A Comparison of Unit Price and Fixed Price Contracts for Infrastructure Construction Projects

Svante Mandell and Jan-Eric Nilsson ()
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Jan-Eric Nilsson: vti - Swedish National Road & Transport Research Institute, Postal: Dept. of Transport Economics, P.O. Box 55685, SE-102 15 Stockholm, Sweden, http://www.vti.se

No 2010:13, Working Papers from Swedish National Road & Transport Research Institute (VTI)

Abstract: Today’s dominant mechanism for infrastructure project tendering is the Unit Price Contract (UPC). While the winning bidder retains risk related to the unit price bids submitted, the Principal carries all risk related to misspecification of the activities required for having a project build. This paper reviews the microeconomic foundations for this contracting procedure and identifies situations where an alternative mechanism, Design – Build (DB) contracts, may be preferable. DB leaves the bulk of project risk with the agent and therefore requires bidders to hedge against unpleasant surprises in the implementation by increasing the demand for compensation for undertaking the job. It is argued that DB should not be used if the number of bidders is expected to be large; this is a means for reducing the duplication of design costs. Moreover, DB projects should be complex with respect to the number of sub-tasks required for construction and it should be feasible to substitute one input for another. This is a way for society to benefit from the agent’s superior information about alternative implementation techniques and relative input prices. The projects should moreover not include too many unobservable quality features and the risks for geotechnical problems should be manageable.

Keywords: Procurement; Unit Price Contracts; Design build; Infrastructure (search for similar items in EconPapers)
JEL-codes: H57 L98 R42 R48 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2010-12-01
New Economics Papers: this item is included in nep-cta and nep-ppm
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Citations: View citations in EconPapers (5)

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