Time and Materials Contracts
Time and materials (T&M) contracts involve both parties agreeing on predetermined unit rates for labor and materials and there is no preset price for construction. This type of contract is used when it is impossible to get an accurate estimate of the total project cost, when the schedule cannot be defined, or when changes are likely to be made during construction. A time and materials contract typically presents the highest risk for the owner or client and the least risk for the contractor because there is no limit on how long the project will take or how much it will cost.
Time and Materials Contracts Items
When using time and materials contracts, the following items may be negotiated:
- Labor rate: The labor rate specifies a fixed rate for all labor, including administrative personnel. When using T&M on large projects, contractors usually offer discounted labor rates to reduce the total project cost.
- Material markup: T&M contracts typically include a markup of 15 to 35 percent on wholesale material costs.
- Not-to-exceed: A Time and Materials Not to Exceed (T&M NTE) contract includes a cap that represents the maximum amount that can be charged by the contractor. This type of contract or clause can help to increase contractor efficiency because the contract price is limited to the cap amount, no matter how long the project takes or how high the materials costs run.
- Maximum labor hours: Similar to a not-to-exceed condition, T&M contracts can set a maximum number of labor hours. If the contractor exceeds a specified amount of labor hours, the additional hours cannot be billed to the other party. This helps to prevent the “lower efficiency = more money” issue that is a common problem with T&M contracts.
Time and Materials Government Contracting
Some federal agencies use time and materials contracts, although this generally is not a popular contracting method for government projects. Agencies that use T&M contracts include:
- Defense Information Systems Agency (DISA)
- Federal Transit Administration (FTA)
- U.S. Department of Defense (DOD)
Time and materials contracts may be used for government projects if the contracting officer determines that it is the most suitable contract that can be issued, and when the contract includes not to exceed conditions. Under Federal Acquisition Regulations (FAR), T&M contracts may be used when it is not possible (at the time of placing the contract) to estimate the extent or duration of the work accurately or to anticipate costs with any reasonable degree of confidence (FAR 16.601(c)). When using T&M, the government must perform surveillance of contractor performance.
Drawbacks of T&M Contracts
Time and materials contracts come with some general disadvantages, including:
- Profit limits: Owners or clients may try to negotiate for not to exceed conditions, reduced markup on materials, or reduced billable per-hour rates, ultimately reducing the contractor's profit.
- Ignored market prices: Sometimes clients will set lower prices, based on their internal cost structure, than actual market rates, or vice-versa.
- Reduced business: Many potential clients are not used to working with time and materials contracts, making finding new business opportunities challenging. Customers typically prefer fixed-price contracts.
- Billing: Time and materials contracts should be structured so that the contractor is able to bill for a sufficient amount of money to cover fixed costs. When the billing hours are reduced, fixed costs must also be reduced at the same rate as the billable hours.