Comparison between Management Contracting and Traditional Lump Sum Contract - Essay Example

Comparison between Management Contracting and Traditional Lump Sum Contract Introduction It is commonly understood that contract management is indispensable in the construction industry not only to protect the interest of construction business but, at the same time to meet the needs of the parties involved in the construction filed as well. It may be simply defined as the process of managing contracts so that performance meets the needs of all contracted parties and funding bodies (Chege, 2002). Managing a contract needs to performed with utmost care and caution so that the interest of all the parties are protected. Among the various challenges in the efforts of managing a contract, procurement strategies assume great importance as it is considered as one of the foundation of construction management. There have been many developments in the field of procurement management over the years. Partnering, Construction Management, Management Contracting , Built-Operate-Transfer / Public Private Partnership, Guaranteed Maximum Price etc are some of the commonly used procurement strategies. With this background, the present essay discusses and compares differences in the procurement of management Contracting and the traditional lump sum contracting. Procurement strategies in Construction Contract The main tasks of the procurement professional are to assess and choose material suppliers based on accessibility, dependability and cost in order to find the good quality products (or services) at the best feasible value (Marsh, 2000). In an online article-Supply and Demand Chain Executive, October, 2003- the author remarks that "while procurement is a critical business function for virtually every company, senior management often misunderstands it. In general, procurement is usually viewed as a cost center, which can only be marginally improved through the application of information technology" (Smith, 2003). Irrespective of the developments in the field, there are some problems and challenges that many companies still are confronted with in the area of procurement management. Some of them are briefed as below: The length of time taken to diagnose a reliable supplier; The confidence that it is not worth the endeavor to make a contract when executing a spot buy; The failure to establish pricing agreements for certain suppliers; Lack of accessibility to contract information; Inability to perceive the supplier performance and reliability based on contract terms; Comparison between Management Contracting Lump-sum Contracts A lump sum contract refers to a kind of fixed price contract where the buyer comes to a fair deal with the provider (or seller) by agreeing to pay a fixed total amount for a well-defined product (Chen, 2001). In other words, while payment is the common factor between these two contract types, differences prevail in terms of the payment modes that can be fixed or contract-based regarding the former, but have to be fixed when it comes to the latter. Whereas management contracting is an arrangement under which a separate enterprise performs the managerial functions of the principal enterprise in exchange of payment. It involves a wide range of functions including the operational functionalities of the enterprise, production, accounting, marketing, and so on (Procurement practice guide, 2008). It is suitable for fast track projects, complex buildings, and a developing brief. However, it perform less in areas characterized by inexperienced clients, cost certainty before starting construction, and clients wanting to pass risk to the contractor. These two types of procurement strategies can be further compared and contrasted in with the major points such as organizational structure, contractual relationships, risk control mechanism, and Suitability criteria and the impacts on the project outcomes. Organizational structure While payment being the common factor between management contract and the traditional lump sum contract, there are several other aspects in which the two can differ as well. In order to understand how the two contract types compete with one another, it is relevant that we make a precise comparison between the two. Let's first discuss the notion of management contracting and its structure. Management contract involves three broad areas: a) service delivery management, for appropriate service, performance and quality, b) relationship management, for constructive relation between the parties (buyer and seller of project management), and c) contract administration, for better governance of the contract and related issues (Sall, 2004). Now coming to the other type of contract, the lump sum contract, the term refers to the contract between the customer and provider which includes a fixed price. A lump sum contract can be beneficial for both customers and providers. It allows the provider to charge a reasonable base fee while the provider can also charge rewards for exceptional performance during the course of the contract. The customer can also get benefits from lump sum contract as there is the advantage of paying a reasonable base fee although the price may increase in future if certain conditions are met. The main structural differences between the two types of contracts can be summarized as following: Contractual relationships What provides the strong base of a management contract is the development of a good working relationship between customer and provider. Only then can it obtain the services as agreed in the contract. Customer-provider relationship helps optimize the efficiency and effectiveness of the project so that it can eventually accomplish value for money. While getting into a management contract, there are certain points that the customers should keep in focus including the following (Grefen, n. d.): Service terms and conditions Pricing mechanism Provider incentives Contract timetable Performance measurement modes Change control procedures Escalation procedures Agreed break options It is important to note that these key points are part of the organizational framework in management contract. This has also been reiterated by Henriod (1988) that these factors are highly relevant in terms of resolving any kind of tensions existing between customers and providers. In the context of lump sum contracts, the Victorian government of Australia focuses on the importance of selecting the appropriate procurement method as well as the associated risk factors while acquiring a new construction contract. The main aspects of the contract are: the clients, consultants, contractors, and suppliers (Building Procurement, 1997). While communication among these aspects is very important, the government policies emphasize on developing legal relationships between them. As structured by the government policy, the lump sum contract includes clients who evolve concepts that are further developed and documented by consultants. To make the design work, the clients then involve contractors. Payment for the contract has a fixed amount that is mutually decided at the beginning. The client pays the consultant and the contractor separately. Risk control mechanism Apart from the aspects mentioned earlier, there is a risk factor of managing the contract in management contract. The accomplishment of the contract may get endangered by several types of risk. One of the main objectives of the management contract is to identify and control all kinds of risk associated with it. One of the most important constituents in lump sum contract is risk management. It involves four main functionalities, Identification, assessment and allocation of risk Linking risk to obligation Monitoring and managing risk Consideration of investment return Therefore, we can say that in terms of risk management, both management contract as well as lump sum contract follow and implement same kind of risk control mechanism while focusing on the same issues. Suitability criteria and the impacts on the project outcomes In terms of management contract, communication is the most essential requirement in customer-provider relationship. An appropriate example of management contract can be demonstrated through the one adopted by United Water, an Australian company that provides water and wastewater services in Australia and New Zealand. The company is owned by Veolia Water, the world's largest water company. United Water manages, operates and maintains water and wastewater systems mainly in Adelaide. Ownership of its infrastructure is retained by South Australia Water, which also controls and implements the pricing policy of the government. The contract includes "the design and project management of new and upgrading of existing infrastructure" (Case study - Adelaide contract, 2009). The impact of the project outcome has been quite progressive and effective as well since the operational efficiencies of United Water have succeeded in a) improving services to customers, b) reducing environmental operations, and thus, c) contributing to greater sustainability. Customer satisfactory ratings also have gone higher beyond 95% (Case study - Adelaide contract, 2009). It is apparent from the case study that operational efficiency in service delivery is important in management contract. It increases performance as well as quality of the project. A key factor is the knowledge of both the customer's and provider's business. This is essential in order to succeed in project management. It is notable that lump sum contracts are widely accepted in the construction industry as they cater to the requirements of small, medium and even single trade projects. The advantage of a lump sum contract is that it offers a clear understanding of the end product before construction begins. Moreover, there is a comparatively lower chance of risk to the client if the scope of the work is well-defined along with limited client variation (Building Procurement, 1997). However, regarding timetable management, lump sum contracts are featured by extensive time requirement in order to complete documentation. Thorough documentation is good for the contract, but if it takes too long, consequently the project will also take a longer time to start (Blas, 2004). This is the main reason why companies are not so much interested in adopting lump sum projects these days. In comparison to it, management contracts are more appreciated mainly due to the functional distribution of the contract into several units resulting in effective as well as efficient contract management. As its function varies from production to accounting and marketing, management contract can also be labeled as an all inclusive contract. Regular assessment of processes and payments is reported to the board of directors due to which there is always a well-maintained coordination intact among the clients and providers. Good relationship between them then leads to further improvement of the operational functionalities of the contract, which eventually results in its success. All these findings can be lustrated and depicted through the following diagrams and table: Traditional Lump sum Contract (Figure 1) Table showing the differences between Traditional Lump Sum Contract and Management Contracting (Table No.1) Factors Management contract Lump sum contract Cost Flexible Fixed Time Fast track projects (less time) Lengthy and less urgent (more time) Quality Complex buildings Less experienced clients Structure Distribution of functionalities Long plan documentation Management Management units for different responsibilities Not enough scope in relationship managements and other such aspects Contractual Relations A strong working relationship Only legal relationship Risk Control Mechanism High High Management Contacting (Figure 2) Conclusion After going through the structures of both contract types, we can conclude that management contracting is an effective strategy for executing and monitoring a contract while maximizing its financial and operational performance and minimizing risk factors. In the recent years, there has been a tremendous change in management contract. With the number of contract types increasing, the complexity of the contracts, and their terms and conditions are also changing rapidly. Therefore, the requirement of an efficient and effective management is a must. While initializing and negotiating in a contract, it is important for the client and the provider to come to a common understanding on the overall infrastructure of the contract including its organizational structure, time limits, cost value, return value, distribution processes, marketing, and other related aspects. Further, the organizational structure includes the identification and assessment of risk factors associated with the contract and its end product. While lump sum contracts deal with fixed amount of payment, there is some flexibility in management contract with regard to increasing its effectiveness and reducing costs. Besides, strategic decisions can also help attain competitive advantages for the project as well as the organization and its clients. The feature of flexibility further provides reasonable and realistic requirements of both parties (client and provider), which means there is sufficient understanding and communication between them. As mentioned earlier, good relationship between the customer and provider in a contract shapes the success story of the project. References Blas, A. M. and Manley, K. (2004), Key Influences on Construction Innovation, Construction Innovation, [Online] Available from [ (accessed on 1st October 2009) Building Procurement (2001) Office of Building and Development, Australia, [Online] Available from (accessed on 1st October 2009) Case study - Adelaide contract (2009) United Water, Australia, [Online] Available from (accessed on 1st October 2009) Chege, L. W. and Rwelamila, P. D. 2002, Risk management and procurement systems - an imperative approach, CIB Report 2000, [Online] Available from (accessed on 3rd October 2009) Chen, F. 2001, Auctioning supply contracts, DRO Working Papers Series 2001-2004, [Online] Available from (accessed on 1st October 2009) Grefen, P., Aberer, K., Hoffner, Y. and Ludwig, H. (No Date) Cross Flow: Cross-organizational workflow management in dynamic virtual enterprises, European Commission, [Online] Available from (accessed on 1st October 2009) Henriod, E. E. and Lanteran, J. M. 1988, 'Trend in contracting practice for civil works', Task Force on Innovative Practice, World Bank, Washington D. C., [Online] Available from (accessed on 1st October 2009) Marsh, P. 2000, Contracting for Engineering and Construction Projects, Gower Publishing, Burlington Procurement practice guide: Contract management (2008) New South Wales Government, Australia, [Online] Available from (accessed on 1st October 2009) Sall, M. and Bartolini, C. (2004), Management by Contract, NOMS, Korea, [Online] Available from (accessed on 1st October 2009) Smith, mark (2003), Contract Management for procurement best practices, Supply and Demand Chain Executive, Imany.com [Online] Available from http://www.imany.com/articles_pdfs/CMProcureBestPracticesOct2003.pdf (accessed on 1st October 2009) Read More