While you may not realize it, Lump-Sum Contracts are extremely common. Although they’re not always designed as “Lump Sum”, or even a contract at all, Lump Sum Contracts are used in many different industries. This includes construction projects, hiring vendors or companies, making purchases and more. So how does a Lump Sum Contract work? In this article, we’ll go through what a Lump Sum Contract is, when they’re used and 5 things to consider before and after signing one! Let’s get started.
- What Is A Lump Sum Contract?
- Risks Of Lump Sum Contracts
- When Are Lump Sum Contracts Used?
- 5 Things To Consider As Project Managers
What Is A Lump Sum Contract?
A Lump-Sum Contract is an agreement between two parties in which one party performs specific tasks or provides certain goods/services, in exchange for a fixed ‘Lump Sum’ amount of money. Rather than paying for these services based on an hourly charge or unit prices, one fixed price is agreed upon between the two parties up front.
For example, a Evergreen Lawn Care agrees to mow the Smith family’s lawn for $100. Evergreen makes the assumption that their labor, equipment and other costs will be $70, leaving $30 as profit. This is a job that should take one hour.
The Smith family won’t pay more than $100 if Evergreen’s costs exceed their $70 budget, nor will Evergreen charge the Smiths’ less than $100 if they perform their work faster or cheaper than expected.
In turn, the party providing the goods & services must perform the work for this set price. In exchange, they take of the risk of ensuring their work can be performed within budget and the timeframe agreed to. This brings us to the next point…
Risks Of Lump Sum Contracts
While the above landscaping example illustrates the point on a basic level, let’s talk about a few additional risks one must consider when managing a Lump Sum Contract.
As stated, the party performing the service or providing goods runs the risk of incorrectly pricing or estimating the work.
If the project, job or goods cost more than expected, the customer is not affected – the company selling their goods or services will incur cost overruns and therefore make less money (profit).
In another scenario, the company may underestimate how long their work will take. The customer will not be happy with a delay, but the contractor or company doing the work will take the biggest hit, as their other projects or work will be delayed in turn.
With Lump Sum Contracts, there are larger repercussions when the scope of work is misinterpreted. Whether the scope is not clear in the contract or the two parties just don’t see eye-to-eye, the two parties are more likely to engage in a dispute over what’s truly owed. Billing the client additional money for budget or schedule overruns is not allowed in a Lump Sum Contract scenario.
After all, the customer or client expects to receive everything they want for one fixed ‘Lump Sum’ price, while the company doing the work expects to perform a very specific amount of work in exchange.
When Are Lump Sum Contracts Used?
Lump Sum Contracts are extremely common – both in the world of Project Management and in daily life. Lump Sum Contracts are generally used when the following statements are true:
- The scope of work is clear and well-defined
- There are little to no unknowns involved in the work
- There is little chance that the scope of work will change
Below are a few examples of Lump Sum contracts, ranging in complexity.
The Construction Industry: How does a Lump Sum contract work in construction? A client hires a contractor to perform some work – building a house, repairing a wall, wiring a garage, installing a new facade or countless other examples – for a set amount of money. Phaeton Contracting provides a quote for the work above and the client agrees to pay them a Lump Sum amount to do so.
Compare this to a different type of contract. On a Time-and-Material contract, the Client may agree to pay a contractor $300 per day plus the cost of materials for a variety of miscellaneous repairs to their home, with no specified end date.
The I.T. Industry: A hospital decides to upgrade their internal network, servers and central software. Jupiter Solutions (love coming up with these names) agrees to perform all of these upgrades for $2.5 million. In turn, Jupiter must perform all of these upgrades for that fixed price. When providing a quote to the hospital, they must consider all of the work these upgrades will entail.
Of course, if the client in either scenario asks for additional work to be performed beyond the agreed-up scope of work, the contractor is entitled to receive additional time and/or money via Change Order.
Lump Sum Contracts in Daily Life: Here are a few examples of how Lump Sum Contracts appear in daily life that you’re almost certainly familiar with, even if they’re not technically written contracts:
- Restaurant: If you order a specific meal, you’ll pay whatever the menu states. If the cook takes longer to make your meal than expected or they can’t make the amount of profit they expect, your price doesn’t change.
- Plane Ticket: Once you buy a plane ticket, you’re flying for the amount you pay. Should the cost of fuel or staff increase, you aren’t charged more.
- Haircut: Barbers and hair salons don’t charge to cut your hair based on how many inches of hair you have. Instead, they offer a few different options, each with a designated price, for you to choose between.
There are countless examples in day-to-day life, but let’s focus a bit closer on what to consider when managing Lump Sum Contracts as a Project Manager.
How Does A Lump Sum Contract Work? 5 Things To Consider As A Project Manager
Now that we’ve defined what a Lump Sum Contract is and when they’re commonly used, let’s go through 5 things we must consider about managing Lump Sum Contracts as a Project Manager!
- Ask Lots Of Questions Before Signing A Contract
- Pay Close Attention To Your Bid & Pricing
- Outline The Scope Of Work In Writing
- Create A Set Of Qualifications & Exclusions In Your Contract
- Make Sure The Contract Outlines Procedures For Changes
We’ll go through a bit of detail on each of these points below.
1. Ask Lots Of Questions Before Signing A Contract
As we discussed above, many clients and contractors or vendors run into disputes due to confusion over scope of work. These disputes are particularly common in Lump Sum scenarios, as both parties are notably concerned over the price changing. Clients don’t want to pay more, nor do companies performing work want to pay less.
As a Project Manager, it’s a great idea to ask the client as many questions as you can about the work they want done before even providing a bid, let alone before signing a contract. Make sure any and all questions you have are asked before providing a final price.
2. Pay Close Attention To Your Bid & Pricing
Once a Lump Sum price is agreed upon, there is very little room for error in terms of managing the project’s cost. As a company performing work or providing goods, keeping costs at or below what’s been estimated is essential to achieving project profitability.
As a Project Manager, Lump Sum Contract work must be bid, priced and executed with great attention to detail, so as to not run into an unexpected cost once work begins. The same can be said for estimating timeframes.
3. Outline The Scope Of Work In Writing
The clearer the scope of work is outlined in a Lump Sum Contract, the less room there is for confusion down the road. The scope of work should be clearly illustrated with as many supporting documents as possible. Here are some ideas for information to include that clearly defines what the scope of work is:
- Drawings, Sketches, Etc.
- A Timeline, Rough Schedule Or Phasing Plan
- Listing Quantities Of Work That’ll Be Performed I.e. Excavating 300 Cubic Yards of Soil
- A Brief Description Of How Your Work Will Be Performed
The more concise, clear and descriptive your scope of work is, the less confused both parties in the agreement will be.
4. Create A Set Of Qualifications & Exclusions In Your Contract
Closely related to the ‘scope of work’ is a written list of qualifications and exclusions in the contract.
Qualifications in a Lump Sum Contract are essentially the assumptions made while estimating, pricing and discussing the work. Here are a few examples of qualifications:
- Work will be performed during normal business hours, Monday through Friday.
- The project will require a staff of three to complete and will take approximate 20 working days.
- Selections by the client for x, y and z must happen before June 22nd in order to maintain the completion date specified.
- A 25% deposit must be paid prior to the project and schedule timeframe commencing.
Exclusions in a contract are pretty straightforward – they’re a list of work items and conditions that are not included in the price, and therefore the contract. Here are some examples:
- Work outside normal business hours and on weekends is not included.
- Performing work to plumbing or electrical systems is not included in the cost or scope of construction.
- Days that work cannot be performed due to weather, client direction or ‘acts of God’ cannot be considered as a delay to the completion date.
Qualifications and exclusions go hand-in-hand with the scope of work in a Lump Sum Contract. Project Managers and clients alike will benefit from having clearer expectations surrounding what’s being done.
5. Make Sure The Contract Outlines Procedures For Changes
Changes frequently arise on all sorts of projects for many reasons, and Lump Sum Contracts are no exception. It’s important to outline how changes are to be handled should any arise, especially on a Lump Sum project – the project has already been agreed to for a fixed amount of money!
Here are some common contractual conditions that pertain to handling changes on a Lump Sum project:
- All changes must be agreed upon in writing before any work proceeds.
- All costs associated with a change must be itemized and quantified for the client to review prior to agreeing on additional costs and/or time.
- The contractor or vendor performing the work will be entitled to x-amount of profit (fixed profit percentage) for any/all changes.
- Should the client request changes, they must request these changes in writing for the contractor to reference while considering additional costs, time, etc.
Many disputes happen when a change in scope is requested – this applies to either party. Having a clear, actionable procedure for handling changes makes navigating these requests a lot more straightforward.
How A Lump Sum Contract Works: In Summary
In this article, we’ve defined what a Lump-Sum Contract is, the risks associated with them, when Lump Sum Contracts are typically used and five things to consider about managing Lump Sum projects as a Project Manager. I hope we’ve answered all your questions and we thank you for reading!
