Payment options for construction management services

Construction management (CM) takes many forms, and various practitioners have probably promised everything imaginable to potential clients.

04/01/1999


Construction management (CM) takes many forms, and various practitioners have probably promised everything imaginable to potential clients. CM is a service that has, up to now, had no defined limits, thus giving the activity a lot of latitude in its promises.

In fact, there are so many different definitions of the term "construction management" that it is, for all practical purposes, undefined. It is a safe bet that if an owner wants a type of construction service, no matter how unusual, bizarre, or outrageous, there is a construction manager somewhere who will offer to deliver whatever is asked.

These promises range from such fairly standard tasks as contractor coordination and control of quality, schedule, and budget; to guaranteed maximum price, design/build or complete turnkey; to the more far-out possibilities like construction manager financing, property development, and lease back.

CM can, and regularly does, produce the desired results. However, as with most project delivery methods, there are pitfalls. The most obvious problem is that the process itself is not always cost efficient for a given project. This situation, of itself, is not a deal breaker as long as the client understands upfront what he's getting for his money.

The real problem with many of these complex delivery systems is that the owner generally understands what he is getting, but he may not get a handle on what these services really cost. In reality, many of the costs are represented by very subtle reductions in quality and/or schedule, and this type of expense can be difficult to recognize and accurately predict. Therefore, it is impossible to control.

This scenario is not to suggest that the CM process cannot be cost effective. More often than not, it provides good service, at a reasonable price, with expected quality, on a realistic schedule, and with a reasonable budget.

It does suggest, however, that CM services and fees are often a real nightmare to understand, and every client needs to explore the various options carefully and knowledgeably, comparing all potential costs against possible benefits, before choosing a CM style appropriate for a given project.

Although there is little dispute that CM is capable of delivering on the majority of its promises, the actual success is largely dependent on the owner's understanding of the process itself. The knowledgeable owner must carefully select the options most compatible with project needs. He then uses the knowledge to assure the desired results for an acceptable cost.

Delivering the goods

The measure of any successful project is found in three elements: cost, quality, and schedule. Delivery is the production of tangible results without an unacceptable impact on these three components.

The simple provision of these services is no longer enough to constitute acceptable delivery. Most, if not all, CM styles provide the services, but the question remains: Do they meet the definition of delivery?

To find the answer, look into the effect each CM style has on the expected results of a project in terms of the three basic measures.

The task seems simple enough, but remember that these three elements are irrevocably linked together. Changes in one has the potential to adversely affect one or both of the others.

For example, budget can easily be reduced by lowering the quality or changing the schedule. The schedule can be shortened by various fast-track or early start methods, but can have an adverse effect on the budget and often the quality. Finally, a specific level of quality can be attained or maintained, but could have an impact on the budget, schedule, or both.

All three factors must receive careful consideration during an effort to control a project by modification of any of them. Since most, if not all, owners have well-defined requirements as far as budget, schedule, and quality are concerned, the responsive construction manager's task becomes a complex one. The construction manager must deliver the expected quality, on the given schedule, within the established budget.

Payment options

There are three major payment options available. Each has its particular affect on quality, budget, and schedule.

1. Cost plus fixed fee (CPFF) - All costs of the construction manager (from personnel to shovels) are reimbursed by the owner (usually through a general conditions budget), and the fixed fee represents the construction manager's profit. When the construction manager fosters competition, makes good value engineering decisions, does the proper scheduling, and facilitates a smooth operation, all savings accrue to the owner.

The construction manager is free to concentrate on providing the most efficient schedule, with the best quality for the budget, without impacting his profitability.

2. CPFF with shared savings (CPFF-SS) - This approach is identical to No. 1 until getting to the issue of savings, which are usually defined as the difference between established budget and actual cost. There is usually some kind of percentage split on the savings (50-50, 60-40, etc.) between the owner and construction manager.

The fee structure assumes that the construction manager's efforts alone have resulted in any cost savings derived; therefore, he is entitled (by contract) to a share. It is not always totally clear what the real cost of these savings are, but in many cases the owner's schedule, quality, or initial budget are affected.

Therefore, in this type of contract the owner has a potential to pay three times: fixed fee, payout of a share of the alleged savings, and the more elusive, but very real costs, related to any compromises in quality and schedule that have taken place.

When the construction manager does the job he is paid for, fosters competition, performs value engineering, and does the proper scheduling, he gets a share of the savings. The main drawback to the option is that the contract has the potential for a conflict of interest.

3. Guaranteed maximum price (GMP) - This payment option is the most seductive promise. What owner would not be enticed to jump at the thought of a guaranteed maximum price?

Under this scenario, the construction manager guarantees that the price will not exceed his established maximum. The approach is very appealing to an owner who wants to be relieved of over-budget woes. However, there is always language in the contract about changes in scope, material, and schedule.

Having made this guarantee, how can the construction manager protect himself from financial disaster?

First, he can assure that the budget is high enough (estimated costs plus contingencies). This figure may prove to be in conflict with the A/E's estimate. The usual end result is that the budget gets bigger or, more often the case, the scope or the overall quality of the project is reduced to meet the established budget.

Second, the construction manager often squeezes subcontractors' prices to increase his profit margin and/or reduce his risk. The approach can bring subcontractors to the point that they have no option but to fight every detail and substitute specified products with cheaper ones in order to remain competitive and profitable.

This activity usually results in more costs to the owner in terms of potential job difficulties; construction manager, contractor, and A/E disagreements; increased A/E time in reviewing the legions of substitutions; and lower quality materials.

When the construction manager performs value engineering, fosters competition, squeezes subcontractors, and lowers quality standards, he usually keeps all the savings. The owner and often the designer share in the extra costs. In short, GMP often means the owner guarantees to pay the maximum price. There are several other payment options sometimes used.

4. Percentage of construction costs - The construction manager's fee is based on the cost of the project. In other words, the higher the cost the more payment the construction manager receives. Clearly, lower cost is not in the best interest of the construction manager in this type of contract, nor are efficiencies in terms of schedule important to him.

5. Cost plus fixed fee with a bonus - This approach is simply a variation of shared savings.

6. Turnkey - This method is loosely translated as "tell me what you want, pay the bills, and stay away until it is done. The job will be the quality you want (if properly documented) for the budgeted amount and will be done when you want it." Clearly, without the proper guidelines and carefully thought out constraints, turnkey can be a very risky endeavor for the unsuspecting owner.

Fee structures

There are many possible fee variations. The only way to sort the possibilities is to further categorize them by fee structure. They almost always fall into two distinct types.

Type 1 is a professional service for a fee that is unrelated to or affected by actual construction costs (CPFF is the only basic example to this type). The construction manager's price is made up of the actual costs for providing the coordination, management, and administration services plus a fixed fee (profit). (In this definition, cost relates to services, not construction.)

Type 2 is a service for a fee directly or indirectly related to actual construction cost. There are many variations (GMP, shared savings, bonus clause, percentage of construction cost, and turnkey). With these types of contracts, the construction manager has an unavoidable vested interest in the costs, because in virtually all of these arrangements changes in the project cost translate into an additional fee for him.

The ability to increase his own fee puts the construction manager in a potential conflict of interest position, making it very attractive for him to cut corners, all in the name of saving money for the owner. Unfortunately, while most savings actually accrue partially or totally to the construction manager, all compromises made in quality or schedule and loss of good will accrue to the owner alone.

By virtue of these differences two factors are obvious.

1. Only with a Type 1 fee can the construction manager represent all of the owner's interests without the potential threat of bias or conflict. Under this arrangement, the CM fee is forever unaffected by construction cost. The only agenda the construction manager has is to provide a service (best quality, price, and schedule) for a professional fee (plus reimbursable expenses).

2. Competitive bidding on construction management fees never effectively reveals the best construction manager, only the cheapest one.

-- Edited by Ron Holzhauer, Managing Editor, 630-320-7139, r.holzhauer@cahners.com

Key concepts

Construction management services and fees are often difficult to understand.

The measure of any successful project depends on cost, quality, and schedule.

Three major payment options are available: cost plus fixed fee, cost plus fixed fee with shared savings, and guaranteed maximum price.

CM classes

There are three generally accepted classifications of construction management based on method and/or source of delivery: agency CM (ACM), extended services CM (XCM), and guaranteed maximum price CM (GMPCM).

Agency CM (ACM), often referred to as "pure" or "original" CM, is a process where the construction manager is hired by the owner as his agent. He is paid a fee to manage and coordinate the project.

This classification offers coordination, supervision, estimating, constructability reviews, fast track, CPM scheduling, value engineering, and overall project leadership for a price. The price is usually based on the actual costs of providing the services plus a fixed fee (profit).

ACM is specifically and contractually unrelated to construction expenses in the sense that the cost of construction does not affect the price of the CM work. This arrangement is usually called cost plus fixed fee (CPFF). (Cost in this context is personnel and direct costs of the CM, not the project construction cost.)

Extended services CM (XCM) is a process in which construction management is offered as an extension to existing professional services. It is provided by architects/engineers or general contractors, and may be referred to as A/E-based or GC-based CM services.

In this contractual relationship, services are much the same as in ACM, but are offered as an extension by one of the two traditional disciplines. This similarity with ACM ends with the cost of the services.

While most A/E-based XCM usually (but not always) have a similar fee structure to ACM (CPFF), the contractor-based XCM often offers a wider variety of payment options, such as percentage of construction , cost plus fixed fee, and cost plus fixed fee with shared savings.

Guaranteed maximum price CM is a procedure where the construction manager, at some contractually specified spot in the process, offers the owner a guaranteed maximum price based on the scope of the project at that given point in the development.

This system offers services similar to the other two classifications and, like the others, the real difference is in the fee structure. Under this arrangement the CM provides a price for the entire project and guarantees that the total contract price will not exceed this number as long as nothing changes in the scope (which rarely happens).

The construction manager's costs for this work are incidental within the total guaranteed maximum price. The arrangement usually creates a situation where the construction manager gets to keep all savings created by his efforts to theoretically offset the risk he assumed, and usually results in the owner paying the maximum price.

There is no rule that says the CM offerings must fall exactly into one of these three classifications. In fact, there is much crossover.

A wide variety of CM options can result, which offer some combination of one or more options from each of the three basic types. The variable nature of CM services can create a very confusing and difficult task for the owner.

All the classifications offer similar types of services. Based on historical evidence, any of the types are capable of providing necessary services. Therefore, the main differentiating factor between the types of CMs is usually the method by which they are paid and how this relates to the real cost of services to the owner.

More info

The authors are available to answer technical questions about this article. Mr. Winn and Mr. Liebi are available at 315-797-5800; jwinn@harza.com and fliebi@harza.com. The company web site is www.harzane.com.





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