Difference between guaranteed maximum price and lump sum contracts

The difference between a lump sum contract and a guaranteed maximum price contract is that a lump sum contract, often used in traditional procurement does not give all the project risk to the contractor. It is not a totally fixed price or guaranteed maximum price. In the guaranteed maximum price, mostly used in Design and Build contracts, means that if the costs are higher then the contractor must bear the additional cost, if lower then how it is shared is agreed beforehand.

A ‘pain/gain’, or a target cost agreement, in a GMP contract can incentivise the contractor to make savings, whilst the client has the security of a cost cap, similarly in a lump sum agreement ‘a fixed price contract where contractors undertake to be responsible for executing the complete contract work for a stated total sum of money’ is true. However there are still mechanisms for the contract value to be adjusted after the contract has started.

A guaranteed maximum price (GMP) is a form of agreement with a contractor in which it is agreed that the contract sum will not exceed a specified maximum. Typically, this is a mechanism used on design and build contracts where the contractor has responsibility for completing the client’s design and for carrying out the construction works, so they are in a good position to control costs.

If the actual cost of the works is higher than the guaranteed maximum price, then the contractor must bear the additional cost. If the cost is lower than the guaranteed maximum price, then the contract should set out whether the savings made go to the client, to the contractor or are shared. This can create a ‘pain/gain’, or a target cost agreement, where the contractor is incentivised to make savings, but the client has the security of a cost cap.

A lump sum contract (or stipulated sum contract) is the traditional means of procuring construction, and still the most common form of construction contract. Under a lump sum contract, a single ‘lump sum’ price for all the works is agreed before the works begin.

It is defined in the CIOB Code of Estimating Practice as, ‘a fixed price contract where contractors undertake to be responsible for executing the complete contract work for a stated total sum of money.’

This is generally appropriate where the project is well defined, when tenders are sought, and significant changes to requirements are unlikely. This means that the contractor is able to accurately price the works they are being asked to carry out.

Lump sum contracts might be less appropriate where speed is important, or where the nature of the works is not well defined. Other forms of contract that might be more appropriate in such circumstances include measurement contracts (used where the works can be described in reasonable detail, but the amount cannot), cost reimbursement contracts (used where the nature of the works cannot be properly defined at the outset, often used where an immediate start on site is required), target cost contracts, and so on (see Procurement route for more information).

Lump sum contracts apportion more risk to the contractor than some other forms of contract, as there are fewer mechanisms to allow them to vary their price, and they give the client some certainty about the likely cost of the works. The tender process will tend to be slower than for other forms of contract and preparing a tender may be more expensive for the contractor.

However, a lump sum contract does not give all the project risk to the contractor, and it is not a fixed price, or even a guaranteed maximum price. The price of a lump sum contract can change.

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