The cost of materials, plant, and labour used for construction works are highly varied in the market due to various reasons, such as demand variations, scarcity, taxes, changes in currency markets, seasonal factors, etc. It prevents bidders in the construction industry from submitting more realistic and competitive bidding. It increases the risk from the bidders’ point of view. Therefore, construction experts thought it is sensible to compute the cost of contracts on present prices, keeping provisions of price adjustment for probable fluctuations.
At the time of preparation of a bid, the bidders do not have a method to predict the future material, labour, and plant prices. Also, they do not willing to take the risk and prepare bids at current market prices and absorb the extra cost. So, they try to pass the risk to the client. If there is no way to recover the additional cost due to the increase in materials, plant, and labour prices, they simply include mark-up for rates or to the bid at the bidding stage.
However, there is no firm methodology available for predicting this mark-up accurately. It is only guesswork. If the contractor adds a high mark-up, most probably he will not be selected. Any other contractor who has used a lower mark-up or zero mark-ups will be selected. Then, it may lead to a cash problem from the contractor’s side. As a result, it causes delays of work and ultimately the employer also suffers.
Construction professionals can avoid these situations by introducing a price fluctuation clause in the tender document. Then the bidders have the opportunity to submit a realistic bid without adding an arbitrary mark-up for escalation. It reduces the risk of the bidder. hence it is a benefit for the bidder.
At the time of implementation, the contractor is reimbursed for any additional expenditure due to price escalation. The employer also gets benefits from the price escalation clause. The bid he receives from the bidder is very realistic. In addition, he has to pay an additional sum only if there are increases in the cost of resources.
Price Variation reimbursement methods
1. Conventional / Traditional Method
Traditionally, price fluctuation was paid only for specified inputs. Computations were based on the actual consumption of such inputs during the period of each interim valuation. Also, the base price of specified materials should be mentioned in the contract document. The contractor has to submit purchasing invoices of such materials with the interim valuation. Adjustment to the contract price was calculated by applying the difference between the basic price and current price and the actual consumption.
Disadvantages of the conventional method;
– This method limits the reimbursement to specified inputs only. Risks of prediction of other inputs were still with the contractor.
– Calculation was laborious and tedious.
– The contractor had to collect many documents.
– Certification of claim also was very tedious.
Example of computation of price fluctuation in the traditional method
2. Formula Method (used in Sri Lanka)
The formula method introduced by the ICTAD (CEDA) provides a mechanism for contract price adjustment due to open market escalation in specified construction inputs such as major building materials, hire charges of plants, and wages for the labour. When we compare this method with the traditional method, computation using the formula is much easier. Also, it needs lesser documents.
F = Price variation for the interim valuation period
V = Valuation of work for the interim valuation period (Work done + 80% Materials at site)
Vna = Value of non-adjustable elements for the interim valuation period
Px = Input percentage of input X
Ixb = Base index for input X
Ixc = Current index for input X
From the interim bill, we can find the values of V and Vna.
Px values are available in the Tender document.
Ixb and Ixc values are available in the respective monthly statistical bulletin of ICTAD (CEDA).