Note: This article is written from a project owner’s perspective.
Time and materials (T&M) and fixed-price contracts can be utilized for capital projects for full engineering, procurement, and construction (EPC) services. When choosing between a T&M and a fixed-price contract, it is important to consider the pros and cons of each contract type. Both have a time and place, and owners often have a preference based on experience. There are many forms of contracts for industrial projects, with T&M and fixed-price representing two of the most commonly used.
T&M contracts bill project owners for work scope based on hourly rates of labor. Project owners are charged for the number of hours spent on a specific project in addition to the cost of materials. T&M contracts are based either on a predetermined rate sheet or a set of rates built into the contract. A rate sheet is a predetermined hourly schedule of rates for labor, owned construction equipment, and predetermined markups for subcontractors, procured items, as well as construction materials.
Conversely, fixed-price contracts are single-sum or lump-sum contracts where the contractor is responsible for completing the entire project within the approved total cost and scheduleThe main difference is that a T&M contract is an estimated final price, whereas a fixed price contract has an agreed upon fixed final price.
Let’s take a look into general considerations for both contract styles and break down the pros and cons of each.
Importance of Change Management
Regardless of contract type, the most important part of each is scope definition. T&M projects occasionally will run into problems if change management is considered unimportant and is treated as an “open checkbook” by owners and/or contractors. Although there are pros and cons to each type of contract, well-defined scopes should be considered vital to both contract types.
Changes in project scope resulting in change management are likely to occur, even with strong and highly detailed scope definitions up front. Thus, having effective and efficient change management procedures is critical for both T&M and fixed-price contracts.
The Pros and Cons of T&M Contracts vs. Fixed-Price Contracts
As for any contract, T&M and fixed-price contracts have their advantages and disadvantages. Understanding the pros and cons of these contracts can provide insight into when each type of contract may be most fitting for a given project.
T&M Contract Pros
- Potential cost savings: If a project is completed under budget, the project owner receives the benefit of savings.
- Reporting transparency: Because the owner receives more cost information throughout a T&M contract, there can be more transparency in reporting as the project progresses in terms of actual cost incurred, whereas, when utilizing fixed-price contracts, the owner might not have as much visibility into the details of the contractor’s cost.
- Higher availability of data: While there is a higher degree of involvement required on the project owner’s end, there is higher availability of data transferred to the project owner, providing greater insight into a project’s progress.
- Rapid start: On some occasions, the owners need a quick start, and T&M contracts allow projects to begin immediately knowing that the owners will cover the cost of materials and labor. Fixed-price contracts require extensive bidding and scope efforts, and the direction of labor is often unknown until estimates are complete and execution plans are in place
T&M Contract Cons
- Lack of financial risk transference: Financial risk is theoretically on the owner for T&M contracts. If a project goes over budget, project owners are responsible for that overage. Contractors and project owners need to recognize that T&M contracts should be handled similarly to fixed-price contracts regarding scope change and change management. If handled correctly, any deviations from the original intent of the project are known and visible to everyone to avoid budget and schedule problems.
- Poor budget control: If project teams or owners and contractors don’t view T&M contracts vs. fixed-price contracts similarly in regards to scope definition, project controls, and project execution strategies, this can result in a poorly controlled project
- High level of administrative involvement: To keep up with reporting and accounting, project owners are required to have a higher level of involvement in comparison to fixed-price contracts. While this does have some benefits, it can be time-consuming for the owner. In a T&M contract, the owner often has more administrative tasks, such as signing timesheets, etc.
- Lack of competitive bidding: Competitive bidding is challenging because some contractors will take advantage of the contract type by being vigilant in the estimate, knowing that the actual cost will be paid.
Fixed-Price Contract Pros
- Risk transference: For fixed-price contracts, the bulk of the financial risk is on the contractor as opposed to the project owner. Contractors are required to complete the work within the approved schedule and budget. This provides a higher level of predictability and certainty to project owners as it pertains to timeline and budget.
- Reduced administrative needs: Compared to T&M contracts where project owners receive a bill for all costs incurred (including cost backups such as timesheets, invoices, etc.), fixed-price contracts yield less cumbersome reporting and accounting requirements for project owners.
- Predictability and price certainty: While scope definition should be highly emphasized for either type of contract, it is particularly important for fixed-price contracts because it’s necessary to limit the number of change orders to remain within a project owner’s budget. With fixed-price contracts, the end price is definitively set, assuming that the scope definition is good and change orders are limited. This can result in a higher degree of predictability and certainty.
Fixed-Price Contract Cons
- Lower availability of data: While project owners have reduced administrative requirements in terms of reporting and accounting, fixed-price contracts typically do not provide the same level of insight into the contractor’s cost details.
- Less flexibility: The fixed price cannot be adjusted. If the actual cost of the project is below the budgeted cost, the contractor yields the rewards. Since the contractor's price is based on detailed scheduling and execution plans, it is more difficult to change directions for a project under a fixed-price contract.
Which Contract Type Should You Choose?
While there is no “right” contract type, both contract types are great choices for specific project circumstances. Below are detailed situations where T&M contracts vs. fixed-price contracts may be beneficial.
T&M can be beneficial for:
- Early-stage project definition: Throughout the stages of defining a project, T&M contracts can be utilized when it is unclear or hard to pin down how long the full development and definition of a project will take. T&M contracts are particularly useful during the front-end loading phase where the scope is not known or defined and the project scope is to be determined.
- The execution stage: T&M contracts can be advantageous during the execution stage when project owners believe the project may finish under budget.
- Maintenance work: T&M contracts can be favorable, as project owners simply pay for the required hours of labor necessary to complete a maintenance job or instances where a known number of people are required at a site continuously.
- Projects under time constraints: Under situations where there are severe time constraints, such as a commercial obligation, and the project schedule overrides any cost risk associated with proceeding, T&M contracts can be appropriate. When the schedule is paramount to project success, T&M contracts allow projects to begin immediately without delay.
- Sole-sourced project: T&M is beneficial for when you know exactly who you want to contract so the project can begin right away.
Fixed-price contracts can be beneficial for:
- Fully defined projects: Fixed-price contracts are valuable for projects where the scope is fully defined. Typically a well-defined scope will yield the most favorable bids.
- Budget-based projects: When budget certainty is of the highest importance for project success, fixed-price contracts may be favorable.
- Competitive bid situations: Fixed-price contracts are ideal when you are looking for the best price.
Determining Contract Type
At H+M Industrial EPC, we value the individual needs of our clients and will work with you to determine which contract type will provide you with the highest level of success. We can complete your capital project from concept to startup or provide individual front-end planning, engineering, construction, or maintenance services to fit your individual needs