All About Cost-Plus Contracts
A cost-plus contract refers to a contract when the contractor gets paid for all construction related expenses as previously agreed. Some cost-plus-contract can be drafted to set a limit that will be used to restraint the contractor on not to exceed that specified amount. The term plus refers to the profit allowed to be earned by the contractor. A cost-plus contract provides a win-win situation for the contractor because all risks are basically covered, and all expenses are likely to be paid.
What to Charge on a Cost-Plus Contract?
A cost-plus contract is a tool that the contractor uses to get paid for almost every expense related to the construction job. However, the contractor must justify and present evidence that justifies that the cost is related to the job. Furthermore, the contractor could be denied to recover associated costs if a negligent act or other relevant error is attributable to contractor's responsibility.
The three main components of a Cost-plus-contract are:
- Direct Costs
- Labor, materials, supplies, equipment and professional consultants being used by the general contractor.
- Overhead Costs (or Indirect Costs)
- Business-related expenses that are necessary to perform the contract. Overhead costs are usually a percentage of labor costs and can include office rent, insurances, office supply, communication expenses, mileage and drawing printing or reproduction.
- Fee (or Profit)
- The profit is usually a fixed percentage based on the labor costs directly associated with the work.
When to Use It
A cost-plus contract might be used when the budget is being restricted or when there is a high probability that actual cost might be reduced. This type of contract is preferred when there is not enough data to perform a detailed estimate of the work, or when the design is not completed. It is also a preferred by governmental agencies because they can select the contractor based on their qualification, instead of the low bidder. It is widely used to perform research and development works because the risk can be controlled by the contracting officer.
Pros and Cons
A cost-plus contract has advantages and some drawbacks depending on which side you are, contractor or project owner.
Some of the advantages of a cost-plus contract are:
- The contractor will not be able to reduce workmanship.
- It can focus on quality instead of cost.
- It could cover all related expenses.
- Contractor's risk is minimized.
While it looks like there are some advantages, be careful as there are some disadvantages too:
- Present uncertainty to the project owners, because the final cost could not be easily determined.
- Requires additional resources and management to reproduce and justify all related costs.
- Might lead to disputes when trying to recover construction-related expenses.
- The project's duration could be longer than expected.
How to Protect Your Business When Using Cost-Plus Contracts
A Cost-plus-contract presents a great opportunity for the contractor to recover all construction related expenses. However, if a good record keeping is not enforced, some costs might be irrecoverable. Follow these simple tips to stay out of trouble.
- Read carefully the cost-plus contract provisions.
- Negotiate critical items that could lead to disputes, such as overhead expenses and main office associated costs.
- Control the material usage. A cost-plus contract can lead to misuse of construction material, so you might end up acquiring more material than reasonably expected.
- Do not take advantage of the project owner. Be honest but beware of exorbitant costs.
- Control your 'hard' and 'soft' costs.
Cost-plus-contract can have some variations that will depend on the needs and special circumstances of each construction projects. Some of the variations of a cost-plus contract are:
- Cost-Plus Incentive Fee - Is a cost-plus contract that provides for incentive fees. The incentive fees are based on the contractor's performance and are set under the contract provisions. The amount and type of incentive could vary depending on the achieve milestone.
- Cost-Plus Award Fee.- A cost-plus award fee provides for award fees, predetermined and set forth in contract documents. The fee could be a penalty or a gratitude fee.
- Cost-Plus Fixed Rate – Cost-plus contract fixed rate is a contract that set pre-determined labor rates based on the contractors' history and labor costs. It is a contract used by specialized contractors that really know their actual costs, but provide little space for contingencies.
- Cost-Plus Fixed Fee - Cost-plus contract that covers direct and indirect costs plus a pre-determined fixed fee.