Although guaranteed maximum price (GMP) contracts are standard across many industries, there are some nuances to this approach that are commonly used in construction and related projects. Companies and individuals entering these agreements need to know the maximum price contract advantages and disadvantages to use them effectively.
What Are Guaranteed Maximum Price (GMP) Contracts?
With GMP contracts, the customer agrees to reimburse the contractor for materials, labor and the contractor's fee that covers profit. The guaranteed maximum price is the highest amount customers would pay for the project, though if the final price is less than the maximum, the client is not obliged to share those savings with the contractor unless stipulated in the agreement. Contractors are responsible for any cost overruns beyond the maximum price unless there are changes to the project design or scope.
Guaranteed Maximum Price vs. Fixed-Price Contracts
Fixed-price contracts stipulate a set price for projects. Regardless of how much the contractor ends up spending to complete the project, the price paid will be the same. Fixed-price contracts are usually paid in installments at different stages of the project. It’s especially important to have all project details before the execution of a fixed-price contract.
GMP contracts, on the other hand, have some flexibility. The customer reimburses the contractor or pays for expenses up to a threshold determined at the outset of the project. The contracts include profit for the contractor, often a percentage of the overall project price. Like fixed-price contracts, if costs go over the expected amount, the contractor is on the hook to cover the overages, unless a formal change order is submitted.
- Guaranteed maximum price contracts provide a limit to project costs for buyers.
- The agreements are standard for projects with open-ended scopes or timelines.
- Contractors work closely with customers to develop the project design, timeline and other details.
- GMP contracts share many similarities with other types of contracts, such as fixed-price contracts, but there are some key differences.
Guaranteed Maximum Price (GMP) Contracts Explained
The guaranteed maximum price is the most a contractor can bill a customer for a project. Also known as "not-to-exceed price" contracts, these agreements require customers to compensate contractors for their direct costs and a fixed fee for overhead and profit, but only to a certain threshold. The contractor is responsible for additional costs once the project has reached this amount. The maximum price can be increased via a change order if the project's scope changes but not for estimating errors or cost overruns.
How Do Guaranteed Maximum Price (GMP) Contracts Work?
Guaranteed maximum price contracts are relatively straightforward, but there are details about which customers and contractors should be aware.
The guaranteed maximum price consists of four parts:
- The project's tasks
- Direct project costs
- The indirect overhead costs a contractor incurs
- The profit a contractor wants to make
From this framework, contractors can determine the project price. For example, a GMP contract to build a grain silo would include the direct project's hard costs of $150,000, overhead costs of $20,000 and a fee including the contractor's desired profit of $15,000 for a total price of $185,000. That would be the most the contractor could charge the customer unless a formal change order request occurs and both parties approve it.
If costs go over that amount, contractors must pay them out of pocket, reducing their profits. If the project comes in under the GMP budget, the customer keeps the savings. However, it's not uncommon for customers to share a portion of any leftover funds with contractors as an incentive to keep costs down.
Construction manager at risk (CMAR)
With GMP contracts, the general contractor's role is as a construction manager at risk (CMAR). Here, the construction manager is responsible for guiding the project's development stage, consulting the customer on the project design and scope, budget concerns, material suitability and availability, construction challenges and other vital aspects. That allows the contractor to develop an accurate, transparent GMP to which both parties agree. Once the project is underway, the CMAR is the primary touchpoint for project owners, laborers and subcontractors, working to keep costs within the agreed-upon threshold and maintaining high-quality output.
When Are Guaranteed Maximum Price (GMP) Contracts Used?
These contracts work best for projects with costs that can be estimated accurately and don't have large fluctuations in price. Guaranteed maximum price contracts can also combine with other types of contracts. In these cases, the GMP serves the same purpose, but the underlying agreement may be according to less strict stipulations, as with cost-plus contracts, which are agreements to reimburse contractors for any expenses, plus a pre-determined amount of profit, usually a percentage of the full contract price.
Uncertainty in GMP Contracts
While guaranteed maximum price contracts are helpful, they are still subject to challenges. In many cases, these issues arise because of scope and cost fluctuations, which can lead to uncertainty.
Schedule of values
As with other project-based contracts, guaranteed maximum price contracts require a schedule of values. This document is critical in GMP contracts as it determines the guaranteed maximum price.
How do schedules of values work?
The schedule of values document itemizes the costs for tasks, personnel and supplies the contractor needs to complete the project. It consists of trade categories (e.g., plumbing, painting, welding, and more) and the estimated labor (including subcontractors), materials and contingency amounts. The sum of the costs in this document is the guaranteed maximum price.
While using the schedule of values is generally to reduce uncertainty, it can be a source of confusion and disagreement when the contractor's numbers are out of line with the customer's expectations.
Confusion within guaranteed maximum price contracts and the schedule of value, in particular, typically occurs when the contractor includes a buffer amount on the schedule of value items known to fluctuate in price over long periods, such as raw material and labor. Contingency amounts also cover the contractor's overhead costs for things like equipment rentals. Although this is a common and prudent practice, contractors must be able to explain the increased costs.
If contractors don't reach the contingency amount by the end of the project, the contractor and customer often split the extra funds. However, this can cause concerns if one party believes they're owed a more significant cut or doesn't want to share at all. The contract should stipulate how contingency amounts divide to avoid disagreements.
After establishing the GMP, neither the contract price nor the project scope can change without an official change order request. This document must include the justification for the change, an estimation of the adjusted costs and whether the proposed changes affect the completion date. Both the contractor and the customer have to agree to the new terms.
Benefits of Guaranteed Maximum Price (GMP) Contracts
GMP contracts can be mutually beneficial for both customers and contractors. They work best for projects with detailed specifications and scopes of work.
Advantages for customers
These contracts are suitable for customers with tight budgets since there is a firm cost threshold. Depending on the stipulations of the contract, customers may get to keep the savings if the project comes in under the GMP, but it’s common to share with contractors as an incentive to finish under budget.
Clients carry less risk in a GMP contract as contractors are responsible for cost overruns. When done well, there is also less risk of paying for inadequate supplies or work because the schedule of value details the jobs the contractor must complete and the materials to be used.
Advantages for contractors
Once the contract is signed, the contractor and customer have likely worked out the kinks and finalized project plans and designs, simplifying the process for them to plan resources, time and money throughout the project. It also mitigates accounting challenges, as changes are minimal.
More project control
The contractor generally works with the customer on the project design, schedule and other aspects of planning. That gives the contractor greater control over costs as well as how the project progresses.
Drawbacks of Guaranteed Maximum Price (GMP) Contracts
Though a useful tool for certain projects, GMP contracts can come with obstacles for customers and contractors. It’s important to understand these disadvantages and address issues as you begin drafting contracts.
Disadvantages for customers
Unscrupulous contractors may try to provide an unreasonably inflated GMP, employ less-skilled labor or use low-quality materials to cut costs on their end. To mitigate this risk, customers should audit the contractor's project financials and other relevant documentation to ensure fair prices.
Disadvantages for contractors
GMP contracts increase contractors' financial risk since they are on the hook if costs exceed the maximum price allowed. These overruns can eat into the contractor's profits, which is why it’s important to understand most project details upfront and only allow scope changes with a proper change order document that accounts for increased costs.
Guaranteed maximum price contracts are "open book" agreements, meaning the customer can audit the contractor's project financials. Contractors are obliged to keep meticulous records, which can be time-consuming. This openness can also feel like an infringement on the contractor's privacy.
Alternatives to Guaranteed Maximum Price (GMP) Contracts
Beyond the fixed-price contracts discussed above, there are four other common alternatives to guaranteed price contracts.
With a lump-sum contract (also known as a fixed-price contract), the project owner provides the contractor with finalized project plans, construction designs and specifications and schedule, and the contractor provides an estimate encompassing the price of materials, labor, overhead and the contractor's profit. Regardless of actual costs, the contractor will be paid that one lump sum. Contractor do not need to open their books to the clients, and individual costs are not reimbursed. With lump sum projects, contractors are paid the agreed upon price and any savings from coming under budget goes to them.
Guaranteed maximum price contracts have similar stipulations, so what is the difference between GMP and lump sum? One of the most significant differences between lump sum and maximum price contracts is with GMP contracts, the customer receives the savings if the project doesn't reach the maximum price. In some cases, the customer may share a portion of any cost savings with the contractor to encourage timely work and keep costs low.
Unit price contracts
Unit price contracts base the project price on the materials' per-unit costs for each project stage. This kind of contract relies heavily on the schedule of values outlining the project tasks by construction trade (e.g., painting, electric, plumbing, carpentry and more) and then itemizing each item's costs. These agreements are most common for unit-based projects, such as painters or carpet layers charging by the square foot.
These agreements are similar to GMP contracts because with cost-plus contracts, the customer agrees to cover the supplies, labor, overhead and contractor's profit and does not require finalized project plans before an estimate is provided.
There are three variations of cost-plus contracts.
- Cost-plus fix percentage: The contractor's profit is a percentage of the project cost.
- Cost-plus fixed-fee: The contractor's profit is a base fee that doesn't depend on the project cost.
- Cost-plus fixed fee with a guaranteed maximum price: The contractor's profit is a base fee that does not exceed a specified amount.
Time and materials (T&M) contracts
These contracts require the project owner to reimburse the contractor for materials and a daily or weekly labor rate. This contract is suitable for projects without predetermined schedules or when changes are likely throughout the project.
The project owner and contractor agree to the labor rates, materials costs and direct labor hours — typically scheduling and availability are baked into the direct labor hour portion when writing up the contract. At the outset of the project and before work begins they negotiate prices that allow for a reasonable markup for the contractor's profit while keeping in line with the customer's expectations and budget. There is no threshold for the total project price, which can be risky for customers as there are no constraints on how long the project might take or its ultimate cost. Some T&M contracts have not-to-exceed clauses that, similar to GMP contracts, place a limit on how much a customer reimburses for labor and materials expenses.
Guaranteed maximum price contracts can be complicated and involve quite a few moving parts. Managing tasks, risks and variations for a GMP contract is much easier with effective accounting software. Financial management software can improve all aspects of project financials, including bookkeeping, invoicing and reporting. This software automates cost calculations as well as payroll tasks and tracks payables and receivables for each project. Financial management platforms also provide job cost modules to monitor and analyze materials purchases, labor costs, overhead and other project-related expenses.
Free Guaranteed Maximum Price (GMP) Contract Example
The American Institute of Architects (AIA) provides more than one guaranteed maximum price contract template. These are considered an industry standard and are widely recognized as comprehensive and reliable documents. The template includes all of the required clauses and helps companies new to this contract or those who want to standardize their existing GMP agreement. However, it's crucial to note templated contracts serve as a guaranteed maximum price contract example and should be tailored to each project to avoid costly legal errors. It's also prudent to have the document reviewed by an attorney to ensure legality.
Guaranteed Maximum Price (GMP) Contract FAQs
The guaranteed maximum price is a standard project management tool for keeping costs low. It also allows contractors to have more of a say in planning, making project management more collaborative between contractors and clients.
GMP stands for the guaranteed maximum price. That refers to the highest amount of labor, materials and profit costs the contractor can charge the customer in the construction industry.
With GMP contracts, the customer and contractor work together on the project design. In many cases, this documentation includes drawings and blueprints illustrating design aspects and the finished product to understand better what the project should look like once it's complete.
A GMP amendment, also known as a change order, is a modification of the original guaranteed maximum price due to alterations of the project scope or other plan aspects. Amendments must occur through a formal change order process requiring both contractors' and customers' sign-off.
The project outlines, designs and blueprints accompanying a guaranteed maximum price contract make up the GMP plans. These documents must be accurate and comprehensive to ensure the GMP estimate is reliable.
The construction manager at risk contract delineates the construction manager's responsibilities regarding the design, supplies and planning for the project. It's an integral part of GMR projects because these undertakings generally require the contractor to consult on these vital elements.