Cost Reimbursement or Prime Cost – An Overview
Under a cost reimbursement or prime cost contract arrangement the contractor is appointed, possibly in competition, but on many occasions by negotiation, to carry out the works on the basis that he is paid his actual costs. He also receives a fixed fee or percentage for overheads and profit, which if competitive tendering is possible, can form the basis of the tender.
This arrangement has by many been likened to the daywork procurement method as the proposals are based purely in many cases on the percentage addition or fixed fee which is placed upon the actual costs of the works in very similar way to when a contractor claims against dayworks executed under the standard forms of contract available in Malaysia.
There is no specific standard form of contract for use in the Malaysian market and to adopt a cost reimbursement or Prime Cost arrangement would require a bespoke contract or adoption of a standard form from overseas such as the JCT PCC 2011 Form of Contract.
If adopting this form generally the arrangement would be that the works proceeds on the basis of a brief specification, drawings (if any) and an estimate of its cost. Interim payments are normally monthly unless stated otherwise. As expanded upon below this is a high risk contract for the Employer in terms of cost and much depends on the efficiency of the Contractor in carrying out the Works economically. The contract contains various provisions to assist in keeping the expenditure of Prime Cost to the minimum needed to provide the Works required by the completion date.
The main advantage to adopting this procurement and contracting option is:
It enables a very early start and involves a very short lead-time or tender period as the contractor has not got to source competitive prices for good, materials, labour and specialist items at the time of submitting his proposal he merely has to estimate and forecast his site administration costs and overheads then add an amount for his for profit expectation.
The disadvantages to adopting the cost reimbursement or prime cost arrangement are:
Overall project cost control can be very difficult due to the Contractor having no great incentive to keep material, labour and subcontract costs down. His main incentive lies in maintaining his overheads within budget and spending more on the labour materials, goods and subcontract packages if he is paid on a percentage basis rather than fixed fee.
It is often difficult to ensure that errors and bad workmanship are borne by the contractor and sub-contracted works, particularly if all works are let on a prime cost basis. It is for this reason that in many cases sub-contract packages are let on a competitive lump sum basis in order to maintain a deal of cost control. Additionally it may be a term of the tender that a reduction in the costs is made to cover such abortive work. Similarly, it is normal to restrict head office staff costs such that a proportion of these are included in the fixed fee; and to agree a schedule of site staff and site establishment costs in order to create some level of cost certainty.
The risk for unforeseen circumstances generally lies with the client. The Contractors risk are minimal and this risk share can lead to the contractor not taking as much care or being as proactive in the problem and risk mitigation areas of administration as would be the case if he were exposed to the risks.
Prime cost and cost reimbursement contract arrangements are seen by many as a last resort method of procuring construction works or a project due to the high level of uncertainty of the final costs which are inherent in the adoption of this process. It is generally only suitable where time is the most critical factor and an immediate start is necessary. Emergency projects are also another example where this method of execution of the works is desirable to remove a risk to the public or to repair a facility which is of critical importance. This is not a procurement route we would recommend for adoption on standard building or engineering projects as the focus is on execution with the shortest possible lead time and not in normal circumstances beneficial to a projects cost, quality or function.