In construction, a cost-plus contract is a formal construction agreement in which the contractor is paid for all project costs plus an additional fee. That extra fee is the contractor’s profit. The remaining billing is for the official project costs.
In this article, we will discuss how a cost-plus construction contract works, in what situations it’s popular, and what the benefits and drawbacks of such an agreement are.
What is a Cost-Plus Construction Contract?
A cost-plus construction contract is an official construction agreement in which the contractor is paid for all project costs, plus an extra fee. That additional fee is all profit and may be a flat fee or a percentage of the expenses. The other project costs were billed to the customer, and our reimbursements were included. The reimbursements include cash for both direct costs and indirect costs.
In construction, direct costs refer to materials, equipment, labor, and subcontractor fees. Indirect costs are attributed to insurance, office support, and other secondary charges.
Example of a cost-plus contract
Imagine a project costs $1 million. The contractor arranges to receive a 15% fee. In a cost-plus contract, the contractor would receive $1 million to cover all direct and indirect costs, plus an additional $150,000. That money would be the contractor’s profit, more officially known as the contractor’s fee.
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Types of Cost-Plus Contracts
There are three popular types of cost-plus contracts and construction that all construction stakeholders should know about.
- Cost-plus fixed fee contract, or CPFF. In this scenario, the contractor would receive a fixed fee regardless of the total project cost. That means the fee is set at a dollar amount, not as a percentage of costs.
- Guaranteed maximum pricing contract. The GMP is essentially a cap on the total project cost. The goal here is to protect the owner from unexpected overspending.
- Cost-plus percentage-of-costs contract. In this agreement, the contractor’s fee is a certain percentage of actual expenses.
As you probably guessed, different stakeholders have different preferences for types of cost-plus contracts. The most neutral option is the fixed-fee contract, as the contractor’s profit won’t fluctuate based on changes to the billing. On the other hand, guaranteed maximum pricing contracts tend to favor the owner. Cost-plus percentage of cost contracts often favor the contractor, as they can incentivize higher spending.
What are the benefits and drawbacks of cost-plus contracts in construction?
There are several reasons to use a cost-plus contract in construction, although these reasons may vary depending on your business’s needs and the type of stakeholder you are. Obviously, owners and contractors will have different preferences. That said, the following advantages and disadvantages can help you determine whether a cost-plus contract is something your business should consider exploring.
The chief benefit of cost-plus contracts is that they encourage a quick start to construction, since work can begin right away. This is in part because, as long as guaranteed maximum pricing is not involved, the final project cost doesn’t need to be known to start construction. This can be beneficial for contractors, but not so much for owners, who could wind up with a larger-than-expected bill.
Similarly, the primary drawback of a cost-plus contract is a lack of cost certainty. Unless guaranteed maximum pricing is included in the agreement, the final price in a cost-plus arrangement may remain unclear until the contractor sends that final bill. As a result, owners may need to oversee a project more closely. What’s more, without a good contract in place, contractors may not be motivated to keep costs as low as possible.
None of these advantages or disadvantages is static. All stakeholders and all relationships between contractors and owners are unique. Creating a contract that makes all parties comfortable is always the best bet for long-term relationships.
When are cost-plus contracts recommended?
In general, construction experts recommend considering a cost-plus contract for custom or complicated projects where the scope is likely to change, for projects that require construction to begin before all plans are finalized, and in situations where the relationship between the owner and contractor is already well-established and positive.
Keep in mind that during construction, a variety of best practices and technologies can make cost-plus contracting easier for all parties involved. From automating the tracking of labor charges to implementing construction inventory management software, it’s never been easier to create efficient, digital records of direct construction costs and inventory.
Having inventory and inventory value data available to all stakeholders at all times can increase transparency and enhance trust between contractors and owners. And, after all, it’s that trust and visibility that’s key to a successful build.
This easy, comprehensive guide can help you:
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About Sortly
Sortly is an inventory management solution that helps you track, manage, and organize your inventory from any device, in any location. We’re an easy-to-use inventory software that’s perfect for construction businesses of all sizes. Sortly builds inventory tracking seamlessly into your workday so you can save time and money, satisfy your customers, and help your business succeed.
With Sortly, you can track construction inventory like supplies, parts, tools, equipment, and anything else that matters to your construction business. It comes equipped with smart features like barcoding & QR coding, low stock alerts, customizable folders, data-rich reporting, and much more. Best of all, you can update inventory right from your smartphone, whether you’re on the job, in the warehouse, or on the go.
Whether you’re just getting started with inventory management or you’re an expert looking for a more efficient solution, we can transform how your company manages inventory—so you can focus on building your business. That’s why over 15,000 businesses globally trust us as their inventory management solution.
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