23 Feb NYC Doesn’t Know the Risk | Guaranteed Maximum Price Contracts
Today’s topic comes from an article from Construction Dive titled NYC to build $6B in new jails using guaranteed maximum price contracts
New York City Selects GMP Contracts for New Jails
The New York City (NYC) Department of Design and Construction are looking to build four new jails each with a budget of more than $1 billion. The city has decided to use the guaranteed maximum price (GMP) as the method of contracting. Based on the article, the GMP format is often preferred over the lump sum contracts as they:
- Provide greater protection from cost overruns.
- Shift significant risk to the contactor.
- Provide an easily understood price and “open books” which allow NYC to see how their money is spent.
In contrast to the lump sum contracts, the GMP format helps to prevent cost from going over a predetermined level and has any cost savings being returned to the owner. A GMP contract may be a fiscally responsible method for NYC to have a predictable and controlled budget. Whether those benefits will be realized will come as more details are released as to how NYC will implement their GMP contract. Many of the largest obstacles to project performance are not resolved through the selected contracting method, but by the approach taken when using such methods. In this article, we will address a potential risk of traditional GMP’s cost cap and how it can be supplemented with a best value practice to increase the likelihood of success.
GMP Contracts Cost Cap are not Capped
The first thing to know is what is included in a Guaranteed Maximum Price (GMP). A project’s GMP considers the cost of work, a contractor fee and project contingency. When the project is completed, whatever money not spent below the GMP is considered savings which can be split between the owner and contractor. The protection for clients with a GMP is that they legally do not have to pay any costs that exceed the GMP. This format perceivably shifts the risk to the contractor who must pay for any risk or miscalculations over the GMP and protects the client from the cost overrun. Additionally, as the money is spent on the cost of work, the buyer is informed on how the money was spent to ensure they are not paying more than the agreed “contractor fee”.
The potential risk is that a GMP, contrary to its name, is not an unconditional price cap. The GMP is still subject to increases based on change orders that the contractor can submit for risk outside of their control. For example, the GMP can increase due to client scope changes, changes in assumptions, design errors, or delays caused by stakeholders not under the contractor’s direct responsibility such as client stakeholders or third-party entities. When analyzing risk, studies by Performance Based Studies Research Group (PBSRG) have validated that over 90% of all project risk is client-generated; scope changes being one of the most common reasons. Most of the remaining 10% of the risk is caused by unforeseen conditions and information which was missing at the beginning of a project. Generally, a negligible amount of risk is caused by the contractor. In other words, the GMP price cap will most likely not protect the client from the majority of risk which can cause cost overrun.
There is always the option for the client to reject a contractor’s change orders and try to transfer their client-generated and unforeseen risk to the contractor. The problem is that traditional methods of transferring risk have had many problems, see “PT: The Dangerous Practice of Transferring Risk”. A common byproduct of transferring risk is increased disputes and eventual litigation. In looking at previous cases, even if a client is successful in a dispute with a contractor there are transactional costs and negative relational costs associated with each dispute (legal fees, extra time, delay, reactive contractor, adversarial relationship, inflated costs). In the end litigation in any form seems to leave no winners on either side.
A Solution to Ensure GMP Contract Success
Performance Based Studies Research Group (PBSRG) has identified that the problem which causes cost overrun and failure deals more with the approach and not the format or method used to procure and contract. The most efficient practice which can improve all contracting and procurement methods from cost overrun, is to identify and utilize expertise. The only way to mitigate client stakeholder risk and unknown risk is to utilize an expert. The expert can see the project simply, preplan and identify risk before it happens, which is what enables them to mitigate risk before it happens. Experts are the stakeholder with the most capability to mitigate risk. Regardless of the contracting method used, without an expert, risk cannot be effectively mitigated. Three key indicators that can be used to ensure you have an expert on your project include their ability to:
- Pre-plan the entire project before they begin which includes a detailed schedule and a plan inclusive of actions to prevent any known risks (missing information, stakeholders not under their direct control/responsibility, and unforeseen conditions).
- Simplify their plan and create transparency which ensures the buyer, and all stakeholders understand and accept the plan and their role in it. It is the vendors responsibility to ensure each stakeholder on the project knows the risks that could occur before the project begins and who is responsible for that risk.
- Have a simple tracking method that is able to document each risk that occurs and identify who is accountable for the risk that has occurred. In addition, the tracking method must be able to update all parties of the project’s status and what they are accountable for within the project plan on a weekly basis.
For more information on how to identify and utilize an expert see:
An Approach that can Fix the GMP Contracting Method
The Best Value Approach (BVA) is a proven approach which can be overlaid on any procurement or contracting method to improve the identification and utilization of expert vendors. The BVA has been proven on over 2,000 projects valuing at $6.6B over 30 years with 94% of project finishing on time and on budget. To learn more about the Best Value Approach to procurement and project management here are some additional resources:
- Free membership for latest tips and news: https://pbsrg.com/membership/
- For latest books, events, and licensed partners: https://pbsrg.com/resources/
- Latest BVA journal publications: www.cibw117.org/
- Annual Best Value Conference in January: https://bestvalueconference.ksm-inc.com/
- Latest presentations and videos: https://www.youtube.com/channel/UCxBi26nXLDTqG4ZRV6p0iiQ