Beneficial Use?

Part 1 can be found here.

The traditional way to implement a project is by Design-Bid-Build. A design team, composed of architects and engineers, produces design drawings and (in many cases) project specifications. These are contract documents, essentially the defined scope of work to implement the entire project. The contract documents are then published for general contractors to bid upon and deliver a bid price. General contractors solicit bids from subcontractors that specialize in various trades necessary for the project. The general contractor’s bid is a summation of the lowest priced subcontractors and their overhead and profit. Although many award criteria can be used, the most common deciding award criterion is lowest price. The lowest price gets the job.

The Design-Bid-Build method will deliver the lowest first cost for any given project. However, the first cost is not the final cost. The final costs are what the owner pays after change orders to the contract. In this model, the final costs can be significantly higher. This design-bid-build method creates an incentive to reward contractors who take a narrow view of the scope and always interpret inconsistencies in the design documents to their advantage. In the worst cases, this can lead to Idiot Contractor Syndrome in which every item not specifically addressed in the documents is assumed not to exist. There is no reward for a knowledgeable contractor who adds in scope of work to cover items that are needed, based on his experience, but not called for in the documents. Thus the best choice may not have the lowest first price. Because all of the items not specified will be added as change orders, the final price will be higher.

Design-Build

One method of avoiding this problem is Design-Build.  In Design-Build, the contractors teams with the designers to produce a final price for the work. This method eliminates the change orders as a problem of drawing and specification errors – the contractor is involved throughout the design process and uses their knowledge and experience to make sure that items are properly covered in the price. Thus Design-Build reduces price risk from change orders. However, it is not a panacea.

Design-Build works best when the finale product is very well defined. Design-Build reduces risk of change orders due to designer error but can increase an owner’s exposure to owner initiated change orders. In the best cases, the owner negotiates directly with one contractor-design team. The design team then determines the owners needs and the owner gets to revisit the projects parameters as the design proceeds. In many cases, Design -Build is a competition between several teams of contactors and designers. Unless the owners needs are very well specified in this competition, the bids may not reflect the same exact project – and the lowest price may not represent the owner’s expectations. In the case of Design-Build competition, we recommend that a professional design team produce a scope document defining, in as much detail as necessary, the owner’s needs and wants. This allows apples-to-apples comparison of prices.

Guaranteed Maximum Price

GMP, VE, DB

The nature of a Design-Build contract is often Guaranteed Maximum Price, GMP. A GMP contract says that the final costs for the project will not exceed a fixed amount. This method  of contracting allows for the contractor to provide value engineering (VE) to the project specifications and share the saving with the owner. Value engineering can be as simple as finding an equal product for less money. In some cases value engineering means the owner’s wants are sacrificed to reducing costs. Value engineering covers a broad range of reducing costs, some of which may be unacceptable to the owner. Caution should be exercised in any situation in which a contractor can “promise” a certain amount of VE -to achieve the savings proposed may change the nature of the project.

If an owner negotiates with a contractor and design team for a Design-Build approach, there is always the concern that the owner isn’t getting the best price.  To reduce this risk, the contractor may “open book” the work. In some cases the general contractor will bid each of the major subcontractors (for example, concrete and steel) and charge a fixed markup on the selected subcontractor. This provides some assurance that the price is as reasonably low as possible. Such a method works best with general contractors that do not “self perform” work – that is, they use subcontractors for the major portions of the project. A general contractor that self-performs work is essentially competing with sub- contractors – and there is a risk of unfair competition.

A new twist on the GMP is the GMP competition. In this case, the design may be partially or substantially complete. Contractors are invited to provide GMP prices to implement the work. Depending on the amount of design provided, the contractor may have to hire a design team to complete the design prior to construction. One disadvantage over negotiation with a single contractor is the loss of contingency. In a negotiation, the contractor is very likely to carry contingency to cover problems in the construction process. Typically this contingency is a line item that is used as issues arise and the excess returned to the owner at the completion of the project. In a competition, however, such contingency is counter to the lowest price and the owner must carry his own contingency.

A GMP contract can be line item or overall. A line Item GMP has estimates for each major trade on the project. In some cases the line items can be very specific – down to individual room finishes. This type of GMP is useful for fast-track projects – projects that are under construction and design at the same time. For example, a shell building under construction and the Tenant Improvement (TI) is in design. A line item GMP allows the contractor to track each design decision as it’s made to see if the budget will be affected. If only the bottom line is important, then an overall GMP is fine – the total contract amount stays the same even if “horse-trading” between line items is necessary to compensate for construction issues.

One new twist on the GMP is a way of defining change orders and their responsibility. The contract is setup in such a way that some types of design errors are simply not allowed as change orders. For example if a ceiling light is shown without a wall switch, the switch is not a change order because a competent contractor would know that a switch is required. In a similar vein, if roof drains are shown without water leaders (drain pipes) the drain pipes would not be a change order – the competent contractor should know that the water leaders are required. However, if a beam shows five bars instead of six bars, the additional bar would be an owner-paid change order because a competent contractor would not know that the extra bar was required without re-engineering the structure. This contract method works but is problematic: the owner assumes a kind of immunity for change orders – assuming that errors will be in the first category, not the second. If this contract type is the result of a GMP competition, then the owner’s expectations are raised too high and the contingency is not in the contract – it is only in the owner’s hands.  Therefore, like Design-Bid-Build, the owner is carrying all the contingency. However, the owner is also under the impression that many of the change orders are eliminated. This is in some ways the worst of all worlds: the owner has a contract that is labeled a GMP but really only provides a portion of the assumed protection associated with the typical contract style.

What style is best for the owner? It depends on the type of owner. If you are a newbie, an owner that rarely develops buildings, we would recommend a Design Build approach using a well defined scope document prepared by a competent design firm (Like us!). If you have a preferred contractor, you can directly negotiate with them. If not, a Design-Build competition would be best. Experienced developers can use any approach – but we still recommend Design-Build. If bidding, we suggest a select list of contractors that are vetted for compatibility with the owner’s needs, wants and, to some extent, personality.

As for a contract, we recommend firat least an overall GMP contract that rewards the contractor for saving the owner money. This can be a savings sharing arrangement or other scheme.

If you truly hate change orders, then the Design-Build method with a negotiated overall GMP is probably your best bet. Note that no matter what, the owner still pays for the project and it’s beneficial use – but some methods have less stress than others.