What is the potential risk of using a lump sum fixed price agreement for the owner?

Utilizing a lump sum fixed price agreement presents specific financial implications for the owner. In this arrangement, the contractor agrees to complete the project for a set price, regardless of the actual costs incurred. This means that if the contractor underestimates the project expenses, they will have to absorb any cost overruns beyond the fixed amount. This situation can lead to budget overruns because if unforeseen circumstances arise—like increased material costs, labor shortages, or other unexpected factors—the contractor may either cut costs through corners, impacting quality, or, if they can’t manage within the fixed price, they risk failing to deliver on time.

The owner, therefore, is exposed to the risk of budget overruns because the fixed price locks them into a set cost without accommodating possible changes in project scope or market conditions. This can lead to financial strain if the project extends beyond the anticipated budget, making effective risk management and accurate forecasting essential in such agreements.