One of the biggest challenges project owners, contractors and design firms have is negotiating a contract price and setting a contingency in lean IPD contracts.
In a lump sum project, that's not an issue, as the owner usually chooses the lowest bid for a contract without having any transparency into the numbers.
However, when using a guaranteed maximum price with a cost-reimbursed contract, or an integrated project delivery model, there is usually a negotiated contingency percentage, which the contractor carries.
The contingency is usually used to address things that were incomplete with the design or means and methods that the contractor chooses to implement. When an issue arises in the field, the contractor usually requests approval from the owner to use the contingency to pay for the additional required work. The owner can’t unreasonably withhold approval, which allows the contractor to resolve most issues with contingency. If the contingency is exhausted, then additional overruns would come from a reduction of the contractor's fee.
When negotiating with the construction team about what's the appropriate contingency, there are three things to consider:
- What stage of the design are we in?
- How comfortable am I with the estimate?
- What are the unresolved issues?
In a traditional contract, the phases are schematic design, design development, and construction documents.
In integrated project delivery, we work with conceptual design, design development, and implementation documents.
In this example, I use schematic design, design development, and construction documents.
Schematic design
In the schematic design phase, we're typically doing the layout and the floor plans. The question here is what is this new space going to look like?
Design development
In design development, we go into more detail and start doing elevations. For a typical healthcare project, we look at what kind of equipment is going to be in each room. What are the walls going to look like? Where are things going to hang, and what is the ceiling going to look like? We start to lay out what we call the reflected ceiling plan. Mechanical, Electrical and Plumbing systems are routed but not coordinated.
Construction documents
In the construction documents phase, the team dives deep into how the project is going to be built. They are detailing the framing, for example. If it's a new building, they're detailing all of the intricate pieces that are going to be required to build the building and get the construction permitted. This will allow the engineers and the building inspectors to evaluate it.
Proft at Rist with an IPD Framework
Image: Evgeniy Surzhan via Unsplash
What stage of the design are we in?
Regarding setting the contingency, this means that if you're very early in conceptual or schematic design or design development, you might want a bigger contingency. More things can happen. More questions haven't been answered.
Consequently, if you have finished construction documents or have submitted for a permit, and you're going to get a permit soon, then the likelihood that there are unforeseen issues is significantly smaller.
The earlier the contingency is set, the bigger the number will be. It could be between 5 and 10 percent.
I think a typical GMP-type contingency, after bidding out all of the lump sum trades, is around 3 percent.
How comfortable am I with the estimate?
Am I getting all the backups from the design and construction team? Can I review the subcontractor bids?
I recommend doing guaranteed maximum prices with the primary trade partners such as mechanical, electrical framing and drywall. I also recommend interviewing them. If I have a high level of comfort with their offer and feel that they are not going to be too aggressive or just throwing big numbers around, I am prepared to set a smaller contingency.
Also, if all of the trades are large companies, the risk factor can be lower for the general contractor and a smaller contingency is advisable.
If a contractor is dealing with smaller businesses and the project is still in the early phases, meaning that numbers can move around, I recommend a larger contingency.
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What are the unresolved issues?
If the chances are high that constructability or permitting issues are likely, I highly recommend increasing the contingency. But instead of just adding a higher percentage, I usually push a team to figure out how much more time they need, whether an investigation is required, and what the team needs to know to reduce the contingency.
From my personal experience, just throwing money at a problem without doing the work usually does not work. In most cases, we don't have that money anyway. And once we figure out what the actual solution is, it ends up costing more than we anticipated.
A reason for this behaviour could be that the issue is complicated and the team doesn’t have a solution for it. They prefer to deal with it later.
My recommendation in this situation is to take more time to resolve the issue. If this is not possible, I advise bracketing it, including assumptions, and expectations of inclusions.
When the team has worked out a solution, they have already “pre-negotiated” what that change order is going to look like down the road.
The contingency sweet spot is at 4 percent
Having seen contingencies from 3 to 6 percent, I feel the sweet spot is right around 4 percent for IPD projects, set in the middle or near the end of the design development phase. 3 percent is a good number if you are doing a GMP and have bid the trade scopes.
When setting a contingency, make sure you are thinking holistically about the upcoming project phases and associated risks on your specific job. It is more important to understand the whole picture of what you want to accomplish than to get caught up with picking a contingency number.
Want to take your construction project to the next level?
The introductory online course to integrated project delivery, designed by the Integrated Project Delivery Alliance (IPDA) and LeanIPD, is for intermediate-level construction professionals who want to deliver complex projects on time, on budget, and with the original intended scope and value proposition.
For those who want to dive deeper, the advanced online course delivers the specifics of Integrated Project Delivery and teaches project owners how to set up and manage their construction projects with IPD. From aligning incentives through shared risk-reward structures to implementing target value design and understanding change orders in an IPD framework, this course will provide the skills to take construction projects to the next level.
Feature image: Ana Municio via Unsplash
James is an expert in the set-up and structure of large, complex capital projects using Lean and Integrated Project Delivery to drive highly reliable results.
He has negotiated IPD contracts and delivered over $650M in complex healthcare projects as an Owner's Representative with multiparty contracts, aligned team incentives and collaborative delivery models.
