As noted in my previous article, Cost Plus Fee Agreements can be structured in a number of different arrangements. Some arrangements can be converted to a fixed price or into a Guaranteed Maximum Price (GMP).
Today I wanted to share how one such arrangement can be converted from variable rates into a fixed price.
Before I get into the process, let me run through the way the three cost categories (fee, GCoC, and COW) should be solicited.
First, your fee should be solicited as a variable fee. This means the quotation will be presented as a percentage of the cost of work.
The next cost category to address is the General Conditions of Construction (GCoC). The costs included in the GCoC are all generally dependent on the project schedule. The longer the project schedule, the higher the GCoC, so when it comes to the GCoC, I like to solicit this cost as a fixed weekly or monthly rate.
Since cost plus agreements are cost reimbursable agreements, the COW wont be known at the time of solicitation, but we may have a control estimate to work with, so it is possible to have some idea of what the cost of work will be.
The final piece of the solicitation is the schedule. That’s right! The schedule is a critical part of how this works. You should always ask for a milestone schedule with every solicitation (regardless of pricing model).
Keep in mind that we are early in the process so, the cost of work and the schedule are merely estimates and should not be considered as binding.
So at the outset of your construction phase, you will have those rates and estimates.
Once your design is complete and you have conducted as much due diligence as possible, the GC will begin soliciting quotes from trade contractors.
At this point, you can begin replacing each line item from your control estimate with the trade contractor’s quotes. Once all (or at least 80%) of the trade contracts have been awarded, you can start to convert all of the cost categories into fixed values.
Converting to Fixed Price or GMP
You will want to start with the COW. At this stage, using the quoted rates from each trade, your cost estimate can be converted from a non-binding estimate to a binding lump sum value. Take each line item from your control estimate and replace the estimated values with the quoted sums from each of the trade contracts secured by your GC.
The GC should now also have enough information to firm up his construction schedule. You can now lock in the substantial completion date and figure out how many weeks of construction duration you should expect.
With a firm duration in hand, you can now lock down the cost of GCoC. Simply multiply the weekly rate by the number of weeks of duration and you will have a fixed set of GCoC costs.
The fee is next. Simply take the cost of the work from step 1 and multiply by the quoted percentage. You now have a firm price fee to work with. Please note, the GCoC should not be included in this calculation. This can be controversial because the AIA and other contract template allow the GCoC and the COW to be calculated in the fee. I make sure that GC is clear that I exclude the GCoC from the fee calculation. Before the GC quotes his rates be sure to communicate this detail so there is no argument at this stage.
Note on GCoC and Fee
I treat the GCoC differently for two reasons. First, GC’s often quote the supervisory labor rate with overhead and profit already loaded, so if we were to add fee on top of this number, the Owner pays the fee twice. Second, during construction if a COW change orders come up, we will use the cost plus rates to calculate fee and GCoC. Since we have established (through our definition of these costs) that GCoC are dependent on schedule, the Owner’s should never pay more GCoC unless the project schedule has been affected. Separating the GCoC from the COW allows the Owner to control for this.
Now you can add the COW, plus the GCoC, plus the fee. The sum of these values becomes your fixed price for the project. If you are looking to lock in a GMP, you will need to allow for the GC’s contingency, but if you set the GMP late in the process as we discussed, the contingency value should be less than 10%.
So there you have it. Five steps to converting a Cost Plus contract into a fixed price or GMP. I hope this has been helpful, please do let me know if you have any questions.
What has been your experience? Have you ever converted a Cost Plus to a GMP? If so, did you follow a similar process? Tell me your stories.