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(White Paper Prepared by FTA)
Definitions
Congress has directed that funds sufficient to meet "project contingencies" be included in all FFGA New Starts budgets. Annually in the Department's Appropriation Statute, or the accompanying Conference Report, the importance of this budget item is reinforced. Contingency levels vary depending on which party assumes the majority of risk in completing a project, and how well the project is defined through engineering plans and specifications at the time bids are solicited. For the two most common contract choices employed by grantees - design/bid/build and design/build - the burden of risk is very different. Project contingency is almost always expressed as a percentage of the overall cost of the project.
Design/Bid/Build
Design-bid-build (D/B/B) projects demand a larger percentage for contingency in relation to the overall project budget because the owner is assuming the majority of risk. Project contingencies for D/B/B contracts typically average around 10% of the overall project budget. For traditional D/B/B projects, the owner provides the contractor with plans, specifications, and an engineer's estimate and the contractor provides a bid to build the project. Any changes to the project become the sole responsibility of the owner and will impact schedule and budget. When there are changes on construction projects, they result from changed conditions, design errors, or additional requirements.
Generally in a D/B/B contract the design consultant maintains a relatively high manpower level in order to review submittals and perform design activities associated with any errors, differing site conditions and/or new program requirements. Most changes add cost to the project budget. Generally the amount of contingency assigned to a project budget declines as a project nears completion. There are exceptions, particularly if a large number of change orders and claims are outstanding.
Design/Build
In a design/build (D/B) contract design activity is integrated into the construction contract. There is only a limited need to transfer data across contract boundaries, particularly for approval on a day-to-day basis. Since the D/B contractor is responsible for design and construction, he has assumed the risks for differing site conditions and design errors. Whenever changes are ordered or new requirements established, the risks and costs are normally the owner's. The presence of a third party with authority to order change has the potential to increase costs and this situation must, therefore, be carefully managed. The owner will normally control internally generated changes and limit financial risk. With only third party changes to plan for, construction contingency can stay well below the normal 8-10%.
Other Related Issues
Project endeavors such as ROW purchase, vehicles acquisition, project management, and miscellaneous construction, utility and startup efforts for design/build contracts typically have nearly the same risks as a design/bid/build contract, but rarely exceed one third of the total project costs. Co-location of the owner and D/B contractor, as compared to the traditional arrangement in which project participants are located in separate facilities, has proven to speed resolution of questions and improved project execution.
Managing Risk
The amount of project contingency is directly related to the risk associated with completing a particular scope of work. If a Request for Proposal (RFP) is ambiguous it will result in bids higher than expected. Contractors when bidding on a project evaluate risk and incorporate its potential cost into their bid. If a contractor's contingency is not used it will become profit. An RFP that clearly defines the project, its operational/quality requirements, and explicitly states how the proposal will be evaluated, generally results in a proposal that will best meet the needs of the owner. This minimizes the risk of changes, and the cost associated with those changes, and reduces the amount of contingency needed by the contractor.
Successes
In evaluating bids for the University Line light rail project the Utah Transit Authority (UTA) observed that considerable funding was included to cover the risk associated with relocation of dry utilities. The D/B contractor had bid an amount more than double what UTA had estimated. UTA proposed that the project be revised through a Best and Final Offer (BAFO) process to eliminate the cause of such a large contingency for relocating the utilities. It was suggested that the work could be accomplished on a Time and Material (T&M) basis thereby reducing the D/B contractor's risk significantly. Incentives were added to the T&M contract to ensure that the D/B contractor performed efficiently. By removing risk from the D/B's contract, UTA was convinced the work could be accomplished cheaper and with a minimum potential for claims. By directly addressing a risk issue and changing the D/B's compensation from a lump sum payment to a direct cost, UTA saved approximately $3.5 million.
The degree to which risk is allocated between the owner and contractor and the amount of incentive provided to the contractor (shared cost savings of a provisional amount) is a function of each individual project. Conducting a comprehensive risk analysis of the project, writing a clearly defined request for proposal, and removing risk and associated cost where possible are good management principles that will be advantageous to both the owner and contractor in reducing project contingency costs.
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