How to Understand the Difference Between GMP and Lump Sum Contracts
In a construction contract, the pricing structure forms the basis for all transactions that occur during construction. Two common pricing structures are guaranteed maximum price (GMP) and lump sum.
Whether you choose a GMP or lump sum contract, it’s important to give careful consideration to how you structure your contract to ensure the choice serves both the size and scope of your project.
Let’s discuss what GMP and lump sum contracts are, the advantages and disadvantages, and the difference between the two.
What is a GMP contract?
GMP stands for “guaranteed maximum price.” The GMP sets a limit on the amount the owner will pay for a project. If the project costs are higher than the GMP, those costs are covered by the contractor. If the project costs less than the GMP, then that is a savings for the owner – or as an incentive, the savings can be split and shared with the contractor.
To set the GMP, the contractor submits an estimate for the project, which includes the cost of the work (labor, materials, storage, transportation, etc.). Typically, the terms/costs for general conditions/general requirements and the contractor’s profit fee (based on a percentage of the actual costs) are negotiated upfront before the cost of the work is established.
When the project is “bought out,” the contractor and client review the subcontractor bids together to determine the best fit for the work based on cost, qualifications, and other factors.
GMP contract structures are best for projects where the design may not be finalized but the costs can be accurately assessed. Often this path is also chosen when the schedule is a priority since this format allows procurement of long lead items and the actual work to begin sooner than it might with a lump sum contract.
What are the advantages and disadvantages of a GMP contract?
An owner who wants to be active in the construction project should consider a GMP contract.
Advantages of GMP contract:
A GMP contract shifts the risk from the owner to the contractor.
A general contractor is motivated to keep costs down and complete the project on time.
GMP contracts provide a mechanism to manage change orders.
An owner keeps decision-making power over materials and subcontractors since they’re paying the actual cost.
It provides for tremendous transparency since the owner receives all of the detailed backup from the subcontractors and can question unit costs for materials, labor, etc.
Financing for a GMP contract can be easier since lenders aren’t dealing with any project cost uncertainty.
Disadvantages of GMP contract:
A GMP requires the owner to be savvy about the construction process and have the time to manage the paperwork, billing, etc. If they don't, the owner can hire an owner's representative to manage these elements for them.
There is a potential for a contractor to submit an inflated GMP and then use low-skill labor and/or low-quality materials to increase savings/profits. If this is a concern, it is critical to ensure that the drawings and specifications are very detailed and your contract language has firm expectations set for quality of work.
Similar to a lump sum format, most GMP contracts contain provisions to address unforeseen costs, so the guaranteed maximum may not be as “guaranteed.” Change orders are often needed when the client changes the design in the middle of the project.
What is a lump sum contract?
A lump sum contract is a flat fee paid to a general contractor for work on a construction project. When bidding, the contractor will submit a total project price instead of bidding for each item. The bid will include the cost of work plus the contractor’s fee and is usually broken out by division. However, you’re not provided with the detailed backup you see in an open book GMP contract.
A lump sum contract doesn’t mean the contractor will be paid only at the end of the project. Similar to a GMP contract, most lump sum projects call for progress payments that are tied to a percentage of the work completed.
Lump sum contracts are best used on projects where the scope of work is clearly defined and straightforward to complete.
What are the advantages and disadvantages of a lump sum contract?
A lump sum contract is a better fit for a client who doesn't understand or need the advantages of a GMP approach and is only familiar/comfortable with a traditional lump sum bid contract.
Advantages of a lump sum contract:
A lump sum contract is a simple construction contract that is easy to draw up and understand.
Clients like these contracts because they are usually the most known type of contract, so it's more familiar to them than a GMP approach and the paperwork is straightforward.
Contractors like these contracts because they’re a simpler way to bid on a project and don't require extensive paper trails and processes.
Contractors also like lump sum contracts because it provides a level of autonomy during the project as they get to select whichever subcontractors they want.
Disadvantages of a lump sum contract:
The scope of the project has to be crystal clear so the contractor can submit an accurate bid and complete the project to specifications.
When changes to the project do need to happen, a lump sum contract doesn’t allow for changes to happen fluidly.
Contractors have a lot more autonomy with a lump sum contract since the owner is not as involved.
It also shifts the risks more to the client since almost everything on a project could become a change order.
Contractors can possibly hide profits since the paperwork is a lot less detailed.
Banks understand that a lump sum contract typically is open to a lot of change orders and may view this as unattractive as a lender.
So what are the main differences between a GMP contract and a lump sum contract?
A lump sum contract remains the same no matter how much a contractor spends to complete a project, and the owner will pay the full amount no matter the actual cost of the project.
For a GMP contract, the owner pays the contractor’s cost plus the fee but only up to the maximum. The owner could have potential savings if the contractor comes in under the capped amount.
Additionally, a GMP is different from a lump sum contract since there is more accountability in a GMP contract. The contractor submits itemized invoices to the owner, allowing the owner to see the actual costs. Whereas, in a lump sum contract, contractors don’t submit itemized bills and the owner doesn’t see the proof of the cost of the work.
Not sure which type of contract to choose?
At The Common Area, as an owner's representative, I can help you determine which contract is best for your project as well as manage it from start to finish. Email or call to set up a meeting today.
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