Investigating the Contractor’s Financial Risk under a Fixed-Price Contract during Crisis Time: The Case of the COVID-19 Pandemic

Fixed price contracts are common in construction. However, extreme turbulences within the construction sector due to the COVID-19 pandemic and other events over the last few years questioned the suitability of fixed price contracts during crisis times. This research investigated the financial loss experienced by construction contractors bounded by a fixed price contractual mechanism during the crisis induced by the COVID-19 pandemic. Financial implications of fixed and fluctuating price contracts were modeled using cost data from a typical construction project and two construction price and cost indices published by the BCIS UK. A total of 12 project scenarios were modeled to represent 3 projects that started a few months before the pandemic, agreed and started during the early phase of the pandemic and agreed and started during the exit phase. Findings show that fixed priced contracts agreed upon before the pandemic and ended in the early months of the pandemic were not in an adverse financial situation. Fixed priced contracts agreed before the pandemic and completed during the pandemic had a high chance of falling into a negative financial crisis, particularly if the project lasted longer. Fixed priced contracts agreed during the exit phase of the pandemic were in a significant adverse financial situation. Fluctuating price contracts could place contractors in a favorable position to avoid significant financial losses during crisis times. Other limitations associated with mechanisms that need to be considered and addressed through further research were also discussed. The finding highlighted the deficiencies in conventional practices of forecasting construction costs and market trends. It emphasized the need for investigating alternative cost modeling approaches that could consider multiple stressors and cascading impacts of such events during crisis times.

Construction contracts could be agreed upon to include either fixed prices or fluctuating prices. In fixed-price contracts, contractors must estimate and agree on prices in advance by considering any possible fluctuation during the project. During the actual implementation of construction works, the contractor will absorb any unforeseen cost fluctuations. In fluctuating price contracts, contractors agree on prices based on the market conditions of a specified base date, and any fluctuation of prices due to the change of circumstance during the actual implementation of construction works will be paid to the contractor based on a preagreed formula and price index. This research investigated the financial risk of fixed-price construction contracts during extreme crisis periods taking the COVID-19 pandemic as an example. Authors found that fixed-price contracts agreed prior to a crisis period and ended during the early phase of a crisis may not be adversely affected. However, fixed-price contracts agreed during and later phases of a crisis period have a high chance of suffering significant financial losses beyond the profit margins.