Construction procurement involves the acquisition of all the materials, equipment, and services necessary to complete a development project. The procurement process also includes selecting contractors to carry out the various aspects of the project and creating contracts that cover the services and materials provided.
Construction contracts lay out the details of the project, including general conditions and general requirements, which lay out the framework for the project and the specific requirements, respectively. The agreement describes:
- The project;
- Quality expectations;
- Materials requirements;
- Timeframe for completion;
- Any other details necessary for satisfactory completion of the project.
Though all contracts specify the general terms and specific rules for the project, they come in many different forms. The type of procurement method and contract can depend on the nature and size of the project, who the stakeholders are, and the type of contractors bidding for the job.
Here is a look at the different types of procurement methods and contract types you will encounter in the construction industry.
General Contracting
General contracting involves managing and coordinating all aspects of a construction project, from start to finish. A general contractor is in charge of hiring subcontractors, scheduling them, and ensuring the quality of their work. General contractors also oversee the procurement of materials and equipment as needed.
The responsibility of completing the project on time and within budget falls to the general contractor, as does the duty of ensuring all work is up to local code and complies with all other regulations.
Developers and project stakeholders who want to have a hands-off approach and whose primary concerns are that the project is done on time, up to the expected standard, and within budget, may choose a general contracting procurement method.
The advantages of this type of contract include:
- Having a single entity in charge of the entire operation;
- Cost savings;
- Time savings;
- Working with someone who has project-specific expertise.
At the same time, owners have to give up flexibility and control over the project.
Design and Build
A design and build contract, as the name suggests, is one in which the contractor is responsible for both the design and construction of a project. In this arrangement, the contractor offers design services themselves or through a third party. They will typically use advanced software tools to come up with accurate pricing for both aspects of the project.
In addition to handling the creation of blueprints and engineering calculations, the contractor is responsible for making sure the design complies with all local codes and regulations and meets all the client's expectations.
This kind of agreement is frequently utilized for projects that need specific design knowledge or require close cooperation between the design and construction teams. Ideally, this approach streamlines the entire process and allows for collaborative problem-solving and quick answers about the cost and feasibility of the design. However, as with general contracting, the owner has to give up some control over the details of the project.
Construction Management
Construction management gives a project's owner effective control over the schedule, budget, quality, safety, scope, and site operation. A construction manager oversees the entire project much like a third-party general contractor would, except they answer directly to the project stakeholders. In some cases, the construction manager could be an owner or project stakeholder.
Because of the centralized control and direct line of communication to ownership, construction management is cost-effective and time-saving. However, because everything is centralized, all the risk for the project falls on the construction manager. They have to assume all the risk for problems with weather, labor issues, supply chain disruptions, and other issues.
Joint Venture
A construction joint venture is a contract between two or more parties who agree to combine their resources, expertise, and assets on a specific project. In addition to combining resources, this arrangement allows them to share the risk so that it does not fall on one party.
This type of contract is common for large, complex development projects that require a wide range of resources, different skill sets, and large investments.
All joint ventures involve shared responsibilities and risks. However, the contract details can differ significantly depending on the division of responsibility, risk, and profits as well as the number of parties involved in the venture.
Private Financing
Private finance arrangements involve investments from non-public sources, such as banks, investors, or developers. This type of construction financing can involve equity investments or loans, and it is most common for residential developments or large commercial projects.
Private financing can cover different types of procurement methods, including design-build and construction management projects. It is also used for lump-sum contracts, which investors often prefer because it means the contractor assumes the risk for cost overruns.
Cost Reimbursement
Cost reimbursement is a type of construction contract in which the owner or client reimburses the contractor for the actual costs incurred during the project, plus an agreed-upon fee, which serves as the contractor's profit for the project. Sometimes this construction option is known as “cost-plus” because it covers the cost and provides the profit for the contractor.
This method is common when the scope of the project is not well-defined or is subject to change, and the owner wants to limit their financial risk by avoiding a substantial upfront investment. The contractor is responsible for managing the project, but since they get reimbursed based on work completed, they do not have to shoulder the risk of budget overruns.
This type of contract requires estimates for each separate aspect of the project. Contractors may rely on concrete estimating tools for the foundation or parking lot portion of the project and then rely on steel estimating software to price the metal components of the structure.
Cost reimbursement contracts are widely used for government and public works projects.
Re-measurable Contracts
Re-measurable contracts calculate the final price of the project based on the actual quantity of work rather than an amount agreed upon at the start of the project.
As with cost reimbursement projects, this arrangement is useful for projects with unclear variables that could change the cost as the work progresses. Re-measurable contracts can have a cost-reimbursement payment model or a unit-pricing agreement. This agreement pays the contractor when they reach a benchmark or complete a defined unit of work during the project.
Lump Sum Contracts
A lump-sum contract involves a significant one-time payment. In many ways, this type of agreement is the simplest in the construction industry. The contractor simply promises to finish the work for a set fee that includes all expenses, such as labor costs, materials, administrative fees, and permits.
Because the money comes in a single payment, the contractor needs to price unforeseen delays or problems into their bid. Because they assume all the risk, contractors typically consider this type of payment method for projects with well-defined requirements and a scope that is unlikely to change. They will often rely on construction estimate software to ensure the pricing is accurate before accepting the contract. The lump sum changes hands after the completion of the project.
Determining Which Method to Use
The choice of procurement method depends on a number of factors, including the size of the project and the investors or stakeholders. Here is a look at the different variables to consider when selecting the best procurement method for a construction project.
- Available resources: Procurement methods can focus on whether a company has access to resources or needs to rely on a third-party contractor or supplier to provide them.
- Risk tolerance: In some cases, developers may want to lower their risk by selecting a contract that spreads a portion of the risk to contractors. Other investors may wish to maximize profits by taking on more risk.
- Timeline: Some procurement methods streamline the bidding and construction processes, while others take a more methodical approach that could be too slow for projects requiring paid completion.
- Regulations: Contractors and companies need to comply with the regulations of the jurisdiction where the project is taking place. Local or state laws could make certain contract types unprofitable, while others may prohibit the agreements altogether.
- Public or private: Some procurement methods are ideal for privately funded projects, while others are better for public constructions, such as roads, bridges, or government buildings.
- Size: Small projects and larger projects require different types of procurement methods.
After assessing the details and requirements of a project, you can select a procurement method and contract type best suited for a particular construction project.
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