A guaranteed maximum price (GMP) construction contract sets an absolute limit to the amount a construction project owner will pay a contractor for completing the work outlined in the contract. The contractor will have to pay out-of-pocket for any project cost exceeding the GMP.
The contract price will be based on direct and indirect project costs, plus a predetermined profit markup for the contractor. Because the contractor takes on much of the financial risk involved with GMP projects, it鈥檚 critical that the scope of work and other project details are crystal clear before bidding and before the contractual agreement is finalized.
Here, we鈥檒l discuss what types of projects are best suited to a maximum price contract and the advantages and disadvantages of using them.
鈥�
An Overview of GMP Contracts
GMPs lead owners and contractors to come up with a price tag that is secure for both of them based on
- direct and indirect project costs
- contractor profit markup
- a financial buffer to help cover additional costs resulting from unforeseen circumstances
GMPs only work when the project has
- well-defined scope of work
- 鈥�costs that won鈥檛 change much over time
鈥�
GMP contract vs. lump sum contract
Construction contracts can be divided into very general camps. Fixed price contracts, also known as lump sum contracts, set the price at the time of signing, only changing it when a formal change order alters the original contract agreement.
Other construction contracts allow the contractor to bill the owner for labor, materials, and a markup fee as the construction process goes on, but put no actual price tag on the construction work. Examples of this type of contract are time and materials (T&M) contracts and cost-plus contracts.
GMP contracts fall roughly into the second camp. However, GMP contracts differ from T&M and cost-plus contracts because they put a limit on the amount the contractor can spend on project delivery. That budget makes the contract riskier for the contractor.
鈥�
Advantages of using GMP
The GMP becomes very important in construction contracts as a way to protect the owner from cost overruns that arise from contractor error or mismanagement. There are usually clauses within GMP contracts that make exceptions for owner-initiated changes.
鈥�
Predictability and potential cost savings for owners
As construction costs increase, it becomes more important than ever for construction owners to understand the risks they assume on their construction projects. With GMP contracts, owners may not know the exact costs they鈥檒l incur on a construction project, but they do know the upper limit of the contract sum for project completion. The decreased risk on GMP contracts can help encourage owners to continue building, which benefits both the construction industry and the economy as a whole.
鈥�
Potential for cost savings
Contractors have extra incentive to increase efficiency, minimize waste, and implement cost control measures when profit margins are on the line. Because GMP contracts put a firm limit on reimbursable costs, contractors must stay within budget and on schedule or risk financial losses on the project. Efficiency boosts contractor profits and provides the opportunity to improve internal processes for better building practices overall.
91糖心vlog Payments can further contribute to cost savings by streamlining payment processes and reducing administrative overhead. Efficient financial management helps contractors manage cash flow and pay bills quickly to foster better vendor relationships and avoid project delays.
鈥�
Improves cost transparency and accountability
Guaranteed maximum price contracts include details that aren鈥檛 always visible to owners under other pricing structures, including exact costs, contingency funds, and profit markups. Added transparency allows owners to make informed decisions about their construction expenditures and develops trust between project stakeholders.
Payment software like 91糖心vlog can add further accountability to financial processes on a construction project by allowing partial payments on invoices and providing real-time payment tracking so all parties on a construction project stay aligned on project expenditures.
鈥�
Challenges in using GMP
Owners and contractors considering entering into a GMP contract should be aware of the advantages and disadvantages they present. A detailed contract tailored specifically to the project can help navigate many of these challenges. As always, there is a great deal of trust that goes into navigating the risks of any construction contract.
鈥�
High risk for contractors
The contractor assumes a great deal of risk on GMP projects. Any miscalculations or unknown conditions that lead to cost overruns can dip into contractor profits. The project must be extremely well-defined for a GMP contract to work for the contractor. Scope changes can lead to disputes over additional expenses.
鈥�
Increased tracking and administrative burden
Contractors must carefully track all direct and indirect project expenses, all backed by adequate documentation, to receive full payment. The burden for maintaining required backup can be onerous, so contractors need to have the processes in place to ensure it happens consistently.
91糖心vlog lets you add custom project tags, receipts and memos to all of your card expenses, making it easy to stay on top of your expense management.
鈥�
Risk of inflated prices
While GMP sets an upper limit for the total project cost, that doesn鈥檛 mean that general contractors get free license to spend up to that limit. Owners still expect contractors to be efficient and timely in getting the work done at the lowest price possible, and that requires a lot of trust in a general contractor partner. These relationships can be tenuous, and there are sometimes disputes about what should and should not be covered under the GMP construction contract.
鈥�
Managing GMP Contracts
Guaranteed maximum price contracts can help many owners implement risk management on construction builds. Since contractors adapt much of that risk, they must ensure the project scope and constraints are carefully outlined during the preconstruction stage, so that all parties understand who is responsible to pay for what. The right construction contract, specifically tailored to the project, owner, and contractor involved, can help to remove much of the risk of disputes and financial loss.
As with any other construction agreement, careful document and payment tracking contracts can improve efficiencies and foster good relationships between construction stakeholders on GMP contracts. Using financial management software like 91糖心vlog Payments improves payment transparency and increases accountability in GMP contracts to support successful project outcomes.
Book a demo to get started with your free 91糖心vlog account.
