A cost-plus contract asks the customer to pay the total project costs plus an additional fee for the contractor’s overhead and profits. This extra expense can be listed as a flat rate or a percentage of the total project depending on the contractor’s business model. Most construction invoices are designed to make sure the contractor turns a profit and covers some of their overhead expenses, but a cost-plus contract explicitly lists those fees.
The Importance of Construction Contracts
Every construction project needs a detailed contract to protect both parties. The customer should know exactly what they’re paying for and have a strong estimate of what the project will cost. The contracted company needs to be clear about their costs and take steps to ensure they turn a profit. Whenever there are disagreements about the work or payment, both parties can refer to the contract.
A cost-plus contract protects companies by providing more transparency into their fee scale. These contracts are meant to prevent surprises when the final invoices are submitted.
How Cost-Plus Contracts Work
A cost-plus contract will estimate the materials and labor costs of a project before it begins and then stipulate that the customer will pay a fee to cover the overhead and profit of the contracting organization. Most contracts have a cost-plus fee scale of 10-25%. A contractor would use takeoff software to calculate the materials costs, but they wouldn’t need to be exact.
Some companies use a cost-plus-fixed-fee (CPFF) instead of a percentage. This is a specific amount the customer is expected to pay on top of covering the materials and labor.
While cost-plus contracts are meant to protect companies from fluctuations in project costs, their estimates still need to be accurate. Otherwise, clients could get frustrated that the final invoice was so much more than expected.
Elements of a Cost-Plus Contract
Cost-plus contracts have multiple standard elements that customers expect to see when they sign them. Here are a few things to include in yours.
- The estimated materials needed and the cost of those items;
- The estimated labor hours needed and the cost for that work;
- The contractor markup, either as a percentage or a flat fee;
- Terms for what needs to be paid and when.
Depending on your business, you can also build optional stipulations into your cost-plus contract. Some companies set a maximum cost for the project to assure customers they won’t charge them excessively. Other contracts include incentives to reduce materials and labor costs, so companies get paid more when they save money.
Benefits of Cost-Plus Contracts
Cost-plus contracts benefit companies and customers by providing greater transparency and communication. Here are a few reasons to consider adopting this contract option:
- Clients can negotiate more easily because there is increased transparency about the project costs.
- Companies know they will turn a profit on the project, lowering the risk of accepting it.
- Both parties can start the project sooner because they don’t need exact numbers for materials and labor costs.
- The quality of the work is potentially higher because companies won’t cut corners to maximize profits.
These contracts can build trust between both parties because everyone is acting transparently and knows what they are agreeing to.
Disadvantages of Cost-Plus Contracts
Despite the benefits of these contracts, there are some drawbacks to keep in mind. Here are a few potential concerns to consider.
- The customer doesn’t know the final cost of the project. It could be much higher than they expect.
- Companies lack incentives to save money on the project unless there’s a financial benefit built into the contract.
- Companies need to have detailed cost-tracking systems in place to provide exact labor and material expenses to clients.
With a generic contract, a company charges a flat fee regardless of the materials and labor costs. However, this doesn’t guarantee that the organization will profit and prevents transparency about the project costs.
Examples of Cost-Plus Contracts
One of the best ways to learn about cost-plus contracts is to see examples of what they look like. Here are a few sample projects that use cost-plus elements.
- A project is expected to cost $50,000 in materials and labor. The contract states that the customer pays a 10% fee on the final project cost. If the actual cost of the project is $56,250, then the project fee would be $5,625.
- A project is expected to cost $100,000 in materials and labor with a $20,000 flat fee. If the materials and labor actually cost $105,000 then the final invoice is for $125,000.
Whether you opt for a percentage-based contract or a flat fee model will depend on your business model and how you track your profits.
Cost-Plus Contracts Template
Here is a template you can use to develop your cost-plus contract. You will need to customize and adjust based on each project.
Even if you’re confident in your cost-plus contract, ask a lawyer to review it. They can make sure all conditions are enforceable and legal. They can also highlight any missing information that’s important to add.
Estimating the Cost
One of the benefits of a cost-plus template is that you don’t need to know exactly what your materials and labor expenses will be. However, you still want to get accurate estimates so your clients aren’t surprised by the final invoice.
Before switching to a cost-plus contract model, evaluate your current estimation process. Now might be a good time to invest in takeoff software to gather accurate and detailed project estimates.
- Artificial intelligence is changing how contractors measure spaces and providing better estimates than ever.
- Modern tools can account for all types of materials. Whether you need to pour concrete or install steel beams, these systems can make tracking materials costs easier.
- Digital estimators automate processes so you can spend less time calculating expenses. This allows you to start the project sooner.
Good estimates highlight your expertise in the field and prove you care about giving accurate information to your clients. They can build trust in the work you do.
Artificial Intelligence (AI) and Fixed Fee Contract Cost Estimation
AI plays a significant role in helping with project estimation. AI tools provide better measurements, so construction teams order the right materials instead of overpaying for things they don’t need. Better measurements, in turn, impact cost-plus contracts.
AI can help compile insights from historical project data, market trends, and other information, making it a key tool in early conceptual estimation processes.
Project managers can provide more accurate estimates from the start, so customers aren’t shocked by the final invoice. This improves your organization’s reputation and leads to better client relations.
Other Types of Contracts
There are multiple contract methods to consider for your business.
- Lump-sum contracts: You provide a flat amount and your customer pays it, regardless of the materials costs and profit.
- Re-measurable contracts: Stipulate that the construction company will provide a final number after the work is done. Essentially, renegotiate based on the final costs.
- Guaranteed maximum price (GMP): A contract is created with both parties agreeing on the maximum cost. The final cost will be determined after the work is complete.
With each contract type, the customer either knows the full payment amount from the start (lump sum) or receives a final bill at the end. Know what kinds of billing your clients expect and agree on a contract format before you agree to work together.
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