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Department of Real Estate and Construction Management & Centre for Banking and Finance (cefin), Royal Institute of Technology Working Paper Series, Department of Real Estate and Construction Management & Centre for Banking and Finance (cefin), Royal Institute of Technology

No 13/2:
Quantity Choice in Unit Price Contract Procurements

Svante Mandell () and Fredrik Brunes

Abstract: A procurement approach commonly used for construction projects involves paying a fixed price per unit conducted, i.e., unit price contracts. We develop an analytical model to study the optimal procurement quantity and monitoring intensity when the required quantities are uncertain. The optimum involves a trade-off between a risk of paying for more units than necessary, conducting costly renegotiations and/or investing in monitoring. The paper adds to the understanding of both optimal behavior in procurements and the presence of cost overruns. In particular, deliberately procuring low quantities, and thereby facing a high risk of cost overruns, is sometimes optimal as it minimizes the expected total cost.

Keywords: Unit price contracts; procurement; construction; cost overruns; (follow links to similar papers)

JEL-Codes: D44; H54; H57; (follow links to similar papers)

29 pages, March 15, 2013

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