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Types of Construction Contracts: Pros, Cons & Best Practices

Year 2023
May 2023
Types of Construction Contracts: Pros, Cons & Best Practices
24 May 2023

type of construction contract banner 300x169 - Types of Construction Contracts: Pros, Cons & Best PracticesWhen managing construction projects, it is crucial to have a clear understanding of different contract types. In Building and Construction industry, these contract types determine payment, liabilities, and protect both builders and owners from conflicts caused by unforeseen issues. Now, many constructors have digitalised with an ERP system to effectively create and manage contracts successfully. Here is an overview of different contract types and how an ERP system can assist in their implementation.

Lump Sum Contracts (Fixed-Price Contracts)

Lump sum contracts involve outlining a fixed price for all the work performed. While seemingly straightforward, these contracts have their pros and cons. On the positive side, finishing under budget results in higher profit margins, and the bidding process is simplified. However, larger projects can pose risks as unexpected setbacks and missteps may impact the lump sum price, affecting profit margins.

An ERP system integrated into the construction workflow simplifies the process of calculating and finalising a fixed price for the entire project. It facilitates accurate budgeting, cost tracking, and ensures that sudden delays or changes are accounted for within the agreed lump sum price.

Cost-Plus Contracts (Cost-Reimbursement Contracts)

Cost-plus contracts involve the owner reimbursing the contractor for project costs, including direct and indirect costs, along with a predetermined profit. These contracts offer flexibility for design changes, and miscalculations in the initial bid are less detrimental compared to lump sum contracts. However, justifying certain costs can be challenging, and contractors may face financial strain if material costs exceed expectations.

With the help of an ERP system, contractors can efficiently track and manage costs incurred during the project’s duration. The system enables the recording and justification of direct costs (such as materials and labor) and indirect costs (like communication and travel expenses). Also, it ensures proper allocation of profit and provides flexibility for incorporating design changes.

Unit Price Contracts

Unit price contracts divide the construction project into separate units, allowing contractors to provide price estimates for each unit of work. These contracts simplify invoicing and provide flexibility for handling change orders and alterations. However, delays in payment can occur due to re-measurement, and forecasting the final value of the contract can be difficult.

An ERP system aids in managing unit price contracts by simplifying invoicing and enhancing transparency. It allows for accurate tracking and invoicing of individual units of work, making it easier to handle change orders and alterations in the project scope.

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Guaranteed Maximum Price Contracts

Guaranteed maximum price contracts establish a cap on the contract price, preventing the owner from exceeding it. Contractors bear the responsibility for covering any costs above the maximum price. These contracts incentivise savings and speed up the bidding process. However, contractors assume the risk of cost overruns, and negotiation and review processes may be lengthened.

ERP software assists in establishing and monitoring a contract’s maximum price, providing contractors with greater control over project costs. The system helps track and manage expenses to prevent exceeding the agreed-upon price while incentivising savings and facilitating efficient project financing.

Time and Materials Contracts

Time and materials contracts are suitable for projects with undefined scopes of work. Contractors are reimbursed for materials costs and receive payment based on an hourly or daily rate. The advantages include simplified negotiations and clear rules for materials and wages. However, such contracts can be time-consuming and may lack incentives for early project completion.

An ERP system plays a crucial role in time and materials contracts by effectively managing material costs, and tracking hourly or daily rates. The system also facilitates efficient communication and documentation. Task management functionalities within the ERP system help streamline processes and improve overall efficiency.

Best Practices

When drafting construction contracts, it is essential to incorporate best practices to ensure clarity and detail. These practices include incorporating incentives, clearly outlining expectations, creating contingency plans, and implementing project task management. Effective communication channels, such as ERP solutions with subcontractor scheduling modules, should be established to avoid miscommunication.

To improve contract effectiveness, certain pitfalls should be avoided. These include a lack of communication by specifying how and when to communicate, being specific rather than general in contract terms, and not addressing how changes will be handled. Accordingly, an ERP system is able to enhance construction contracts with efficient communication and collaboration among all parties involved in the contract, ensuring transparency and avoiding misinterpretation or miscommunication.

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Synergix ERP Construction solutions can help businesses understand and manage the above contract types and follow best practices. Thanks to this,  construction businesses can create successful contracts, enhance communication, and improve overall project efficiency. We have successfully been a good assistant in the process of digitalisation of many clients such as Ley Choon Group, Wonhup, Deluge, etc. As an approved vendor by IMDA, construction sectors can tap on several to get funding of up to 50% of the qualifying costs.  If you are looking for a Construction ERP system, feel free to contact us today!

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