How a Shared Savings Clause Can Help Cut Costs
With this clause, construction managers and owners can team up to mine savings from a cost-plus contract.
When an owner decides to invest time and money in a new construction project, it's safe to say he or she expects a quality structure that is built to specifications and doesn't exceed the budget. As for the contractor, it's all about making the owner happy without overspending. Once in a while, however, both owner and contractor can pocket a little extra money and cuts costs at the same time if they use the right contract.
There are different types of construction contracts — lump sum, design build and integrated project delivery, to name a few. The one that provides an opportunity to share cost savings achieved through the course of the project is the cost-plus contract with a guaranteed maximum price (GMP) and a shared savings clause.
Here's how it works.
As part of the typical bid process, contractors provide proposals to the owner, and the overall estimated cost plays a big role in which contractor gets chosen. The winning company's bid establishes the GMP, according to attorney Andrew Richards, chairperson of the construction practice group at Kaufman Dolowich Voluck in New York.
In a cost-plus contract, the owner pays actual costs plus some percentage for profit and overhead. The GMP part means that, generally speaking and barring any contractual exceptions, the owner will pay no more than that amount, even if material prices go up, the contractor made a miscalculation or for some other reason the job ends up costing more.
To incentivize the contractor to reduce costs, the owner will often include a shared savings clause. It allows the owner and contractor to split the difference when expenditures come in lower than the GMP.
According to Richards, the bulk of any savings is typically achieved through renegotiation of subcontracts, often referred to as the buyout process. Since there’s little wiggle room on material prices and other cost elements of a job, the goal is to persuade subcontractors — who are now secure in the knowledge that they will be working on the project — to come down on their price by cutting their labor markups.
It’s all part of the dance. "They know they're going to get [negotiated] down later on," Richards said, "so they [often] give a higher price in the original bid."
By the way, as part of a cost-plus contract, the construction company must open its books to the owner for the audits that will determine final costs.
How the owner and construction manager split the savings is specified in the contract. Richards said it's typically a 50-50 split. If the owner doesn’t give enough, “the [contractor] is not going to kill themselves to get savings," he said.
All in all, the cost-plus contract with a GMP and a shared savings clause can be a win-win if the owner is willing to give a little and the construction manager knows how to negotiate.