Monroe-Matic Calculating Machine
A Bonus, is either 100% Profit or 100% Liquidated Damages, (LD's). It is all or nothing, resting on achieving Practical Completion, on or before the agreed date. So which is it?...
Profit, a financial gain, the difference between the amount earned and the amount spent in buying, operating, or producing something.
OR
Liquidated Damages, as a deductible day rate, is a Band-Aid for a paper-cut. We can all survive a paper-cut, but no one wants 40 of them in a row.
When, How and Why a bonus works.
When you have a small value project, that if delivered one day late, has huge client losses attached, and the amount of LD’s eclipses the project profit, customarily made, use a bonus to hit the date. For example, re-roofing a classroom block over the school holidays, and classrooms must be usable at the start of the next term or relocatable classrooms must be brought in and commissioned. The unavoidable lump sum loss of relocatable classrooms is better not spent, if it can be avoided. You only have to be one day late to have to climb failure mountain, as well as walk along LD’s daily track. And it is client risk.
To avoid the mountain, incentivise your contractor with a bonus.
Traditional Profit Bonus LD structure
[1] Project costs $500,000 with say a 10% profit customarily attached equals project value $550,000.
[2] Liquidated damages, for being one day late $50,000 lump sum plus $2,500 per working day.
[3] Bonus amount = Nil.
Tender market response
Project Costs $500,000
Profit $ 50,000
Bonus adjustment -$ 0
Risk (LD amount profit cannot absorb) $ 20,000
Tender price $570,000
High Performance Profit Bonus LD structure
[1] Project costs $500,000 with say a 10% profit customarily attached equals project value $550,000.
[2] Liquidated damages, for being one day late $0 lump sum, Just $2,500 per working day. Take a punt that a bonus is enough to avoid the loss.
[3] Bonus amount = $30,000. (Transferred from LD’s Lump Sum.
Tender market response
Project Costs $500,000
Profit $ 50,000
Bonus adjustment -$ 30,000
Risk (LD amount profit cannot absorb) $ 0
Tender price $520,000
Where LD’s are unsustainable, they are added to the price. The client pays for it upfront in cash as if the project is late. But when you transfer lump sum LD’s to a Bonus, a contractor confident of making the date, will put a proportion of margin at risk on the date, to win the project tender. The Contractor will then pursue the bonus, to maximise the profit opportunity of the project.
A Bonus is a negative Liquidated Damage, and two negatives make a positive, i.e. a lower tender price.
Bonus = a lower tender price
A bonus is always valued as a ratio of potential profit.
1. If the programme is achievable, the Bonus will be value between 50-100 cents on the dollar and deducted at that value, from the total profit proposed.
2. If the programme is not achievable, the Bonus will be valued at 0 cents on the dollar, It will have no effect, on the profit proposed.
But, you will always set a realistic programme, so it will always be true, that a Bonus will lower a tender price and incentivise a contractor to meet the date.
“Celebrating 50 years of New Zealand Building Economist 1972 to 2021”
By Matthew Ensoll
Life Member NZIQS. Reg.QS.
Editor New Zealand Building Economist.