Contract price change during the construction phase: unforeseen market conditions

Construction practice knows quite a few possible ways to calculate the index of price differences. Each method has its advantages and disadvantages. When calculating price differences, however, all parties involved must be aware that construction contracts are concluded for large values, so when calculating indices for price differences, each percentage point represents a nominally large amount. In practice, the following methods are most often used:

the calculation method;

The calculation method is intended for calculating the index of price differences. It is based on the calculation of the item price change according to the actual costs. The price differences of the items are calculated by comparing item price calculations by calculative elements. The price change is determined on the basis of calculation elements price lists and price analyses. The calculation of the base contract price is dated on the starting date s (CPs) using calculation elements base price lists and price analyses. The new contract price is calculated using price lists and price analyses valid on the chosen date c (CPc), according to the observed period. CPc is determined according to Eqs (2.1)–(2.3). In this way, we periodically calculate the price differences between the base (starting date) contract price (CPs) and the new (chosen date) price (CPc) (Žemva 2010).

2.1CPc=CPDscCPs$$CPc = CPDscCPs$$

2.2IPDsc=CPcCPS$$IPDsc = {{CPc} \over {CPS}}$$

2.3%PD=(CPcCPs)100$${\rm{\% }}PD = \left( {{{CPc} \over {CPs}}} \right)100$$ where CPDsc is the quotient of the price difference between the start date s and the chosen date c. CPDsc can be expressed as an index (IPDsc) as in Eq. (2.2), as a percentage (%PDsc) as in Eq. (2.3) or as a nominal value.

The calculation procedures are as follows: each month, the monthly index (IPDsc) is calculated, which means that all items in the base estimate are recalculated with new price lists. The monthly index thus obtained is then reduced by the agreed percentage of price invariability, i.e. 2%, 5% or even 10% in the case of fixed prices. The monthly situation is then multiplied by the surplus of the monthly index (IPDsc) over the agreed percentages and the price differences in each month are obtained.

This method reflects the exact structure of the contract works by calculative elements. It is essentially an improved index method. The other methods described below refer only to the items as a whole and to the statistical indices, which refer only to the average structure of selected types of work. On the other hand, the calculation method does not reflect the differences in the price of the work actually carried out. So, the bid price structure of the items is maintained throughout the duration of the project (which is better than the index method of GZS-ZGIGM), but it does not reflect the actual structure of the work carried out in the month in question.

The disadvantage of this method lies in the proof of changes in calculation elements’ price lists (the burden of proof lies with the contractor), in non-standardised lists of works (in Slovenia, there are standardised descriptions of road construction work (Directorate of Roads of the Republic of Slovenia 2006); and in December 2022, a proposal for document standardised descriptions of works, materials and equipment for buildings was introduced (Slovenian Chamber of Engineers 2022)) and in various contractors own norms, which may call into question the credibility of the calculation. In any case, proof is easier if at least price analyses for the most important items and calculative price lists are submitted together with the tender. One way to improve the method could be the creation and regular publication of indices of construction material prices based on the example of Croatia.

The price differences according to this method are determined by calculating the shares based on the price analysis and multiplying them by the relevant indices. The difference between the new price and the base price is the price difference or price change caused by a change in the input calculative elements. To calculate with this method, we also need a calculative elements price list, price analyses and an index source. If the starting points were not submitted and agreed together with the tender, there is also a problem in proving the changes, as is typical of the calculation method (Žemva 2010).

With this method, not only the input data on the prices of the calculative elements must be known, but also their shares, i.e. according to the contractually agreed structural index of labour, equipment and machinery as well as material. The quotient of the price difference is calculated using a modified sliding scale formula, Eq. (2.4) (Žemva 2010; Pšunder et al. 2012; Mužina and Ekart 2022).

2.4CPDsc=a+bLcLs+cEcEs+dMcMs$$CPDsc = a + b{{Lc} \over {Ls}} + c{{Ec} \over {Es}} + d{{Mc} \over {Ms}}$$ where CPDsc is the quotient of the price difference for the observed period (starting date s and chosen date c); a is fixed share, if determined by the contract; b, c, d are shares of individual price elements (labour (L), equipment (E), machinery and material (M)); Lc, Ec and Mc are indices or prices of individual price elements at the chosen date c (end of the observation period); Ls, Es and Ms are the base indices or prices at the starting date s (beginning of the observation period).

After calculating the quotient CPDsc, the new contract price (CPc) is calculated in the same way as in the calculation method (Eq. (2.1)). In this method, too, all starting points (structure of contractually agreed works and source of the indices) must already be contractually agreed.

The advantage of this method is that it does not require a wide range of data, but only for representative elements of the price (b, c, d). It is also useful for monitoring individual prices whose amounts represent the largest share in each type of work. The use of this method is also suggested by the International Association of Consulting Engineers FIDIC (https://fidic.org/).

In Slovenia, this method was often used in the construction of highways. When submitting the tender, the tenderer attached the bid price structure of the items on the prescribed form from the tender documents. The price structure had to be filled in according to the type of work and the share of the individual price elements. On the basis of the attached form and the data from the SORS, the index valid for the period under consideration was calculated on a monthly basis. Each type of work in the corresponding monthly situations was multiplied by the index calculated in this way. Today, this method is generally no longer used due to possible speculation when filling in the price structure. In our opinion, this is one of the most correct methods.

This method is considered as an important tool for calculating the revaluation of costs in the construction industry in Slovenia. The method was developed by the Chamber of Commerce and Industry of Slovenia and the Chamber of Construction and Building Materials Industry of Slovenia (GZS-ZGIGM) and uses indices calculated by the Chamber. The Chamber has been calculating the indices on a monthly basis since 1972. The indices are used to determine the price difference resulting from changes in construction costs in a given period. The indices are given for (a) various types of work, such as construction, installation and finishing and (b) both main types of construction, i.e. buildings and civil engineering works. They are calculated on the basis of the average structure of the individual works and current data on price trends for all types of construction materials, hardware and transportation prices and wages (GZS-ZGIGM 2022). Eqs (2.5) and (2.6) show how the index of price difference (IPDsc) and the percentage of price difference (%PDsc) are calculated, where the GZS-ZGIGM indices are used for the chosen date (Ic) and the starting date (Is). Eqs (2.5) and (2.6) apply under the condition that all contractually agreed works are carried out in one calendar year and therefore there is no transition between years. In the case of an interannual transition, the index is recalculated via, e.g. 2 years.

2.5IPDsc=(IcIs−1)$$IPDsc = \left( {{{Ic} \over {I{\rm{s}}}} - 1} \right)$$

2.6%PDsc=(IcIs−1)100$${\rm{\% }}PDsc = \left( {{{Ic} \over {Is}} - 1} \right)100$$

The new contract price (CPc) is calculated according to Eq. (2.8), considering the price difference coefficient (CPDcs) according to Eq. (2.7), where CPDcs is expressed by the GZS-ZGIGM index for the considered period and for the corresponding type of work, and CPs base contract price.

2.7CPDsc =(1+ IPDsc )$${\rm{CPDsc\;}} = (1 + {\rm{\;IPDsc\;}})$$

2.8CPc=IcIsCPs=(1+IPDsc)CPs$$CPc = {{Ic} \over {Is}}CPs = (1 + IPDsc)CPs$$

The calculation procedures are as follows: each monthly situation is multiplied by the corresponding monthly index, taking into account only the value of the index that exceeds the contractually agreed threshold of price invariability (±2%, 5% or 10%). The contractor is entitled to pay the price difference only for the part that exceeds the agreed percentage.

When using this method, doubts naturally arise as to whether the indices really reflect the actual situation of the project. There are several different indices, but regardless of which one is chosen, its structure does not exactly reflect the structure of the project. In addition, the data for the GZS-ZGIGM indices are provided by companies producing construction materials, technical goods trading companies and construction companies, although the amount of data is not always the same and the number of data received for each value also varies. The question is also what share of the construction market the rapporteurs represent. In addition, the calculated statistical indices could also show a time lag compared to the actual situation.

Based on rich construction practice and some thoughtful solutions, a hybrid method can be used to calculate the price difference that is acceptable to both contracting parties. The following is a proposal for the introduction of a hybrid method in which the key items that represent the majority of the bid price are treated according to the calculation method, while all other items are calculated using the method of determining the price difference with the GZS-ZGIGM indices. When determining the key items and the other items, we apply the principle of ABC analysis, which is based on the fact that a small percentage of the items account for a high percentage of the construction costs. According to the concept of ABC analysis, we assume that the key items account for approximately 15% of all items, which in total account for approximately 75% of the total costs in contract price (position A), while all other items account for the remaining 85% of the items, which in total account for the remaining 25% of the total costs in contract price (positions B and C). The method can be used for both main types of construction, i.e. buildings and civil engineering works.

For items A, the proposed method calculates the price differences by comparing the unit price calculations made on the chosen date c using the price lists and price analyses valid on the chosen date and on the start date s using the base price lists and price analyses. Their quotient represents the price difference (CPDsc). The quotient for position A is therefore calculated as the ratio between the cumulative invoice amount for the month ‘m’, including price differences, and the cumulative invoice amount calculated using the base contract price. The quotient for positions B and C is calculated as the ratio between the GZS-ZGIGM index for the month ‘m’, i.e. on the chosen date (Ic) and the GZS-ZGIGM index on the contractually agreed starting date (Is). In this way, we periodically calculate the price difference between the base contract price (CPs) and the new contract price (CPc), as well as the price difference coefficient (CPDsc) as a quotient of these two values.

The calculation of price differences usually begins when the method determines that the price change has exceeded the agreed percentage of price invariability. Thereafter the calculation is made monthly on the basis of the value realised in each month in question. It can also be carried out in the final calculation of the contracted works, but the calculation must be carried out in the same way as if it were performed as an on-the-fly calculation in each month. The monthly calculation is carried out according to Eq. (4.1).

4.1IAm =[ (IABmA−IABm−1A)IAmAIABmA ]+[ (ICBmBC−ICBm−1BC)IcIs ]+IAm−1$$\matrix{ {{\rm{\;IAm\;}}} \hfill & = \hfill & {\left[ {(IABmA - IABm - 1A){{IAmA} \over {IABmA}}} \right]} \hfill \cr {} \hfill & + \hfill & {\left[ {(ICBmBC - ICBm - 1BC){{Ic} \over {Is}}} \right] + IAm - 1} \hfill \cr } $$ where IAm is the cumulative invoice amount per month ‘m’, including price differences; IAm-1 is the cumulative invoice amount per penultimate month ‘m-1’, including price differences from the previous period (i.e. up to and including the previous month); IABmA is the cumulative invoice amount, calculated with the base contract prices for month ‘m’ for positions A; IABm-1A is the cumulative invoice amount calculated with base contract prices per penultimate month ‘m-1’ for positions A; IAmA is the cumulative invoice amount for the month ‘m’ for positions A, including price differences; IABmA is the cumulative invoice amount for the month ‘m’ for positions A, calculated with base contract prices; ICBmBC is the cumulative invoice amount calculated with base contract prices for the month ‘m’ for positions B and C; ICBm-1BC is the cumulative invoice amount calculated with base contract prices per penultimate month ‘m-1’ for positions B and C; Ic is the GZS-ZGIGM index for the month ‘m’; and Is is the index GZS-ZGIGM index on the contractually agreed starting date.

The main advantage of the proposed hybrid method is that for approximately 75% of the largest items by total value, the calculation method that best reflects how price increases affect the contract price is applied. However, for the credibility of the contract price, it is necessary to include calculation bases or at least price analysis calculations for the most important items already at the time of submitting the tender. If the investor or client has not requested these attachments, it will be very difficult to provide proof. On the other hand, index methods have the advantage of giving the client a sense of trust in the credibility of the indices, as they are prepared by official institutions.

In the following, the calculation of the indices of the recognised price increases of contract works is shown using the example of a public contract for the construction of sewers for two sewer sections named canal 1 (C1) and canal 2 (C2). We have chosen the example of a construction project carried out in the period from 2021 to 2022, when there was a significant increase in the prices of materials and services. All elements of the public contract in question that are essential to the purpose and credibility of the results are considered. The calculation of the recognised price increases of contract works for the period under consideration is presented by the calculation method, by the method with GZS-ZGIGM indices and by the hybrid method. The calculated indices are then compared.

4.2.2

Calculation and comparison of indices of recognised price increases

The calculation of the indices of recognised price increases of contract works is given for each channel for the observation period March 2021 to March 2022, using three methods: the calculation method, the method with GZS-ZGIGM indices, and the hybrid method. The index for recognised price increases of contract works is given as a ratio between the new contract price taking into account the price increases (CPc) and the base contract value (as base bid price) (CPs). The final value, i.e. new contract price is calculated only at the end of the observed period and not by an on-the-fly calculation each month.

The calculation of the new contract price according to the calculation method is based on Eq. (2.1). The CPs and CPc for C1 and C2 are the bases for the calculation of the coefficient of price difference (CPDsc), while index IPDsc is calculated according to Eq. (2.2). The procedure for calculating the new contract price is as follows: the calculation bases were first updated in the computer program BLIST (Best IT d.o.o. 2024). The new value of the hourly labour rate and the estimated hourly rates for fixed assets are recalculated for the observed period in the BLIST. The offers for materials and subcontractors were also obtained at the end of the observation period. In the next step, the changed and updated data were entered into the calculation elements price list, which is linked to the base estimate. The recalculation of the price analysis results in the new value of the contract price (CPc). The calculation of the index of recognised price increases of contract works for each channel according to the calculation method in the observed period is shown in Table 3.

Tab 3.

Calculated indices of recognised price increases according to the calculation method

Channel	Base contract price (CPs) March 2021	New contract price (CPc)	March 2022	Index
C1	40,802,91 €	45,681,93 €	111.96
C2	40,002,27 €	50907,78 €	127.26

C1, canal 1; C2, canal 2.

The new contract price at the end of the observation period (CPc) using the price difference calculation method with the GZS-ZGIGM indices is calculated according to Eq. (2.8). The price difference coefficient (CPDsc) is expressed by the GZS-ZGIGM index and calculated according to Eqs. (2.5) and (2.7). The starting points for the calculation are the base contract price (CPs) and the GZS-ZGIGM price indices for the relevant period and for the corresponding type of work. For the construction of sewage channels, we choose the index for the construction work under the number 06, other civil engineering works. The start date is 31 March 2021 (Is), the chosen date is 31 March 2022 (Ic) and the transition to the next year is set to 31 December 2021 (In). The indices for the observed period are as follows: Is=I1.1.202131.3.2021=103.25$$Is = I_{1.1.2021}^{31.3.2021} = 103.25$$;Ic=I1.1.202231.32022=107.04$$Ic = I_{1.1.2022}^{31.32022} = 107.04$$;In=I1.1.202131.12021=113.20$$In = I_{1.1.2021}^{31.12021} = 113.20$$ (Chamber of Commerce and Industry of Slovenia, Chamber of Construction and Building Materials Industry of Slovenia 2022). The calculation of the index of work price increases for the period from 3 March 2021, to 31 December 2021, is shown in Eq. (4.2) and is up to the observed period from 31 March 2021 to 31 March 2022 in Eq. (4.3). The calculated index applies to both channels.

4.2I311.3222131.12021=InIs100=109.64$$I_{311.32221}^{31.12021} = {{In} \over {{I_s}}}100 = 109.64$$

4.3I3113.202131.3.2022=(InIs100)lc100=117.36$$I_{3113.2021}^{31.3.2022} = {{\left( {{{{I_n}} \over {{I_s}}}100} \right){l_c}} \over {100}} = 117.36$$

The calculation of the new contract price (CPc), expressed by the GZS-ZGIGM index, for each channel according to the GZS-ZGIGM method in the observed period is shown in Table 4.

Tab 4.

Calculated new contract price according to the GZS-ZGIGM method

Channel	Base contract price (CPs) March 2021	Index GZS-ZGIGM	New contract price (CPc) March 2022
C1	40,802,91 €	117.36	47,886,30 €
C2	40,002,27 €	117.36	46,946,66 €

C1, canal 1; C2, canal 2.

The calculation of the new contract price (CPc) using the hybrid method is based on the principle of Eq. (4.1). In doing so, we calculate the index of recognised price increases of contract works between the estimate of the base contract price and the estimate of the price that was valid in March 2022. In the calculation, we have summarised the principle of ABC analysis. For C1, positions A (25% of the key items) account for 72.06% of the contract price, and positions B and C (75% of other the items) account for the remaining 27.94% of the contract price. For C2, position A (26% of key items) accounts for 71.59% of the contract price, and positions B and C (74% of other items) account for the remaining 28.41% of the contract price. The basis for the calculation is the base bid price, i.e. base contract value for both channels. For the calculation of the index of recognised price increases of contract works, two types of indices are used: for position A, the index (IDPsc) as used in the calculation method, and for positions B and C, the GZS-ZGIGM index applicable to the corresponding period and type of work under consideration. The calculation of the index of recognised price increases of contract works for each channel according to the hybrid method in the observed period is shown in Table 5.

Tab 5.

Calculated indices of recognised price increases using the hybrid method

Channel	Base contract price (CPs) March 2021	New contract price (CPc) March 2022	Index
C1	40,802,91 €	46,298,56 €	113.47
C2	40,002,27 €	49,781,79 €	124.45

C1, canal 1; C2, canal 2.

Graph 2 shows a comparison of the indices of the recognised price increase of contract works according to all methods. The comparison shows that the use of a different method leads to greater deviations. For example, the index calculated using the calculation method is 5.4% lower for C1 and 9.9% higher for C2 than using the GZS-ZGIGM index method. The comparison with the hybrid method shows that the index for C1 is 1.51% higher and for C2 2.81% lower than with the calculation method. The comparison of the hybrid method with the GZS-ZGIGM index method shows that the index for C1 is 3.98% lower and for C2 even 7.09% higher.

Graph 2:

In addition, there are generally large differences in contract price increases between the channels C1 and C2. These differences are mainly due to the influence of the structure or working technique, the index lag (e.g. the input data are the invoices received, reporting delays for the GZS-ZGIMG indices) and the different price increases for materials and services. Since we have used the same bases for both channels, it is an obvious fact that the price even for the same type of work is strongly influenced by the structure of work or technology of construction. This is also the real reason for some percent of the price difference between C1 and C2: 15.30% according to the calculation method and 10.98% according to the hybrid method.

The disadvantage of both calculation methods is that price changes must be proven by price analyses and new calculation bases, especially if the starting point and the type of proof are not specified in the contract. Here, the burden of proof for recognised price increases of contract works lies with the contractor. Furthermore, the approximate index, to which the GZS-ZGIGM index belongs, reflects only the approximate average of the calculated indices, which is valid for both channels. We believe that the use of the GZS-ZGIGM indices in two separate contracts would imply an unfair calculation of price differences as far as the calculation of the price difference for C2 is concerned.

With both the calculation methods, it should also be noted that the price differences and the corresponding indices must be recalculated each month. This means a monthly collection of subcontractor offers, even for services and materials that have already been carried out at the start of construction (e.g. demolition work) or for materials that are only required at the end of the construction (e.g. asphalt). This problem could be avoided by applying the principle of ABC analysis, as we have proposed in the hybrid method.

Despite the fact that the calculative elements of bid prices of the items have increased, many investors or clients still do not choose to regulate the method of calculating price differences already in the tender documents or in the contract, or they leave it to Article 656 of the Obligations Code 2007 and CPC 2020 if they are not excluded. And when setting fixed prices, the risk of a price increase of up to 10% lies with the contractor, which is why he calculates the risks differently depending on his own forecasts. It is therefore very likely that the investor or client will not receive realistic and comparable tenders. In addition, the investor runs the risk of paying too much for the contractually agreed works if market prices fall. If, on the other hand, prices continue to rise, the investor even runs the risk of the contract being terminated because the contractor is unable to fulfil the contractual obligations. All this leads to a speculative rise in bid prices and a multitude of complications in solving the problem. Due to the urgency of the issue, an initiative has already been launched in Slovenia to regulate this issue in the amendment to the CPC 2020.

Large contracting authorities of infrastructure projects in Slovenia, such as Družba za avtoceste v Republiki Sloveniji (DARS d. d), have recently decided to use the Rules on the methods of valuing financial obligations contractually agreed upon by public sector entities 2004 in the tender documents regarding the methods for determining price differences. They refer to one of the indices compiled by Chamber of Commerce and Industry of Slovenia, SORS or EUROSTAT.

The next question that arises is the appropriateness of the application of Article 656 Obligations Code 2007, which transfers the risk of a price increase of up to 10% to the contractor. Due to the comparability of tenders, it would make sense for clients or investors to give the tenderer the option of indicating the level of risk in the tender documents or in the cost estimate. In order to avoid speculation, it would make sense to set the price stability threshold at a level of ±2%, which represents an acceptable risk for both contracting parties.

An example of good practice in the calculation of price changes, which can already be found in procurement practice today, is the calculation of the valorisation from the time the tender is submitted and taking into account the corresponding GSZ-ZGIGM index, namely when the price increase exceeds the threshold value of ±2%. The internationally used FIDIC contract can also be cited as an example of good practice, which even stipulates 28 days before the submission of the tender as the ‘base date’ for the calculation of price adjustments. However, it makes sense to include a provision on price variability even for contracts with a term of less than 1 year. In addition, the introduction of such a provision would provide the client or investor with information on whether and to what extent contractors have included risks related to price differences.

The methodology for calculating the price difference index is the next challenge. Usually, clients or investors defend the use of indices calculated by a state institution for reasons of credibility and simplicity of calculation. However, the price changes calculated according to the index method are usually lower than those calculated according to actual costs. In addition, the client usually does not have adequate personnel to check the calculations and take responsibility for the correctness of the calculated index. On the other hand, the calculation method carries the risk of the credibility of the calculated indices, which the contractor must prove. This is a particular challenge if the client or investor has not requested calculation elements, price lists and price analyses for at least the most important items when submitting the tender.