American Society of Professional EstimatorsMarch 26, 2010

Contracts, Risk and Construction Pricing

Jim Scott Greensfelder, Hemker & Gale

It is tough to make predictions, especially about the future.

Yogi Berra

Baseball Coach

• Introduction

• Estimating Contract Risk

• Methods Risk Drivers

• Content Risk Drivers

The impossible sometimes happens; the inevitable sometimes does not.

Daniel Kahneman

Nobel Prize Economist

There are things we know, things we know we don't know, and things we don't know we don't know.

Donald Rumsfeld

Secretary of Defense

2001-2006

Pricing Contract Risk

• The construction industry . . . is one of extreme competitiveness, with high risks, and margins of profit generally low. . .

• Pricing mostly takes place in the bidding process. . . There has only been one pricing approach used in construction: cost-based pricing.

Mochtar and Arditi, 2000

Construction Contract Risk

• Contracts are usually Owner prepared

• 75% contain following risks:– Uncertainty of work conditions– Delay– Indemnity– Liquidated Damages– Sufficiency of Contract Documents

Pricing Risk is a Dart Throw

In setting the markup, contractors mainly rely on their intuition after subjectively assessing the competition.

Mochtar and Arditi, 2001

RISK PREMIUMS

Average of 8% to 20% based on ideal or adverse market conditions.

Zaghloul/Hartman, 2002

Federal Highway AdministrationOctober 2006

A Black Swan Event

• Surprise

• Major Impact

• Later Explained as Something to be Expected

RISK MANAGEMENT

• Umbrella

• Ostrich

• Gut

• Brute Force

• Snowboard Ride

Predicting rain doesn’t count; building arks does.

Warren Buffet

METHOD RISK DRIVERS

• Form of Contract

• Method of Project Delivery

• Pricing Arrangement

CONTENT RISK DRIVERS

1. Scope2. Performance Standards3. Change4. Loss Shifting5. Schedule

Scope

• Division of Responsibility

• Detail

• Exclusions

• Deliverables

• Clarifications

• Contingency

Performance Standards

• Warranties

• Performance Guarantees

Change

• Changes

• Changed Conditions

• Force Majeure

• Commodity Price Spikes

Loss Shifting

• Indemnity

• Waivers of Consequential Damages

• Limitation of Liability

Schedule

• Time extensions

• No damages for delay provisions

• Liquidated damages

• Incentives

The Well Prepared Estimate

• Document scope.

• Communicate knowledge of the project by demonstrating an understanding of scope and schedule as it relates to cost.

• Alert project team to potential cost risks and opportunities.

• Record key communications made during estimate preparation.

Well Prepared Estimate (con’t)

• Provide a record of all documents used to prepare the estimate.

• Source of support during disputes.

• Establish baseline for scope, quantities and cost for use in cost trending throughout the project.

• Provide historical relationships between estimates throughout the project lifecycle.

• Facilitate the review and validation of the cost estimate

Risk is a choice rather than a fate.

Peter Bernstein

Thank you.