be integrated in the UnitContractor overhead must be integrated in the Unit’’s Pricess Prices

The lowest bidder is normally selectedThe lowest bidder is normally selected

Necessity of an Owner presence on site to measure the actual Necessity of an Owner presence on site to measure the actual quantitiesquantities

Unit Price ContractUnit Price Contract

Highly dependant on the accuracy of the estimation of the Highly dependant on the accuracy of the estimation of the quantities given by the Owner/Designerquantities given by the Owner/Designer

Difficult to accurately quantify the work necessary Difficult to accurately quantify the work necessary

Contractor can make a more profit because payment is based on acContractor can make a more profit because payment is based on actual tual quantities but he can also lose money in the same wayquantities but he can also lose money in the same way

The total cost for the Owner can be greater than plannedThe total cost for the Owner can be greater than planned

UnitUnit Price: ExamplePrice: Example

Activities:Activities:FootingsFootings 80 $/sq ft80 $/sq ftColumnsColumns 1,550 $/unit1,550 $/unit

Scheduled quantities:Scheduled quantities:FootingsFootings 100 sq ft100 sq ftColumnsColumns 9 units9 units

Contract initial value:Contract initial value:80 * 100 + 1,550 * 9 = 14,750 $80 * 100 + 1,550 * 9 = 14,750 $

Example: Pile DrivingExample: Pile Driving

Too risky to just charge fixed priceToo risky to just charge fixed price

Geotechnical uncertainties make length of piles uncertainGeotechnical uncertainties make length of piles uncertain

Risk allocationRisk allocation

Price risk more under contractor control (efficiency, crew and Price risk more under contractor control (efficiency, crew and equipment selection): to contractorequipment selection): to contractor

Length out of contractor control: to ownerLength out of contractor control: to owner

Owner must precisely monitor length usedOwner must precisely monitor length used

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Cost Plus Percentage FeeCost Plus Percentage Fee

The Owner is paying The Owner is paying the actual costthe actual cost plus a fixed percentage feeplus a fixed percentage fee

High risk for the OwnerHigh risk for the Owner

Maximum flexibility for the OwnerMaximum flexibility for the Owner

Used only if the pricing could not be calculated in any other waUsed only if the pricing could not be calculated in any other way y and if it is urgentand if it is urgent

No financial insurance of ultimate costNo financial insurance of ultimate cost

Cost Plus Percentage FeeCost Plus Percentage Fee

Little incentive to reduce costs Little incentive to reduce costs

The Contractor agrees to do his/her best efforts to achieve the The Contractor agrees to do his/her best efforts to achieve the goalsgoals

Whatever the quality of the work, the reward is the same but theWhatever the quality of the work, the reward is the same but theowner gets the quality he/she pays forowner gets the quality he/she pays for

Permits collaboration at the early stages of the ProjectPermits collaboration at the early stages of the Project

Cost Versus Price for Cost Plus %Cost Versus Price for Cost Plus %


$11,025

$10,500

$9,975

$9,5

00

$10,

000

$10,

500

}}

}

A

B

CFi

nal P

rice

Final Cost

A = If final cost is $9,500, contractor profit is $475 (5%)

B = If final cost is $10,000, contractor profit is $500 (5%)

C = If final cost is $10,500, contractor profit is $525 (5%)

Time-and-Materials Contract

(Price = cost plus 5%)Figure by MIT OCW.

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Cost Plus Fixed FeeCost Plus Fixed Fee

Cost may vary but the fee remains firmCost may vary but the fee remains firm

The fee is independent of the duration of the projectThe fee is independent of the duration of the project

Used only if the pricing could not be determined in an alternatiUsed only if the pricing could not be determined in an alternative ve mannermanner

No financial insurance of ultimate costNo financial insurance of ultimate cost

Cost Plus Fixed FeeCost Plus Fixed Fee

Little incentive to reduce costs but high incentive to finish eaLittle incentive to reduce costs but high incentive to finish earlyrly

The Contractor agrees to make best efforts to complete the workThe Contractor agrees to make best efforts to complete the work

Promotes collaboration at the early stages of the projectPromotes collaboration at the early stages of the project

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Guaranteed Maximum Price (GMP)Guaranteed Maximum Price (GMP)

Variation of the Cost Plus a Fee by having a cap, or GMPVariation of the Cost Plus a Fee by having a cap, or GMP

The Contractor assumes any additional costs after the The Contractor assumes any additional costs after the ““CeilingCeiling””Point is reachedPoint is reached

Similar to CPFF but quality may be sacrificed to avoid increasesSimilar to CPFF but quality may be sacrificed to avoid increases in in cost beyond GMPcost beyond GMP

Variation: Usually, GM Shared Savings Variation: Usually, GM Shared Savings -- Below the guaranteed Below the guaranteed maximum, savings are shared between Owner and Contractormaximum, savings are shared between Owner and Contractor

Cost Versus Price for GMPCost Versus Price for GMP


}}

A

B

C$10,500

$10,000

Fina

l Pri

ce

Final Cost

Guaranteed-Maximum-Price Contract

(Price = cost of work plus fixed fee of $500 with a maximum price of $10,500)

A = If final cost is $9,500, contractor profit is $500 (5.26%)

B = If final cost is $10,000, contractor profit is $500 (5%)

C = If final cost is $10,500, contractor profit is $0 (0%)

$9,5

00

$10,

000

$10,

500

Figure by MIT OCW.

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Principles of Incentive ContractsPrinciples of Incentive Contracts

TARGET COST: $20,000TARGET FEE: $1500SHARING RATIO: 80/20 %

•CUSTOMER PAYS 80 % OF OVERRUN

•CONTRACTOR PAY 20 % OF OVERRUN

•PROFIT IS $1500 LESSCONTRACTOR’S 20 %

•CUSTOMER KEEPS 80% OF UNDERRUN

•CONTRACTOR KEEPS 20% OF UNDERRUN

•PROFIT IS $1500 PLUSCONTRACTOR’S 20 %

Note: Limitations may be Imposed on Price or Profit

EXAMPLE

Additional Profits are Possible by Lowering Cost Customer and Contractor Share Cost Savings

Source: Kerzner, 2000

$20,000

Incentive Contracts: ExampleIncentive Contracts: Example

Fixed Price Incentive FeeFixed Price Incentive Fee•Sharing: 70/30 (O/C)

•Target Cost: 10,000

•Target Fee: 850

•Target Price: 10,850

•Price Ceiling: 11,500

Fixed Price Incentive Fee

-4000

-2000

0

2000

4000

6000

8000

10000

12000

14000

9000 10000 10928 11300 11500 12000 13000

Profit

Final Price

Incentive Contracts: ExampleIncentive Contracts: Example

Cost Plus Incentive FeeCost Plus Incentive Fee•Sharing: 85/15 (O/C)

•Target Cost: 10,000

•Target Fee: 750

•Maximum Fee: 1350

•Minimum Fee: 300

More financial risk for the owner in a CPIF, the target fee is usually less than in an FPIF contract and the contractor’s portion of the sharing ratio is small

Cost Plus Incentive Fee

0

2000

4000

6000

8000

10000

12000

14000

16000

4000 6000 9000 10000 13000 14000

Profit

Final Price

ContractorContractor’’s Riskss Risks

FFPCPPF Risk For Contractor

HIGHLOW

LEGEND

FFP FIRM FIXED PRICE-LUMPSUMCPPF COST PLUS PERCENTAGE FEE

Source: Kerzner, 2000

Contractual Risk AllocationContractual Risk Allocation

100 %RISK Allocation

Lump-Sum (Fixed Price)100 %

CO

NTR

AC

TOR

’S R

ISK

OW

NER

’S R

ISK

RISK SHARING METERModified from Kerzner, 2000

0 %

0 %

Fixed-Price w/ Economic Price Adjustments

Fixed-Price Incentive

Cost-Plus Incentive

Cost-Plus Fixed Fee

Cost-Sharing

Cost-Plus Percentage

ConclusionConclusion

When the market is not very good, clients insist on fixed price When the market is not very good, clients insist on fixed price bids bids whereas when the project offers are numerous, it is more difficuwhereas when the project offers are numerous, it is more difficult to lt to obtain those conditionsobtain those conditions

The Choice of payment scheme (i.e., contract type) must depend oThe Choice of payment scheme (i.e., contract type) must depend on:n:

The accuracy of the estimationThe accuracy of the estimation

The ultimate cost known since the beginning or at least the maxiThe ultimate cost known since the beginning or at least the maximummum

The desired riskThe desired risk

The priority of the goal of quick completion of workThe priority of the goal of quick completion of work

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Competitive Bidding Competitive Bidding –– Lowest PriceLowest Price

Traditional & Widely UsedTraditional & Widely Used

Time consuming process involving a bidding period as well as a bTime consuming process involving a bidding period as well as a bid evaluation & id evaluation & review period prior to issuing notice to proceed with constructireview period prior to issuing notice to proceed with constructionon

Work awarded to lowest bidderWork awarded to lowest bidder

Project constructed with specified quality at lowest priceProject constructed with specified quality at lowest price

Formal procedure for public agenciesFormal procedure for public agencies

Two main typesTwo main typesOpen Form: Bid open & read publiclyOpen Form: Bid open & read publiclyClosed Form: No public openingClosed Form: No public opening

Contractor estimates cost of building project along with profitContractor estimates cost of building project along with profitUnitUnit--PricePriceLumpLump--SumSum

Loss is absorbed by the Contractor, if actual cost exceeds contrLoss is absorbed by the Contractor, if actual cost exceeds contracted amountacted amount

Issues with BidsIssues with Bids

Low bidders can be unreliableLow bidders can be unreliablePrequalify aggressively!Prequalify aggressively!

Pressure for lowest bid can createPressure for lowest bid can createCutting cornersCutting corners

LowLow--quality personnelquality personnel

Bad feelingsBad feelings

Growing Frequency: innovative bidding methodGrowing Frequency: innovative bidding methodMultiMulti--parameter bidding (e.g., low bid + other factors)parameter bidding (e.g., low bid + other factors)

To Bid or Not to BidTo Bid or Not to Bid

Strategic Goals of the CompanyStrategic Goals of the Company

Capabilities of the CompanyCapabilities of the Company

Location of the WorkLocation of the Work

Bid LogisticsBid Logistics

LicensingLicensing

PrePre--QualificationQualification

BondingBonding

Scope of WorkScope of Work

Resource RequirementsResource Requirements

BondingBonding

Protection for Owner against ContractorProtection for Owner against Contractor’’s Defaults DefaultThe Miller Act (1935) The Miller Act (1935) –– the level of bonding required for federally funded projects. the level of bonding required for federally funded projects.

Source: Halpin and Woodhead, 1998

Owner Contractor

Surety(BondingCompany)

BondingBondingBid Bond: will the selected bidder start the project? Bid Bond: will the selected bidder start the project?

PublicPublic~20% or as low as 5% of Bid~20% or as low as 5% of Bid

PrivatePrivate5% to 10% of Bid5% to 10% of Bid

Performance Bond: will the contract work be completed and complyPerformance Bond: will the contract work be completed and comply with project with project specification?specification?

100% Complete Job at Bid Price100% Complete Job at Bid Price

Payment Bond: will a contractor pay any associated charges (e.g.Payment Bond: will a contractor pay any associated charges (e.g., subcontractor fee)? , subcontractor fee)? Cover Unpaid Bills by ContractorCover Unpaid Bills by Contractor

50% for < $1M50% for < $1M40% for $1M < X < $5M40% for $1M < X < $5M2.5M for > $5M2.5M for > $5M

Most Institutions Now Require 100%Most Institutions Now Require 100%

Bonding Capacity CalculationBonding Capacity CalculationNo Track Record: (5 or 6) No Track Record: (5 or 6) ×× Net Quick Assets Net Quick Assets Old Reliable Record: (40+) Old Reliable Record: (40+) ×× Net Quick AssetsNet Quick Assets

Net Quick Assets = Quick Assets Net Quick Assets = Quick Assets –– Current LiabilitiesCurrent LiabilitiesSource: Halpin and Woodhead, 1998

MIT Wood Inc.MIT Wood Inc.

Bonding Capacity Bonding Capacity $2,500,000$2,500,000

Potential New JobsPotential New JobsPP1: $750,000PP1: $750,000PP2: $1,000,000PP2: $1,000,000

Current Jobs as SubCurrent Jobs as SubP1: $1,000,000; 25% CompleteP1: $1,000,000; 25% CompleteP2: $1,000,000; 50% CompleteP2: $1,000,000; 50% Complete

Current Job as GCCurrent Job as GCP3: $500,000; 50% CompleteP3: $500,000; 50% Complete

BondingBondingPotential New JobsPotential New Jobs

PP1: $750,000PP1: $750,000PP2: $1,000,000PP2: $1,000,000

Current Jobs as Sub Current Jobs as Sub PerformancePerformance

P1: $1,000,000*0.75 = $750,000P1: $1,000,000*0.75 = $750,000P2: $1,000,000*0.50 = $500,000P2: $1,000,000*0.50 = $500,000

Current Job as GC Current Job as GC PerformancePerformance

P3: $500,000*0.50 = $250,000P3: $500,000*0.50 = $250,000PaymentPayment

P3: $500,000*0.50*.0.50 = $125,000P3: $500,000*0.50*.0.50 = $125,000

Used Up BondingUsed Up Bonding$1,625,000$1,625,000

Available BondingAvailable Bonding$875,000$875,000

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NegotiationNegotiation

PrePre--selected Contractorselected Contractor

Common practice for private ownersCommon practice for private owners

Owner picks Contractor on basis of:Owner picks Contractor on basis of:ReputationReputationOverall qualifications to do the jobOverall qualifications to do the job

Typical financial contract types are:Typical financial contract types are:Cost Plus FeeCost Plus FeeGuarantee Maximum Price (GMP)Guarantee Maximum Price (GMP)

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Best Value

Used by the Federal GovernmentProvides a uniform set of procurement regulationsRequest for Proposal (RFP) states:

Relative importance of priceTechnical meritTechnical evaluation criteria and their weights

Selection of Contractor is based on the best value of the proposed work

PriceTechnical Factors