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5 Important Types of Contracts for Engineering Firms

The engineering contract is the foundation of every successful project. Learn about the types of contracts along with the pros and cons of each.


Engineering contracts might not be the most exciting part of your job, but they are by far one of the most important. Without a good solid contract in place, your projects can easily fall apart. And if you don’t know the best contract to use for your various projects, you might as well not have one at all. But when you have the right contract in place and your clients have signed and you’re ready to begin work, that extra comfort knowing your firm is safeguarded is worth the hassle of putting together a contract in the first place.

So what exactly are engineering contracts? Engineering contracts are formal agreements that assign the specific terms and conditions governing the relationship between clients and engineering firms.

In each of these contracts they should clearly state the scope of work, deliverables, timelines, and payment terms, serving as a legally binding document that safeguards the interests of all parties involved.

Engineering contracts are a huge benefit to your firm. They help in setting a clear pathway by specifying the role and responsibilities of each party, with the goal being a harmonious and productive working relationship - which is what all firms should be striving for anyways.

Importance of Selecting the Right Contract Type

Choosing the right type of contract is important in the successful execution of an engineering project. The right contract can greatly influence your project’s financial stability and the working relationship between you and your client.

When you choose the right contract for your project, think of it as applying the right roadmap with milestones and well-defined objectives to help aid in project management and stick to the timeline and budget.

There are various types of engineering contracts you can use, such as fixed-price, cost-plus, time and materials, unit price, and lump-sum contracts, each catering to different project needs and scenarios.

To create a strong contract for each of your projects, you want to know what each type entails and whether or not it’s the right fit for your project.

Types of Engineering Contracts

Fixed-Price Contracts

First up let’s discuss the popular Fixed-Price contract, also known as a Lump Sum contract. This type of contract means you agree to complete the project work at a predetermined fixed price.

The price is set after a detailed analysis of the project scope, objectives, and deliverables. It should include all the costs, such as labor, materials, and other direct and indirect costs, combining the entire project life cycle costs in a single fixed price.

Pros of a Fixed-Price Contract

Predictable costs
The biggest advantage of fixed-price contracts is that they offer financial certainty. Your clients can comfortably allocate a budget knowing the exact amount that will be required to complete the project. This aids in maintaining financial stability and avoiding unexpected costs down the line.
Limited financial risk for clients

Often your clients tend to be somewhat insulated from the financial risks associated with cost overruns since you’re usually obligated to deliver the project within the stipulated price. This means that any additional costs to be incurred due to unexpected issues or hurdles have to be taken care of by you, not your client.

Cons of a Fixed-Price Contract

Potential for lower quality output

Since the price is fixed, you might be tempted to cut corners to save on costs which can potentially lead to a compromise in the quality of the output. This could involve using less expensive materials or rushing through tasks to finish under budget and on time.

Less flexibility for changes

Fixed-price contracts usually have stringent terms and conditions. Any deviation from the initial plan can be complicated and potentially expensive, as it might involve renegotiations and amendments to the original contract. This could limit the client’s flexibility in making changes or updates as the project progresses.

When to use a Fixed-Price Contract

Well-defined projects

Typically, fixed-price contracts are best suited for any of your projects where the scope, goals, and deliverables are clear and well-defined right from the very outset. This includes projects with standardized requirements and a clear pathway to completion where you’re not concerned about any upcoming changes.

Projects with a clear scope and deliverables

Engineering projects that have clear blueprints, where all specifications are detailed carefully, benefit from fixed-price contracts as well. They provide a defined pathway, allowing you to precisely estimate the costs and resources required, and your clients to have clear expectations regarding project delivery and financial commitment.

 

Cost-Plus Contracts

When you hear Cost-Plus Contracts, these refer to the contractual agreement where you are reimbursed for the defined costs associated with the project, plus a fee or a profit margin. This kind of contract is usually implemented in scenarios where the project scope is not well-defined, and there are uncertainties concerning the work required.

Pros of a Cost-Plus Contract

Flexibility for changes

A big pro is that Cost-plus contracts offer significant leeway for modifications and changes during the project lifecycle. They cater to the evolving needs and spontaneous decision-making, which is especially beneficial in projects with dynamic scopes. This flexibility ensures that the project can adapt to new requirements or unforeseen circumstances efficiently without having to renegotiate the terms constantly.

Potential for higher quality output

Since contractors are assured that their costs will be covered on their construction projects, they are more likely to focus on delivering the highest possible quality without the fear of exceeding the budget. This paves the way for superior workmanship and use of higher quality materials, thus ensuring an excellent end product.

Cons of a Cost-Plus Contract

Uncertain final project costs

A significant drawback of cost-plus contracts is the uncertainty in the final project costs. Since the contract accommodates changes freely, it can potentially lead to a surge in the project's overall costs, making financial planning and budget allocation a challenging endeavor for the clients.

Higher financial risk for clients

Clients bear a higher financial risk as they have to cover all allowable costs plus the agreed-upon profit margin for the contractor. This can sometimes incentivize contractors to prolong the project timeline unnecessarily, thereby escalating the costs further, putting the client at a financial risk.

When to use of a Cost-Plus Contract

Projects with an unclear scope

For projects where the scope is unclear or yet to be fully defined, cost-plus contracts can be a wise choice. It allows for the project to unfold organically, adapting to changes and nuances that get unraveled as the project progresses.

Innovative projects where costs are hard to estimate

Innovative projects, especially those involving new technologies or groundbreaking designs, are often accompanied by uncertainties and unknown variables. Cost-plus contracts are ideal in such environments as they allow for flexibility in execution, adapting to the learnings and developments as the project advances, without the constant need to adjust the financials formally.

 

Time and Materials Contracts

Time and materials contracts are a type of agreement commonly used in civil engineering projects, where the client agrees to pay you based on the time spent and materials used, including a markup for the contractor’s profit. Under this contract, all activities and milestones related to engineering work are documented meticulously in contract documents to maintain transparency and track the project's progression through different phases, including the pivotal construction phase.

Pros of a Time and Materials Contract

Flexibility for scope changes

This contract type naturally allows for considerable flexibility in managing scope changes, which can be a recurring phenomenon in civil engineering projects. It facilitates smooth adjustments to the scope without necessitating massive alterations in the contract documents, making it a preferred choice for projects with evolving requirements.

Better suited for long-term projects

Time and materials contracts can be particularly beneficial in long-term projects that span over several phases and involve a depth of engineering work. The adaptability of this contract type can prove to be excellent in managing the complexities and fluctuations that often characterize long-term engineering initiatives.

Cons of a Time and Materials Contract

Open-ended project timeline

While flexibility is a strength, it can also lead to a potentially open-ended project timeline. The constant changes and adjustments can elongate the construction phase, sometimes resulting in a project timeline that extends much beyond the originally anticipated completion date, which might not always be favorable for the client.

Client bears the risk of cost overruns

In a time and material cost contract, the financial risk borne by the client is substantially higher compared to other contract types. The client has to bear the brunt of any cost overruns arising from extended timelines or alterations in the scope of engineering work, which can potentially lead to a financial strain.

When to use a Time and Materials Contract

Projects with a vague scope

When embarking on projects where the scope is not crystal clear or is expected to undergo changes as the project unfurls, opting for a time and materials contract can be a prudent choice. It allows the necessary room for adjustments and refinements in the engineering work as the project moves forward.

Projects prone to changes and developments

In environments where developments are rapid and changes are the norm, especially in innovative civil engineering landscapes, this contract type stands out. It provides the flexibility to adapt to new developments efficiently, ensuring that the project remains current and aligned with the latest advancements without needing frequent revisits to the contract documents.

 

Unit Price Contracts

Unit Price Contracts, prevalent in the construction contract landscape, entail an agreement wherein payment is determined based on the unit price of each category of work performed. This type of contract delineates costs per unit for the various tasks and materials involved in the project, facilitating a structured approach to procurement and payments. It requires a detailed breakdown of all aspects of the project, including the professional services rendered, often involving numerous subcontractors working in tandem.

Pros of a Unit Price Contract

Payment according to work done

One of the standout features of unit price contracts is that payment is directly tied to the amount of work executed, which can be a motivation for subcontractors to maintain a consistent workflow. This system ensures that clients pay precisely for the amount of work done, making the payment process transparent and straightforward.

Flexibility for changing quantities

Given the fluid nature of construction projects, where the quantities of materials and labor might change, having a contract that allows flexibility for changing quantities can be a substantial advantage. It permits easy accommodation of change orders without the lengthy process of substantial renegotiations, ensuring the project adapts smoothly to changing dynamics.

Cons of a Unit Price Contract

Uncertainty in total project cost

While unit price contracts offer flexibility, they also introduce a level of uncertainty in the total project cost. Since the final total costs are heavily dependent on the exact quantities used, which might fluctuate during the execution phase, it can be challenging to pinpoint the exact financial requirement at the outset.

Contractor may prioritize quantity over quality

A potential pitfall of the unit price contract is the tendency for subcontractors to focus on the quantity of work done to enhance their payment, sometimes at the expense of quality. This emphasis on quantity can potentially lead to a rushed job, not giving enough attention to the finer details which are crucial in ensuring the longevity and functionality of a construction project.

When to use a Unit Price Contract

Projects with uncertain quantities

In projects where quantities are a moving target, and a definite procurement list is elusive, opting for unit price contracts can be the ideal choice. It allows for a dynamic approach to sourcing materials and professional services, adjusting as per the real-time needs of the project.

Large scale projects where work can be quantified in units

Large-scale projects, which involve extensive layers of work and myriad materials, benefit enormously from unit price contracts. Breaking down the project into quantifiable units streamlines the workflow, offering a structured pathway for the execution of the project, while accommodating the changes that are almost inevitable in large-scale projects.

 

Target Cost Contracts

In a target cost contract, both you and your client agree upon a "target cost" for the work to be performed. The actual costs are reimbursed to you, but there are mechanisms in place to deal with any cost overruns or underruns.

If the actual cost is below the target cost, the savings are shared between your client and you based on a pre-agreed formula. However, if the costs exceed the target, both parties share the additional cost, again based on a predetermined formula.

Pros of a Target Cost Contract

Fair Reimbursement

Your firm will be reimbursed for the actual costs, which means less risk than a fixed-price contract.

Profit Opportunity

Your firm has the opportunity to earn more than the initial profit if you can bring the project in under the target cost.

Cons of a Target Cost Contract

Financial Risk with Cost Overruns

Even though this contract distributes risk between you and your client, there's still a significant risk for your firm. If the actual costs exceed the target, you must share in the financial burden of the overruns.

Potential for Scope Creep

Since your client is sharing the risk of cost overruns, they might be more inclined to request additional work or make changes during the project. These changes can incrementally increase costs and complexities, leading to potential overruns.

When to use a Target Cost Contract

Projects with Potential Savings

If a project's final invoice is less than the targeted amount, the accrued savings amount will be split up based on a pre-negotiated ratio by both parties.

Projects with Potential Cost Overruns

If a project's final invoice amount exceeds the targeted amount, then only a partial payment will be required based on a pre-negotiated ratio by both parties.

 

Use Your Contract Knowledge to Build a Better Proposal

Now you should have a better idea of why understanding the nuances of different engineering contract types is so important. Each contract type, whether it’s Lump Sum, Unit Price, Cost-Plus, Time and Materials, or Fixed-Price, caters to distinct types of work and project requirements, offering a range of benefits and posing unique challenges. When used correctly, your project and firm are set up for success.

Whether you’re securing engineering services for intricate design projects or engaging contractors for public works, utilizing standard forms of contracts can provide a structured, legally sound, and organized approach to successful project execution.

Selecting the right contract safeguards the interests of all parties involved, striking a harmonious balance between flexibility and accountability. It essentially becomes the blueprint of the working relationship, delineating responsibilities and setting the stage for a productive and respectful collaboration.

Now that you know the pros and cons of each contract and when to use them, it’s time to take the next step and learn how to get clients to say yes to your proposal. BQE Software presents a free on-demand webinar run by Douglas Teiger, FAIA, on how to build a better proposal to equip you to land your next client.

Build a Better Proposal: How to Get Clients to Say Yes

Watch our free webinar on the necessary and crucial steps to developing a well-defined and structured contract proposal.

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