Fixed-price Contracts Research Articles

Construction contracts expenses and revenues reporting

According to the Conceptual Framework of the International Accounting Standards, expenses are recognized when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. Under the matching principle between revenue and expenses, the latter are recognized based on the direct relation between the actually paid expenses and the earned revenue during the reporting period. In this context, expenses forming the value of finished goods are recognized when the revenue received from the sale of such goods is earned. In cases when the economic benefits are expected to be acquired during several reporting periods, expenses should be deferred and recognized during different reporting periods within which the acquisition of economic benefits is converted to cash. To defer them, a certain allocation base which is an item of the accounting policy followed by the entity should be applied. The key issue in the accounting of expenses and revenues under construction contracts is related to the allocation of the contract revenues and expenses between the reporting periods during which such works have been executed. Accounting standards outline the criteria for when to recognize expenses and revenue so that to identify the correct time when they should be recognized in the financial statements of the entity carrying out the works. The main concept underlying the accounting standards is that contract revenues and expenses associated with a construction contract are to be recognized as revenues and expenses by reference to the stage of completion of the contract activity at the end of the reporting period. Construction contracts applied in practice are classified as fixed-price contracts and cost-plus contracts. A fixed-price contract is a construction contract in which the contractor agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses. A cost-plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee.

Do buyers have bargaining power? Evidence from informal groundwater contracts.

In developing countries, the emergence of informal groundwater markets is accidental rather than planned due to the water scarcity and supply-side constraints. It is less often that water markets are assessed for agents bargaining power and equity impacts. In this paper, I examine the relative bargaining power of sellers and buyers in informal groundwater markets in India. To understand the process of bargaining, a framed-field experiment is conducted with actual buyers and sellers in groundwater contracts. In the experiment, sellers and buyers make a series of choices between output-shared and fixed-price contracts under varied risk conditions, first individually and then jointly. I define bargaining power as the relative ability of the agent to influence the joint decision for their individually preferred contract type. I find that there is a large preference disagreement between sellers and buyers. Buyers have preferences for output-shared contracts while sellers' choices are motivated by expected earnings. Using the random-parameter probit model, I show that sellers have relatively more power to drive the joint decision in their favour. Nevertheless, factors like interpersonal relationships between buyers and sellers, such as kinship ties, long contractual history, and higher education of buyers augment buyers' power relative bargaining power.

Operating cost reduction by electricity profiling and demand management

Abstract Like many other industries, water utilities use a high amount of electricity to operate water and wastewater treatment plants and incur a large percentage of their operating cost as electricity bills. This study investigates the electricity usage profile of a water utility and employs demand management strategies for cost reduction. Two cost reduction strategies are verified in this research – (i) fixed price contract, and (ii) electricity time-of-use shifting. An illustrative case study has been presented with two years of interval data from eight selected sites of an Australian/Victorian water utility. The study results suggest that by employing the demand management strategies, up to 22% cost reduction could be achieved from annual electricity bills. The study recognizes that the solution could be customized for each individual site based on the site-specific electricity usage profile.

Research on the variable buyback contract

Purpose Based on the traditional buyback model, this paper aims to propose a new buyback method – the variable buyback contract – to solve the serious inventory backlog in the current economic situation. Design/methodology/approach In this paper, the authors further study the buyback problem in a two-level supply chain with uncertain demand. Such a problem can be found in many research papers, which also use the Stackelberg game model. They put forward many factors that affect the buyback price, including risk preference, random arrival of consumers, etc. Different from the existing research, the authors propose another factor that may affect supply chain buyback – the retailer's remaining inventory to study the buyback contract. Findings First, the authors found that under the variable buyback contract, there is an optimal retail price, wholesale price and an optimal range of parameter settings for the buyback price. Second, the proposed Pareto-optimal solution for system improvement can achieve supply chain coordination. Third, under some conditions, the variable buyback contract is better than the wholesale price contract and fixed-price buyback contract. Originality/value First, this is the first paper to discuss to measure the buyback price with the retailer's remaining inventory. Second, the proposed buyback contract can help decision-makers to choose the optimal improvement strategies. Third, this contract has a certain practical significance, which can effectively alleviate the current inventory backlog problem.

Dynamic criticality of by-products used in thin-film photovoltaic technologies by 2050

Thin film photovoltaic technologies are playing an increasingly important role in the transition to a low carbon economy. Their extensive deployment will require large amounts of raw materials, especially those of companion metals. Concerns about whether the availability of materials will impede the development of low-carbon technologies have led to growing research in resource criticality. However, previous studies on criticality generally provide only static assessment models and pay little attention to the difference between base metals and companion metals. This article makes an attempt to dynamically evaluate the long-term criticalities of companion metals at a global level by combining the supply risk and impact of supply disruption. The results highlight germanium and indium as the elements with the highest criticality; tellurium and selenium exhibit a relatively moderate criticality while gallium and cadmium show very low criticality. The findings will offer proper guidance for stakeholders to address supply shortages in advance and encourage thin film technologies development. Priority measures for high criticality materials are discussed to alleviate the supply disruption potential, such as strategic stockpiling, implementing fixed-price contracts, increasing by-product recovery and secondary supply, material substitution and strengthening global mining.

A Decision Support Contract for Cost-Quality Trade-Off in Projects under Information Asymmetry

The three key drivers of a project success include cost, completion time, and scope, the interplay of which have a significant impact on the decision making in project management. In this study, we propose a theoretical framework to be used as a Project Management Decision Support System for understanding and balancing the interplay between the project cost and quality, which is a key component of the project scope. To this end, we develop a Decision Support Contract (DSC) for a project manager when outsourcing to a contractor whose delivery outcome is subject to quality risk. On the one hand, to reduce the risk of project failure, the contractor can invest in a quality improvement effort, the cost of which is the contractor’s private information. On the other hand, the contractor’s decision on quality improvement is unobservable to the project manager. In designing the DSC, we consider both problems resulting in information asymmetry between the project manager and the contractor. We first obtain the first-best solution assuming that the cost efficiency of the contractor is publicly known, and then solve for the second-best optimal cost plus incentive fee (CPIF) contract under information asymmetry. Our comparative study between the first- and second-best contracts reveals that the project manager may prefer to incur efficiency loss due to underinvestment decision by the high-cost contractor to reduce the information rent demanded by the low-cost contractor. Finally, we compare the effectiveness of CPIF contract to that of fixed-price contract, which enables us to characterize the value of incentive fee term for the project manager. This latter analysis reveals that incentive-fee term is more valuable when the improvement effort is more likely to reduce the quality failure risk.

The impact of industry consolidation on government procurement: Evidence from Department of Defense contracting

We study the relationship between market structure and public procurement outcomes. In particular, we ask whether and to what extent consolidation-driven increases in industry concentration affect the way in which the government procures its goods and services. We focus on the defense industry, by far the largest contributor to federal procurement spending in the U.S. This industry experienced a sharp increase in the level of concentration during the 1990s, driven by a series of large mergers between defense contractors. Using detailed microdata on Department of Defense (DoD) contract awards, we estimate the causal effect of industry concentration on a series of procurement outcomes, leveraging the differential impact of these mergers across product markets. We find that market concentration caused the procurement process to become less competitive, with an increase in the share of spending awarded without competition, or via single-bid solicitations. Increased concentration also induced a shift from the use of fixed-price contracts towards cost-plus contracts. However, we find no evidence that consolidation led to a significant increase in acquisition costs. We infer that the government’s buyer power, especially relevant in this context given the government is often the only purchaser, constrained firms from exercising any additional market power gained by consolidation.

Predicting collusive patterns in a liberalized electricity market with mandatory auctions of forward contracts

In this paper, the main objective is to analyze the effect of the introduction of regulated long-term tariffs in liberalized electricity generation markets, which are supposed to guarantee reasonable and predictable prices to consumers. Several authors have argued that the introduction of this kind of regulation increases competition and leads to offer prices closer to marginal costs.Spanish electricity market brings a unique opportunity to analyze and use mandated auctions as a natural experiment (fixed-price contracts that were implemented between 2007 and 2013). The main contribution of this study is to develop and to validate the hypothesis of the existence of strong incentives to increase prices in daily electricity markets when fixed long-term tariffs are applied. Using triple difference-in-differences, we find that prices increased 15 percent 70 days before the mandated auctions (compared to a control group: Nord Pool market) and that effect disappeared once the auction was no longer carried out.The theoretical and the empirical findings support our policy implications: The uncompetitive outcome seems to be driven by a highly concentrated market, a high elasticity to react to competitive regulations, a context of high volatility and the particularities of the auction design.

Cost Efficiency and Endogenous Regulatory Choices: Evidence from the Transport Industry in France

We study the impact of different regulatory designs on the cost efficiency of operators providing a public service, exploiting data from the French transport industry. The distinctive feature of the study is that it considers regulatory regimes as endogenously determined choices, explained by economic, political, and institutional variables. Our approach leans on a positive analysis to study the determinants of regulatory contract choices, which, in turn, affect the costs of operating urban public transport. Our results show that given similar network characteristics, networks operated under fixed-price contracts exert lower costs than those regulated under cost-plus contracts. This finding is in line with the theoretical prediction of new regulatory economics that fixed-price contracts provide more incentives for efficiency. Importantly, ignoring the endogeneity of contractual choices would lead to significantly underestimating the impact of contract type on cost efficiency. Our findings provide useful policy implications suggesting that the move toward more high-powered incentive schemes is indeed associated with significant cost efficiencies. Moreover, they highlights the importance of accounting for the endogeneity of regulatory contract choices.

Time and Cost Performance of Fixed Price Building Contracts in Tertiary Institutions in Nigeria

This qualitative and quantitative study evaluates the time and cost performance of fixed-price contracts in Tertiary Institutions projects in Plateau State, funded as intervention projects from the Tertiary Education Trust Fund. Literature review gives the background on the types and forms of contracts. Questionnaires, interviews and records from projects are tools that were used in collecting the relevant data. Sixty-two professionals consisting of 12 Architects, 8 Builders, 12 Engineers, 22 Quantity Surveyors and 8 Estate Surveyors randomly selected responded to issues of time and cost challenges. Records were purposively obtained from Twenty-Three projects studied. Regression Analysis was used to predict the time and cost performance. Results show a cost increase of $14, 423.59 for every one-month increase in time. Interviews revealed all 23 projects suffered time overruns with only 5 overrunning in cost. Specifications of 18 projects were found to be changed in order to satisfy the client’s budget objective of the firm price. The research recommends that to enhance time and cost performance, designs must be fully completed before biding. Alternatively, the entire procurement system which favours the fixed price arrangement should be overhauled to accommodate other options.

Demand Shocks, Procurement Policies, and the Nature of Medical Innovation: Evidence from Wartime Prosthetic Device Patents

We analyze wartime prosthetic device patents to investigate how procurement policy affects the cost, quality, and quantity of medical innovation. Analyzing whether inventions emphasize cost and/or quality requires generating new data. We do this by first hand-coding the economic traits emphasized in 1,200 patent documents. We then train a machine learning algorithm and apply the trained models to a century's worth of medical and mechanical patents that form our analysis sample. In our analysis of these new data, we find that the relatively stingy, fixed-price contracts of the Civil War era led inventors to focus broadly on reducing costs, while the less cost-conscious procurement contracts of World War I did not. We provide a conceptual framework that highlights the economic forces that drive this key finding. We also find that inventors emphasized dimensions of product quality (e.g., a prosthetic's appearance or comfort) that aligned with differences in buyers' preferences across wars. Finally, we find that the Civil War and World War I procurement shocks led to substantial increases in the quantity of prosthetic device patenting relative to patenting in other medical and mechanical technology classes. We conclude that procurement environments can significantly shape the scientific problems with which inventors engage, including the choice to innovate on quality or cost.

Supply contract design under price volatility and competition

This study analyses index-based contract designs and contract equilibria in a competitive setting. We consider a two-echelon supply chain consisting of two manufacturers and a retailer. Each manufacturer procures a commodity in a spot market and uses such a commodity to produce a product. The manufacturers initially choose either an index-based or fixed-price contract. Thereafter, the manufacturer that adopts an index-based contract designs the contract price on the basis of the spot and forward prices of its input commodity. Finally, the two products are sold through the common retailer. Our analysis indicates that an index-based contract provides a manufacturer with a contingent pricing mechanism, thereby enabling the contract price to respond to the spot price of its input commodity. If only one manufacturer adopts an index-based contract, then the contract price is designed to respond positively to the corresponding spot price, while the contract design constantly benefits the designer but may either benefit or hurt the rival and retailer. If both manufacturers adopt an index-based contract, then the contract price may be designed to respond negatively to the corresponding spot price. The reason is that the manufacturer intends to dampen competition by adopting an opposite contract price design. Further study shows that in equilibrium, both manufacturers consistently adopt an index-based contact if the spot prices are positively correlated. However, differentiated contract strategies may be optimal for manufacturers if the correlation is negative.

Coordinating Project Outsourcing through Bilateral Contract Negotiations

Problem definition: Project outsourcing has been a pronounced trend in many industries but is also recognized as a major cause for project delays. We study how companies can coordinate outsourced projects with uncertain completion times through bilateral contract negotiations. Academic/practical relevance: Misaligned subcontractor incentives may result in substantial losses to both project clients and subcontractors. Coordinating subcontractors' efforts through proper contracts is imperative to the success of project outsourcing. Most previous studies on project contracting have not addressed subcontractors' bargaining powers or the dynamic bargaining process in negotiations. We fill in this gap by studying bilateral bargaining between the client and subcontractors, which better reflects real-world negotiations. Methodology: We model project contract negotiations as a multi-unit bilateral bargaining game. We derive the conditions such that bilateral negotiations can achieve system coordination and characterize the equilibrium negotiation outcomes. We then compare the conditions and equilibria under various model settings to study their impact on project contracting. Results: Our study uncovers how the coordination of project outsourcing is impacted by the contract form, bargaining power structure, precedence network topology, payment timing, external opportunities, and negotiation protocols. For single-task projects, the widely used fixed-price (cost-plus) contract can achieve system coordination only when the subcontractor (client) possesses full bargaining power. Cost-sharing and time-based incentive contracts, which perform well for single-task projects, may not be effective for projects with parallel tasks when any subcontractor's bargaining power is sufficiently high. Projects with serial tasks can be coordinated only under certain extreme bargaining power structures. Delaying payments always exacerbates the incentive misalignment. Managerial implications: Our analysis provides insights and guidelines to companies regarding how to select proper contract forms and payment timing schemes, based on the characteristics of the projects and subcontractors, to ensure the effectiveness of project outsourcing. Our results also highlight the importance of bargaining modeling in project contracting.

Design development post contract signing in New Zealand: client’s or contractor’s cost?

By offering fixed-price contracts for designs supplied by clients, contractors legally warrant that they can build what has been designed and do so within their fixed price. Yet detailed drawings are often issued during construction in response to contractors’ requests for information on the basis that they cannot otherwise build what has been designed. Claim-entitlement decisions are often made by construction professionals (architects, engineers and quantity surveyors) without legal training in contractual interpretation, potentially varying who pays for design development after contract signing, contractors or clients. Prior studies have addressed buildability obligations relating to ground conditions and foundations. This study applies key principles of contract law to consider who should pay for instructed drawing details post contract signing under the New Zealand standard NZS 3910:2013, ‘Conditions of contract for building and civil engineering construction’, in terms of (a) when a variation claim may be accepted; (b) the effect of contractor involvement on design development; and (c) the effect if claimed from a building subcontractor to a consultant manager (no head contractor). A claim-entitlement flow chart and a table comparing the head contractor’s and consultant construction manager’s obligations provide practical guides for contract administrators. Identifying terms prone to interpretation informs contract drafters towards reducing ambiguity for contract users and therefore the potential for dispute.

Optimal service parts contract with multiple response times and on-site spare parts

This study examines user outsourcing of spare parts management to vendors through a service contract. The user’s selection of a fixed-price service parts contract is formulated as a stochastic integer programming model that decides multiple response times and on-site spare parts, while considering component breakdown with uncertain failure rates. We analytically derive the optimality conditions for the continuous case and subsequently design an efficient algorithm. Numerical illustrations and analyses are conducted to evaluate decisions under various scenarios. Our analysis shows that when both failure rate and expedited contract cost are high, coupled with low part cost, users would prefer the purchase of spare parts for all components to expedited contracts. A fixed-price expedited contract has a lower marginal cost with respect to failure rate than a fixed-price next day contract and a usage-based contract. We also examine inventory behaviour for a single part, multiple types of parts, and multiple groups of parts. It is shown that there is a cost-saving pooling effect in spare parts for identical items, which significantly raises the likelihood of having on-site stored parts. The problem becomes more complex for multiple items, reflecting bundling effects between items for a given contract.

Constructability opportunities in the engineering design of marine pier structures: a case study

This case study identifies design decisions that generated significant constructability benefits on a concrete pier project at San Diego, California. The new 152 m (1,500-foot) pier was built to support the utility needs of multiple stationed ships. The project was design-build with a fixed-price contract. Based on their experience with similar projects, the engineer and contractor incorporated several new design features to reduce the difficulty of the work, improve the productivity and safety of the operations, and reduce project cost and schedule. The engineer and contractor identified nine design features as most important in improving the constructability of the new pier: (1) Design of plumb rather than battered piles; (2) Optimal and uniform pile spacing; (3) Increased depth of pile dowel tubes; (4) Use of T-headed dowels over angled dowels; (5) Pile caps embedded in concrete deck; (6) Design of flush deck soffit; (7) Reduced variety of rebar sizes; (8) Increased depth of concrete rebar cover; and (9) Minimizing expansion joints.

Incentives and risk-sharing in public procurement of innovations

Purpose Public procurement of innovations (PPIs) addresses a specified need of the public-sector customer or aims at fostering private firms’ innovativeness. In an operational sense, issues of information asymmetry and risk sharing between the public agency and the supplier are of paramount importance. The purpose of this paper is to focus on the contract design issues of PPI. Design/methodology/approach Explicit and implicit contracting methods are reviewed, and a conceptual framework is proposed in which procurement characteristics are analyzed, focusing on the dimensions of the supplier’s sensitivity to the procurement risk and the power of implicit contracting methods. Findings Because of its complex nature, applying cost-plus contracts instead of more common fixed-price contracts is advisable in PPI. Originality/value Possible reasons for the more prominent role of contract design in the USA as opposed to the European Union procurement are discussed.

Risk of Increase in Prices of Performance in Indian Construction Industry and Sufficiency of Contractual Provision to Mitigate the Same in EPC and Item Rate Contract

Escalation is change in price levels driven by underlying economic conditions. From construction point of view, it is increase in price of cement, steel and other construction material used in construction industry for a defined period of project. Escalation in the construction industry in recent years has been extremely volatile and same scenario is expected to continue in future and also due to tremendous competition for resources like material and skilled workers which are the key factors to complete construction projects. Many contract these days are fixed price contract and it is expected that the risk of price escalation should be taken up by the contractor. It is very difficult for the contractor to take whole risk and in many cases quality delivery becomes difficult. Even the provision of escalation in contract does not cater all the aspects or the escalation in prices of work. Whatever the escalation clause is used outside India, cannot be directly applied in Indian scenario because of low inflation rate present there as compared to India. Therefor in present study, an attempt has been made to study and analyze the volatility of price. The objective of this research is to Study the escalation clauses presently used in construction contracts adopted by various Government departments/ agencies in India and to study the provision of existing contract & its sufficiency to cater the risk arising, its adequacy & coming up with proper solution so that risk can be mitigated and also to study how far cost escalation has an impact on the outcome of construction projects. For this, data has been collected from Economic advisory of India and Labour Union for estimation of percentage of price volatility of construction material and labors from 2012 to 2018 in the interval of 6 months. Years showing maximum fluctuation have been highlighted along with efficiency of present escalation clause with an example. Questionnaire survey will be conducted to highlight important factors related to escalation and come up with proper solution to mitigate the risk for above. And finally a case study will be conducted for the application of above solution.

The benefits of purely financial participants for wholesale and retail market performance: lessons for long-term resource adequacy mechanism design

In April 2015, Singapore introduced an anonymous futures market for wholesale electricity. Using data on prices and other observable characteristics of all competitive retail contracts signed from October 2014 to March 2016, a larger average quantity of open futures contracts that clear during the term of the retail contract a month before the retail contract starts delivery predicts a lower price for the retail contract. This outcome is consistent with increased futures market purchases by independent retailers causing lower retail prices. Consistent with the logic in Wolak (2000) that a larger volume of fixed-price forward contract obligations leads to offer prices closer to the supplier’s marginal cost of production, a larger volume of futures contracts clearing against short-term wholesale prices predicts lower half-hourly wholesale prices. Both empirical results support introducing purely financial players to improve both retail and wholesale market performance. The paper then outlines how a regulator-mandated standardized futures market can be used as a long-term resource adequacy mechanism for the wholesale market regime.

Risk sharing in procurement

We introduce bilateral risk aversion into the mixed adverse selection - moral hazard model of Laffont and Tirole (1986). The presence of exogenous risk interacts with the adverse selection problem in interesting ways. In particular, we show that it is never optimal to present the firm with a fixed price contract, that the efficient firm typically bears more risk than the inefficient firm, and that an increase in exogenous risk may bring about a decrease in expected cost of the project. As a by-product, we also establish that the famous ‘no-distortion-on-the top’ result in adverse selection models relies on risk neutrality of the agent.