Thursday, July 28, 2011

Non-Legal Fine Points of Contract Negotiations and Management - V

          It may seem to be only a small variance in nomenclature, but the difference between an “estimate” and a “quotation” makes a really big difference contractually.  An estimate is just that, a (hopefully educated) guess as to what a particular job will cost. In contrast, a quotation represents an offer to complete a defined scope of work for a firm fixed price. The quotation details not what the job may cost, but what the firm or individual quoting will charge.
           In some sectors of commerce, final prices are expected, and in some cases even regulated to be within 10% of any estimate originally provided. But, in yacht and ship building and refit, there isn’t any such requirement, nor is there often a contractual rider that establishes such a limit. Going into a big job on an estimate is a very big risk for a vessel’s owner. Against that, insisting on the quotation of a firm fixed price for a given job most likely results in a higher price for the job than one might have paid, had one opted to accept a looser estimate and/or had chosen to go the route of T&M (time and materials billing).

          Occasionally, a contract will be built around a third pricing concept, namely, an estimate with a firm fixed maximum price quoted. This approach is referred to by some as “NTE” (not-to-exceed) pricing.  NTE pricing is initially appealing to many. It appears, on cursory consideration, to give the buyer a lower target price, while protecting him/her against the cost of the job reaching beyond a defined ceiling. However, unless the builder or shipyard is contractually incentivized to bring the job in under the NTE number, any not-to-exceed price ceiling will every time become the actual final price, and in reality no different from a firm fixed price quote. The lower “estimated” price will be a snare and a delusion.
           When comparing estimates and quotations, it is a mistake to think that a relatively low shop rate will result in a lower bill. It does no good to secure a shop rate per hour than is two thirds of competitive estimates, if the number of hours eventually expended by a particular yard is twice as much as for competing yards. It is also a mistake to focus solely on shop labor rate, to the exclusion of other billable costs and charges. For example, a relatively low ship rate may be accompanied by additional charges for facilities support, dry dock days, consumables, environmental controls, and so on. The bottom line is that it is the bottom line that counts, not how you get there.

Next posting will deal with emergent work and change orders.

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