Unit Price: The Best Use of this Contracting Strategy
The Unit Price contracting strategy can be leveraged in several industries and situations where the work to be performed can be broken into units, or predefined blocks.
These units of work can be defined at different levels of precision to ensure the right price is defined between the buyer and the supplier.
To help explain the concept of unit price, we will walk through a simple example of painting a room, using fake numbers, in this article.
Our Example: Paint a 500 square foot room with premium paint with 20% of the work being at a tall height.
Preparing for a Unit Price Contract:
Prior to the request for work, the buyer and supplier define a “catalog” of units, typically leveraging specific industry standards, with as much granularity as necessary for both parties. They can also define specific scenarios where the price may fluctuate based on material, situational, or location-based conditions and factors.
The Unit Price catalog governing the engagement defines the following: to paint 1 unit of wall (1 unit = 100 square feet), it would take 1 hour. With a crew rate of $20 per hour, the base unit rate would be $20 per 100 square feet of wall painted. By including the use of premium grade paint, we would multiply the base rate by a factor amount (1.2). We also noted that 20% of the 500 square feet, or 100 square feet, would be at a height adding another factor of 1.1 times the base rate.
Based on the catalog definitions of base units, crew rates, and factors, calculating the estimated prices of the engagement is relatively simple.
Unit Rate 1= $20 base rate * 1.2 (premium grade paint) = $24 per unit
Unit Price 2 = $20 base rate * 1.2 (premium grade paint) * 1.1 (height) = $26.40 per unit
Invoice Amount Payable to Contractor = ($24 * 4 units to paint) + $26.40 * 1 unit to paint) = $122.40 for 500 square feet
Why would you use a Unit Price contracting strategy?
As noted above, the Unit Price contracting strategy is best utilized when the work can be defined in blocks, or units, of work. Leveraging this approach makes it simple to compare the crew rate and base units across various supplier during the selection process. It also make scope changes easier to define and manage over fixed fee contracts based on the catalog that helps to define the work estimates.
What are the challenges of Unit Price Contracts?
While our above example was simple, the uses of the Unit Price contract can become complicated. For example, in some cases, the initially scoped work may not cover the needs of the specific engagement or a required function may not be defined specifically in the catalog. As a result, the final cost of the engagement is not defined from the beginning and is unknown.
Second, suppliers need to measure the number of units completed for billing purposes. Additionally, the buying organization needs to validate that those units are completed and meet the quality requirements before payment is issued.
Finally, the Unit Price approach can tend to lead to unbalanced bids where, according to Cohen Seglias, a “bidder places a high price on some items and a low price on other items in a unit price contract.”
What can help me manage Unit Price Contracts?
The first suggestion is to clearly defined a unit price catalog when leveraging a Unit Price contract. Defining a detailed hierarchy can help with estimation as well as soliciting the same details across contractors for selection purposes.
Second, consider leveraging a Contractor Management Software, such as Track. While the strategy is based on units of work completed on a given time scale which Track supports, leveraging a site’s Proof of Presence solution, or a mobile alternative, can help to provide the historical data to help with validating costs and scoping efforts in the future.
Finally, understand the work to be completed at your company that may benefit from leveraging a Unit Price contract. If your company does leverage this strategy, it is important to not overlook the importance of ensuring that the work completed aligns to the required quality standard before issuing payment.
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