Project Contract Types

Project Delivery Systems vs. Contracting Methods: The two terms that are often referenced interchangeably

In construction and infrastructure projects, determining who assumes the risk and how it is allocated and mitigated is crucial for success. Research shows that the effectiveness of risk allocation and mitigation largely depends on the chosen Project Delivery System (PDS) and Contract Method[1]. The two terms that are often misunderstood and are sometimes used interchangeably.

In June 2022, the Airports Council International-North America, along with other collaborators, developed a comprehensive guide for selecting the Project Delivery System (PDS) in airport projects [1]. The guideline clarifies the distinction between a Contracting Method and a Project Delivery System. According to the report, "a PDS defines the relationships among the various parties involved in the project and the distribution of responsibility, risk, and liability." In contrast, contract types specify how the parties are compensated for the risks they assume. In other words, the PDS determines the allocation of risks between parties, while the contract method governs the compensation mechanism.

The attached figure from the report provides guidance on using different contract types (compensation approaches) based on the level of design completion. For example, a lump sum contract is generally advantageous when the design is well-defined, while a cost-plus contract is preferable when it is not. Various contract types can also be used for collaborative risk-solving. For instance, a Guaranteed Maximum Price (GMP) contract, often used with CM@R and PDB, involves the builder taking on the risk of cost overruns once the target cost is agreed upon. If the project is completed under the target price, the owner benefits from the savings. An owner might incentivize the builder by sharing the construction cost savings to enhance project performance.

The paper concluded that the earlier an owner sets the final price, the more contingency and risk the builder will include in their price. For example, in a GMP contract under PDB or CM@R, construction costs may be locked in when the design is only 50%-60% complete. In this scenario, the builder's contingency will be higher to account for the greater number of unknowns or assumptions at risk. Conversely, the GMP can be set as late as 90%-100% design completion, when all subcontractor work has been procured, providing higher accuracy in final pricing. However, this is often not an option in public infrastructure projects due to time constraints.

In your projects, what approach do you use for allocating risks between parties? Which compensation mechanism do you recommend to encourage the risk-solving capabilities of the involved parties? Your insights would be appreciated.

[1] Source: https://lnkd.in/gm6P9hJG