A core competency of a Construction Manager ('CM') and/or General Contractor ('GC') has always been the ability to effectively manage 'subcontractor risk'…that being the risk that the CM or GC incurs additional uncompensated time and cost to fulfill the contractual obligations of the subcontractor.
Under the traditional fixed-price arrangement, the Project Owner knows the price of the project, while any construction cost savings goes directly to the GC's bottom line. Under this model, the GC is incentivized to hire the lowest priced subcontractor, but not necessarily the 'best contractor for the job'. Furthermore, the GC can reduce its 'subcontractor risk' by purchasing surety bonds, the cost of which is incurred by the GC, rather than the Project Owner.
However, as construction projects become more complex and expensive, collaborative construction delivery methods have become more popular. In fact, with Ohio Construction Reform having been implemented just a few years ago, public projects that otherwise were under the fixed-price model can now be under a CM at Risk model.
The Project Owner still has a guaranteed price and has more flexibility in changing the scope of the project through 'allowances' in the GMP. Generally, any cost savings go back to the Project Owner and so under this model, the CM is incentivized to hire the 'best-value' subcontractor, not necessarily the lowest price subcontractor.
The ‘best-value’ contractor is the one who best reduces the CM’s ‘subcontractor risk’ and at a price the Project Owner is willing to pay in order to meet the 'project budget'. Under this model the CM receives a fee for managing the project and this fee is typically a percentage of the total cost of construction. The higher the cost of construction, the higher the fee. Accordingly, the CM is further incentivized in the 'best-value' subcontractors rather than necessarily the lowest price.
In fact, with the advent of Subcontractor Default Insurance (‘SDI’), the CM is further motivated to hire the 'best-value' contractor. This is due to the fact that SDI transfers more 'subcontractor risk' to the CM than would a bond. While more risk is transferred to the CM by way of high deductibles, a portion of the premium is used to fund any future losses.
The best part for the CM is that the Project Owner pays the entire premium and to the extent that the CM effectively manages subcontractor risk, the excess funds are available and refundable to the CM. Again, this incentivizes the CM to hire the 'best-value' subcontractor, not necessarily the lowest price contractor, but how does this impact the subcontractor?
Under the ‘best-value’ concept, both price and performance are part of selection criteria.
In fact, Ohio Construction Reform defines the ‘best-value’ contractor as the one who offers the most advantage and greatest value to the project owner and includes the following criteria:
- Past project experience and performance
- Financial condition
- Facilities and equipment
- Management experience and skills
- Ability to meet diversity inclusion goals
Trade contractors must rethink their traditional business development model in order to secure work in the industry. While it is extra work to gather the necessary data to demonstrate ‘best-value’, there are inherent advantages. For instance, profit margins can be increased by demonstrating best value, without necessarily the lowest price. Furthermore, more productive and safer working conditions are also a benefit of the new process.
Leveraging existing relationships with construction managers and project owners is a must for trade contractors looking to embrace a transparent ‘best-value’ selection process. Understanding what these stakeholders value, both overall and project-by-project, will help the selection process run smoothly. By putting their best foot forward during the entire process, trade contractors can demonstrate they are the best fit for the job, even if they are not the lowest price.
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