(This story was originally published in the Dallas Business Review – Volume VIII. It has been edited slightly for length.)
We were doing great until we built our new headquarters building last year. The construction was a nightmare! Yeah, we doubled our manufacturing space, but spent about 30% more than we could afford – and we’ll probably end up in the courthouse with the contractor before it’s all said and done. Our competitor beat us to the market because our contractor let the project stall and we missed our target for move-in by three and a half months. Sound familiar? In each of these scenarios, the owners’ outcomes didn’t meet their expectations.
More and more, construction project delivery systems are being designed to control outcomes and give owners more certainty as to cost (including life-cycle costs), quality, schedule, and even certainty in terms of the level of an owner’s risk and the involvement of the owner’s staff in the construction process.
Over the past 20 years, construction management in its various forms has gained increasing favor as a delivery system that can let owners sleep peacefully while their projects are being built by having certainty and control of outcomes. Construction management is a project delivery process in which a qualified firm is engaged to manage construction of a project on behalf of its owner. Unlike traditional lump-sum contracting, in which the contractor derives a profit from the difference between bid price and cost, construction management allows its practitioners to earn a fee for managing the work and representing the interests of the owner.
Since about 1970, the private sector has turned increasingly to construction management, while the public sector – until fairly recently – has stayed with the lump-sum approach to contracting. To understand the trend toward more construction management as a delivery system – and especially to a version of construction management called CM/GC (construction manager/general contractor) – we must first understand the built-in problems and limitations in traditional lump-sum contracting.
Twenty-five years ago, the traditional approach to private sector construction contracting was pretty much the same everywhere in the country. The so-called lump-sum approach begins with an architect determining a project owner’s needs and budget. The architect then develops a design and, after approval by the owner, prepares a complete set of construction drawings. The drawings are made available to contractors who develop cost estimates based on the drawings and then submit sealed-bid, lump-sum prices based on their estimates and the owner’s time allowance for project completion. The bid prices represent each contractor’s estimate of the project’s total cost (including the prices provided to the general contractor by subcontractors), plus a margin for contractor profit. Once the bids are opened, the project is awarded to the lowest-price qualified contractor.
One readily apparent drawback to lump-sum contracting is that the owner frequently will not know the cost of a project until it is completely designed and bid. If the bid prices exceed the owner’s budget, then the owner is faced with the additional cost (and time) for redesign of the project to take out cost.
Also inherent in lump-sum contracting is the unstated assumption that time is always available for the architect to build the entire project on paper (the drawings) before the competing contractors enter the picture. But at today’s rapid pace of change and technological progress, time has become a basis for competition. Project owners race one another to get new production and service facilities online, and speed is often as much a basis for competition as technology.
There is another way that lump-sum contracting frequently prevents the owner from realizing the lowest possible cost. Lump-sum bidders provide for contingencies in their bids. If unexpected circumstances occur, and if the contractor’s contingency provision is sufficient, then the contractor’s cost is covered. However, if the contingency provision is not needed, then the savings are added to the profit priced into the job by the contractor, and the owner derives no benefit from the savings.
Work scope definition is another problem in lump-sum contracting. In theory, the architect furnishes the competing contractors with complete construction documents that 1) fully identify the scope of contractor work required, and 2) represent the exact final product the owner wants. Often, however, the process falters and theory fails when unanticipated scope changes arise after construction is underway or when the owner has a change-of-mind about some aspect of the project. Both circumstances are fairly common on any construction project, but they are especially exacerbated on larger, more complex projects. Lump-sum contracting lacks the flexibility to accommodate these changes in an efficient manner.
In theory, lump-sum contracting uses free-market competition to connect the project’s owner with the most cost-effective contractor. The theory, however, can be wishful thinking if at least one bidder chooses to low ball the bid with the expectation of making it up, and then some, by exploiting inevitable design hiccups and the uncertainties and changes described in the preceding paragraph. It’s a mindset of, “I’ll bid the job cheap and make up the difference on changes.” Clearly, this approach does not serve the interests of a project’s owner. In my view, it is shortsighted on the part of the contractor and it simply sets the stage for claims, disputes, and adversarial relationships, both during and after the project.
Another major limitation to lump-sum contracting is the absence of a builder’s participation in deciding what to build, i.e., the design of the facility, to achieve the owner’s objectives at a minimum cost. As owners and architects have turned to construction managers for help with budgeting during the design phase, the construction managers, most of whom are builders, have responded with considerably more than cost data alone. “We can take $400,000 out by eliminating two tower cranes for six months, and we can eliminate the two cranes without compromising schedule if the architect can do so-and-so.” Construction management involves the contractor much earlier in the process than under the traditional lump-sum approach, giving owners and their architects the benefit of a builder’s perspective. This input is often called value engineering, and it frequently saves the owner more than the contractor’s entire profit.
In the old days, architects were sometimes called master builders because they not only converted the owner’s needs to an on-paper design, but also frequently represented the owner in overseeing the construction phase of the project and supervising the contractor. Over time, design professionals became less enthusiastic about running the whole show because of liability issues and a greater litigation mindset in the industry. Meanwhile, larger projects were becoming increasingly complex and the risks associated with these projects were correspondingly greater. The term risk as I use it here refers to the consequences of unfavorable outcomes like missed completion schedules, cost overruns, defaulting subcontractors, claims, litigation, poor workmanship, and many other possible negative repercussions that can be dark clouds over a construction delivery process. Thus, the gradual retreat of the design community from a project leadership role (refocusing on the role of master architect instead of master builder) and the simultaneous complexity and increased risks on large projects created a leadership vacuum, which helped set the stage for the emergence of construction management.