The Hidden Costs of Cost-Plus/GMP Work

There are cost inefficiencies intrinsic to the cost-plus/GMP delivery of construction (often referred to simply as GMP delivery).  The cost-plus/GMP method may have merit when delivering projects with significant unknown risks such as first-of-a-kind projects, or projects with limited historical data, or when a project must start construction without completion of the design.  However, when cost-plus/GMP delivery is used to deliver projects with well-established cost histories or projects with reasonably complete construction documents, then the cost-plus/GMP delivery method is likely to produce a cost premium when compared to a stipulated sum contract delivery (Lump Sum delivery).

Let’s explore why.

In a lump sum contract, the contractor is incentivized to deliver the project quickly and cost efficiently.  The incentive is simple.  When the contractor effectively drives the project with the optimal staff, he finishes on time or early and he enjoys the savings which result.  Lump sum contractors track their costs accurately and they develop robust cost history data.  That cost history is used to adjust estimating models to adjust means and methods to improve efficiencies.

GMP projects generally include more general conditions than lump sum contracts.  The contractor has more administrative work to do in a GMP delivery.  Subcontractor selection, change management and invoicing, all require more administrative effort and therefore more staff.  In addition to higher staffing levels, the problem is worsened when GMP is used to start a project before the design documents are completed.  Those projects are likely to have longer construction durations – which increases general conditions.  In GMP deliveries general conditions costs are oftentimes shifted to subcontract scopes of work.  The reason for this is that GMP contracts usually limit reimbursable general conditions items, so the shrewd GMP contractor will shift general conditions costs into the trade packages where there is no limitation on reimbursable costs.  Because of the shifting of costs to take the best advantage of reimbursability, GMP contract deliveries do not lend themselves to establishing unambiguous subcontract cost history.

The cost premium for GMP delivery also includes inefficiencies in subcontractor procurement.  In a GMP delivery, the contractor and the owner are not completely aligned in subcontractor selection.  The contractor is incentivized to select the subcontractor that represents the lowest risk to the contractor’s fee.   The owner would benefit from the contractor preferring to procure at the lowest total cost but the GMP delivery method does not promote that behavior.  If the total cost is trending to budget, the GMP contractor will select subcontractors with whom they have existing relationships, who have the strongest balance sheets, and, at times, to whom they owe a favor.   The stipulated lump sum contractor will select the lowest cost subcontractor that can execute the work.

Construction contingency is necessary for a GMP contract.  Construction contingency is carried within the GMP contract and is not the same as the owner’s contingency which is carried outside the GMP contract.  The amount of construction contingency varies as negotiated by the parties, but it is typically 2%-3% or more.  Shared savings of the contingency provides a limited incentive to align the contractor with the owner’s interests but the alignment is incomplete.  The contractor will not be as hard driving when negotiating subcontractor change requests if there are available contingency funds to cover the change.

There are even instances when it could be beneficial for a contractor to agree to settle subcontractor disputes on one project with change orders on a second project (when that second project has available contingency funds)…this is improper, but the structure of the agreements provides the incentive to do so.  There is no such incentive on stipulated lump sum contracts.

Stipulated lump sum contracts avoid the cost inefficiencies inherent in GMP contracts arising from general conditions inefficiencies, misalignment of procurement objectives, and inefficiencies and conflicts of interest derived from the existence and use of contingency.   Stipulated lump sum contracts are an effective alternative to GMP contracts especially when the project type has a proven cost history; when using a contractor experienced in the project type; and when construction will start with reasonably complete design documents.

Peter Douglas, P.E.
The Douglas Company

Read More >