Cmgc white Paper

CMGC White Paper

Guaranteed Maximum Price

CMGC White Paper Topic No. 2:

Guaranteed Maximum Price (GMP)

1. 
   Introduction
   

Under traditional design-bid-build (DBB) contracting, contractual price is reached through a competitive bidding environment, with the selected contractor being the bidder with the lowest price that is able to meet other contractual obligations such as bonding and insurance requirements. However, under CMGC contracting, contractual price is negotiated between the owner and the contractor by agreeing on what is commonly called a Guaranteed Maximum Price or GMP. The purpose of this white paper is to define GMP and outline various approaches in the industry that are used to reach GMP on CMGC projects.

2. 
   Definition of GMP and Assumptions
   

The National Cooperative Highway Research Program (NCHRP) explains that the term GMP is often misunderstood, because the term GMP implies that the contractor “guarantees” the owner that the price will never exceed a maximum set amount.ⁱ However, this is not the case, particularly in highway CMGC contracting, where GMP is typically defined simply as the contractual price agreed upon between owner and the contractor based on conditions and assumptions set at the time that the GMP is contractually set. In most cases, the CMGC contractor is allowed increased compensation beyond what was set in GMP if the scope of the work changes or if quantities change substantially beyond what was assumed when the GMP was negotiated. There are several approaches that can be used to justify adjustments to the GMP when there are substantial changes to quantities or scope.

1. 
   Follow DBB Procedures for Quantity Overages and underruns. In unique situations owners have elected to consider the GMP no more than a DBB bid and administered the contract similar to a bid item unit rate contract, paying for overages of individual items and not paying for any underruns.
   
2. 
   Follow DBB Procedures for Changed Conditions. Some states follow standard design-bid-build contracting procedures to adjust price when there are substantial changes to the scope or quantities. This approach is used by UDOT, for example. For owners starting out with CMGC contracting, this may be the easiest approach because it is a familiar method to contract administration for handling changed conditions. In addition, this approach does not require substantial and potentially time-consuming changes to existing policy and procedures.
   
3. 
   Define Procedures for Changed Conditions in CMGC Manual. Some states establish new procedures for changed conditions in their CMGC manuals. This is the case for Arizona DOT in their Construction Manger at Risk (CMAR) Guide.
   
4. 
   Define Procedures for Changed Conditions in the Contractor RFP. This approach may be advantageous to use for complex projects where, due to factors like high risk or unique project characteristics, the owner wishes to further clarify what constitutes changed conditions.
   

3. 
   What is GMP?
   

In Section 2 GMP was defined as the contractual price agreed upon between owner and the contractor based on an agreed upon set cost model, schedule, and other assumptions between the contractor and the owner. The GMP consists of four price components:

1. 
   Project Direct Costs. This consists of actual costs for the contractor to perform the work including labor, personnel, equipment, materials, and subcontracted work.
   
2. 
   Indirect Costs. This consists of the contractor’s overhead costs required to manage the project such as project management, supervision, quality control and administration. Indirect overhead is often separated into field overhead and home office overhead. Bonding costs may be included in the overhead costs or it may be broken out separately.
   
3. 
   Profit/Fixed Fee. This consists of the fee that the contractor will be allowed to add to costs.
   
   1. 
      Fixed fee can be either a lump sum or a percentage of the total project cost.
      
   2. 
      When using a fixed fee percentage, owners should establish a fixed fee percentage early with the CMGC contractor that will be used throughout the life of the project. Although the fixed fee can be negotiated after contractor selection, it simplifies GMP negotiations if the owner defines the fixed fee (or acceptable range for fixed fee) during the CMGC selection process, either by directly listing it or asking the CMGC contractor to provide a value in their proposal. NCHRP states that “based on a Washington State study of [CMGC] projects, the average fee for a general contractor can range from 2% to 15% and the fee amount is contingent on such factors as project risk, contract conditions, competition, and project complexity [and that the] fee is typically larger for smaller projects”.ⁱⁱOpen Book accounting requirements assist in ensuring the fee is eventually realized. It should also be noted that Generally Accepted Accounting Principles (GAAP) allow variation in overhead and direct costs which can lead to fixed fee not representing the same for each contractor. Owners need to understand accounting processes used in construction. This can be another area where an experienced ICE can assist an owner.
      
   3. 
      Some agencies wrap the preconstruction services fee into the overall fixed fee. However, in the event that the owner fails to reach GMP with the contractor and needs to sever the contract with the CM, it is advisable that the contractor’s fee during the preconstruction phase be handled separately as part of the preconstruction services contract.
      
4. 
   Contingency. Contingency is discussed in more detail under Section 6.
   
1. 
   Negotiating GMP
   

Reaching GMP is one of the most difficult parts about CMGC contracting. It requires a paradigm shift in which the owner and contractor trust each other and sit down together in a collaborative effort and if necessary in an open book process to negotiate a price that is fair and equitable for both parties. It will challenge both owners and contractors who are new to CMGC contracting, and it is not uncommon for owners and contractors to switch out staff that are not capable of making this paradigm shift.

1. 
   Use interim pricing milestones to keep pricing on target as design progresses and avoid surprises at final GMP negotiations. One of the most critical steps in successfully negotiating GMP on a CMGC contract is to develop interim pricing milestones as the project develops. The contractor and owner price the job as design progresses at milestones. The number of pricing milestones varies based on the complexity of the project, and logical pricing milestones are built into the typical design process (for example 30%, 60%, and 95% review meetings). Pricing milestones allow the owner to expose pricing disagreements early in the CMGC process, which allows time for both owner and contractor to resolve these inconsistencies prior to the final GMP commitment. The interim pricing milestone process is described in greater detail in White Paper Topic No. 1 – Independent Cost Estimating.
   
2. 
   Price Evaluation Models. There are several methods used in CMGC contracting by which the owner estimates the price for the job independent from the contractor and compares it with the price proposed by the contractor. Below is a summary of each approach. Table 1 summarizes the pros and cons for each approach.
   
   1. 
      Independent Cost Estimator (ICE). In this approach the owner hires an independent, third party estimator to develop the owner’s estimate. The ICE is typically an experienced contractor estimator with experience using commercially available contractor based estimating software and with the background necessary to fully understand the cost model used by the contractor (including an understanding of labor, production rates, crew sizes, and other means and methods that go into bidding highway construction). Minnesota statute states that MnDOT must “conduct an independent cost estimate” to validate the proposed contract price, but the statute does not implicitly state that an ICE must be as justification for the contractual GMP. Finally, it should be noted that the ICE method is the only method that is suitable for non-unit price contracts (for example lump sum pricing) as all other methods discussed in this white paper assume the work can be rolled up into pay items that can be assigned a cost per unit price.
      
   2. 
      Engineer’s Estimate. In this approach the owner uses internal or consultant staff to estimate the work similar to the process used in low bid contracting. Staff producing the estimate may or may not be experienced in contractor based estimating. Engineer’s estimates are often based on historic average unit bid prices (discussed in the next section). Some states supplement the ICE with an Engineer’s estimate because it can typically be done with minimal cost/effort and it provides estimating redundancy to help defend the ICE’s estimate. However, care should be taken if the owner decides to use this approach because it can lead to owner conflicts if the ICE and the Engineer’s estimate disagree and cannot be reconciled.
      
   3. 
      Average Unit Bid Prices. In this approach, the owner uses historical average bid prices from a database of past projects to estimate the work. Average prices can be filtered and honed by comparing with pricing on past projects that are of similar size, complexity, attributes, etc. This is the easiest approach but also the least likely to match the CMGC’s cost model.
      

	Price Evaluation Models – Advantages & Disadvantages
Model	Advantages/Disadvantages
ICE	Advantages: Highest estimating accuracy. The ICE is done by professionals with a background in construction estimating and with training and experience to understand the contractor’s cost model. Unbiased, third party estimate. Helps the owner defend to the public that the negotiated price is fair and competitive. ICE help negotiate pricing changes after GMP because they are familiar with the cost model and the assumptions that were used to derive pricing. Disadvantages: Requires the owner to enter into a separate contract with the ICE. Increased effort and cost to pay for the ICE. Difficulty of finding a qualified pool of ICE providers. Potential conflicts of interest between ICE and CMGC contractor.
Engineer’s Estimate	Advantages: Less expensive & complicated. Can typically de done with in-house or consultant staff. Disadvantages: Increased likelihood of pricing disagreement because the estimating is done by staff that does not typically have a background in “bidding projects like a contractor”. Use of non contractor typical pricing tools. Not an unbiased, third party estimate. Demands on the owner’s estimator to sit through interim and final GMP negotiations.
Average Unit Costs	Advantages: Inexpensive, easy to complete, and quick. Disadvantages: Least accurate approach and highest likelihood of pricing disagreement. Difficult negotiation and more likely to result in additional compensation for changed conditions because average unit prices are not derived by using the CMGC’s cost model. Cost is not derived from a project specific cost model that reflects unique means and methods that go into developing unit costs.

1. 
   Evaluating Price for Fairness
   
   1. 
      Establish Level of Agreement. In order to negotiate GMP, the owner sets an expectation for the level of agreement that must exist between the owner’s estimate and the contractor’s estimate in order to award a GMP contract. Some states set this at ± 10% which is a common percentage used in design-bid-build to determine the ability of an agency to award bids. Alternatively, an owner may wish to set this percentage on a project by project basis or based on current bidding environment. Regardless, it is important that this expectation be established early and this expectation should not change throughout the process unless both sides agree that a change is warranted.
      
   2. 
      A detailed outline of the process of comparing the owner’s estimate to the contractor’s estimate is outlined in more detail in White Paper Topic No. 1 – Independent Cost Estimating.
      
1. 
   When to Negotiate GMP?
   

Timing on when to set GMP is entirely up to the owner. However, NCHRP states that “selecting the point in time where the GMP is established is an extremely important decision” and that a “GMP set late in the design process will have less contingency included than the one required early in the design phase”ⁱⁱⁱ.

1. 
   Negotiating GMP Prior to 100% Design. NCHRP research states that nine out of ten agencies studied required the GMP before 100% design. It is not necessary to develop plans to 100% in CMGC contracting. This is one of the advantages of CMGC contracting. It has been demonstrated that contractors can estimate costs within an acceptable level of risk and accuracy for most owners well before 100% plan development. Negotiating GMP prior to 100% plan development has two advantages:
   

• 
  First, it allows construction to start earlier than traditional contracting methods. As soon as the GMP is reached, the owner can award the project to the General Contractor (GC)and construction can commence. Indeed, this is one of the reasons why many states use CMGC contracting. How early to award the construction contract is a decision call by the owner, but the decision to award GMP early should be supported by thorough risk assessment and adequate contingency budget depending on the identified risks.
  
• 
  Second, it reduces design costs. For example, an owner may choose to reach a GMP with the contractor at 80% plan development. The contractor can then, in theory, build the project using 80% plans, and save the cost associated with advancing design from 80% to 100%. Of course, design plans can always be advanced to 100% following GMP if desired by either the CMGC contractor or the owner.
  

One important point to note about early construction without 100% plans is that although contractors can build projects using less than 100% plans, owners may not be prepared for this scenario. It may be necessary for an owner’s design processes for design progression and milestone reviews to be modified to adapt to CMGC contracting.

2. 
   Splitting Projects up into Multiple GMPs. Several agencies using CMCG contracting allow a project to be broken up into phases or work packages. Individual GMPs are negotiated for each work package. Splitting a project up and developing multiple GMP’s is typically justified based on cost saving or schedule acceleration. For example:
   

• 
  Early Construction. Separate GMPs to allow the contractor to start work early on construction of critical path tasks in order to accelerate the construction schedule. These tasks could be constructing an embankment that has a long settlement period or moving a utility on the critical path.
  
• 
  Procurement of long lead materials. Early GMP to allow the contractor to procure long lead materials (such as steel and girders).
  
• 
  Escalation Control. Early GMP on materials to lock in commodity prices to eliminate escalation on materials (such as fuel or steel).
  

Although multiple GMPs have become common in CMGC contracting in some states, owners should not make this decision without considering the increased risks and potential cost increases that can accompany multiple GMP contracting. This White Paper recommends that an owner strongly consider the following suggestions prior to using multiple GMPs on a project:

1. 
   Construction of each GMP package should be a separate, stand-alone contract. If construction packages are not stand-alone, the owner is put at increased disadvantage when negotiating subsequent GMPs. Furthermore, if the owner fails to successfully negotiate GMP on additional construction packages and another contractor is selected to perform that work, the owner may end up in a scenario where two contractors work in a common work zone, which increases the possibility of delay claims. Arizona’s CMAR Guide has specific requirements that must be met before allowing a project to be split into multiple GMP, including most importantly, that the CMAR contractor be able to demonstrate that they can construct the entire project within the project budget^iv. On the Mountain View Corridor project, UDOT allowed the CMGC contractor to begin work early on the southern half of the 15-mile project. However, prior to awarding the first GMP, UDOT entered into an agreement with the contractor to get a commitment for the overall contract price. On the Riverdale Road project, UDOT awarded two early packages, an early order of bridge girders and piles on the first package, and allowing the CMGC contractor to start construction on a trunk storm sewer line on the second package. For each package the CMGC contractor was required to commit to the ultimate completion date and the work was sequenced to allow a second contractor to start the base work.
   
2. 
   Because multiple GMP packages typically produce separate construction contracts, each contract must then be administered separately. This increases costs and efforts associated with managing separate contracts, both for the owner and for the contractor.
   
3. 
   Multiple GMP packages may increase design costs or result in design that is “out of sequence” from standard design processes. For example, an early GMP for an early grading package will require the designer to produce a separate set of early grading plans. An early GMP to order steel for a bridge will require the designer to advance the bridge and girder design plan.
   
1. 
   GMP Contingency
   

Contingency is bid into every project, regardless of contracting method, and is reflective of the risks present at the time the contact is bid. Typically, higher risk means higher contingency, and lower risk means lower contingency. One of the major benefits of CMGC contracting is that it allows the owner and contractor to collaboratively work together during the design phase to better understand, manage, and lower (or eliminate) risks on the project (thereby lowering contingency costs). The contractor performing the work is best suited to advise the owner and designers on risks associated with schedule, phasing of the work, and materials assumptions. Contingency management and documented contingency cost savings in CMGC contracting is documented in the supporting literature by NCHRP^v. When negotiating GMP, this White Paper makes the following recommendations related to contingency.

1. 
   Recognize that the contractor will include contingency in their GMP bid for common construction risks such as labor availability, material pricing fluctuations and availability, schedule delays, and subcontractor management. However, in CMCG contracting, the owner has the advantage of requiring the contractor to use an open book estimating process. This tool, combined with the advantage of having an ICE with contracting background on the owner’s side of the table allows the owner to fully understand the contingency that the contractor has assigned to the work, and can work with the contractor to reduce risks that are contributing to contingency in the bid, where possible.
   
2. 
   Agree upon who owns the various risks and contingencies. If the owner agrees to take ownership for certain risks, then the CMGC contractor can reduce contingency based on this understanding. For example, the owner may choose to be responsible for acquiring the right-of-way or clearing utilities by a certain date. The contractor will then establish a Critical Path Method (CPM) schedule based on these assumptions and remove contingency associated with delays caused by right-of-way and utility risk. Assignment of risk is central to GMP negotiations in CMGC contracting.
   
3. 
   Use “Provisional Sums” for work that involves a high degree of uncertainty. In other contracting methods, contractors tend to assign a premium cost to items of work that involve a high degree of uncertainty. In CMGC, the owner can identify uncertainties with the contractor’s input, and then break uncertainty work out into separate pay items. The contractor is then asked to include a cost or bid the uncertainty work as part of the GMP. If the contractor finds that the Provisional Sum work is needed during construction, the owner has established competitive price for the work, and the contractor gets paid. However, if the work is not required, budget associated with Provisional Sums is returned to the owner. Provisional Sum budget belongs to the owner. This method of managing uncertainties also acts as a way for the owner to be made aware of uncertainty risk and provides an incentive for them to actively work to eliminate these risks. On the Mountain View Corridor project, UDOT indentified $10 million in Provisional Sum work. At the end of the project, less than $1 million of the Provisional Sum work was needed. This savings rolled back to the owner. Under design-bid-build or design-build contracting, the contractor would have kept most of these savings.
   
4. 
   Establish management reserve. Because CMGC contracting involves sharing risks between contractor and owner, a “management reserve” budget should be held by the owner to cover any potential risks for which the owner has assumed responsibility.
   
1. 
   Value Engineering and Shared Savings Clauses
   

Many agencies include shared savings clauses in their construction contracts to provide an incentive to the contractor for cost-saving value engineering solutions identified during construction. In CMGC contracting, it is highly recommended that shared savings clauses be eliminated. In CMGC, the owner is paying the contractor to identify cost savings as part of their preconstruction services fee. Allowing shared savings clauses in GMCG creates a conflict of interest to the contractor and risks the contractor “holding back” some of their best cost-savings ideas, because they can get paid for them later. NCHRP states that the three agencies most experienced with CMGC contracting (UDOT, Glendale, and Pinal County) “did not share savings with their contractor.”^vi

1. 
   ADOT expects the contractor to participate in value engineering process as part of their preconstruction role but their CMAR manual states the following about post-construction value engineering proposals:
   

“Acceptance of a Value Engineering proposal during construction is unlikely in CMAR project delivery. In determining whether to entertain a VEP that will result in a sharing of cost savings between the CMAR Contractor and the Department, the Sr. RE/RE will consider the fact that the CMAR Contractor participated in the design effort during the Preconstruction Phase. The CMAR Contractor may not share in any cost savings where the Value Engineering Proposal could have reasonably been made by the CMAR Contractor during the Preconstruction Phase. Therefore, an additional condition required in the CMAR Contractor’s proposal is a satisfactory explanation why the VEP was not made during the Preconstruction Phase. The PM and Value Engineering Manager must concur with the CMAR Contractor’s reasoning.”^vii

2. 
   UDOT eliminates value engineering savings clauses in CMCG by modifying their construction specification that covers this issue.
   

8. 
   Failure to Negotiate GMP
   

Failure for the owner to successfully negotiate GMP is a legitimate risk with CMGC contracting. However, it is important to realize that cost-savings and innovation associated with CMGC contracting far outweigh the risks. Furthermore, based on owner’s that are experienced with CMGC, the risk of failing to negotiate GMP is small. According to NCHRP “of all the agencies interviewed [as part of the research project] only one had ever experienced failure to negotiate a GMP”^viii. However, should the owner find itself in a position of failure to negotiate GMP, the following options are suggested:

1. 
   Put the project out to competitive bid. The mere threat of this option is typically a driving factor to motivate contractors to provide fair, competitive pricing. Opening the project up to competitive bid may require additional time and design effort on the part of the owner to get the plans to 100% development. Depending on the design level at GMP, this could be a substantial effort and a delay to the project.
   
2. 
   Some agencies open negotiations with the second rank contractor. This may require modification to the statute in Minnesota.
   

i^ NCHRP Synthesis 402, Construction Manager-at-Risk Project Delivery for Highway Programs, Transportation Research Board Chapter 6 “Procedures for Establishing the Guaranteed Maximum Price”, page 65.

ii^ NCHRP Synthesis 402, Construction Manager-at-Risk Project Delivery for Highway Programs, Transportation Research Board Chapter 6 “Procedures for Establishing the Guaranteed Maximum Price”, page 70.

iii^ NCHRP Synthesis 402, Construction Manager-at-Risk Project Delivery for Highway Programs, Transportation Research Board Chapter 6 “Procedures for Establishing the Guaranteed Maximum Price”, page 65.

iv^ Construction Manager at Risk (CMAR) Guide, Arizona Department of Transportation, September 2010, Section 4.10.

v^ NCHRP Synthesis 402, Construction Manager-at-Risk Project Delivery for Highway Programs, Transportation Research Board Chapter 6 “Procedures for Establishing the Guaranteed Maximum Price”, page 71-73.

vi^ NCHRP Synthesis 402, Construction Manager-at-Risk Project Delivery for Highway Programs, Transportation Research Board Chapter 6 “Procedures for Establishing the Guaranteed Maximum Price”, page 75.

vii^ Construction Manager at Risk (CMAR) Guide, Arizona Department of Transportation, September 2010, Section 5.3.

viii^ NCHRP Synthesis 402, Construction Manager-at-Risk Project Delivery for Highway Programs, Transportation Research Board Chapter 6 “Procedures for Establishing the Guaranteed Maximum Price”, page 75.

Prepared for MnDOT by Parsons Brinckerhoff, Page