Contracts specify the terms of the agreement between an employer and a contractor. Because these agreements are so diverse, there are many different types of contracts, each with their own benefits. One of these is called a cost-plus contract.
Imagine you’re building something conceptual, but you only have a general idea of how to do so. You’ll want to hire a contractor who’s familiar with this type of job and knows the specific steps to take. If this type of project is totally foreign to you, you can’t be certain of costs. When this is the case, you might want to consider a cost-plus contract.
What is a Cost-Plus Contract?
A cost-plus contract is an agreement between an owner and a contractor, in which the contractor covers the expenses of the project and is reimbursed by the owner upon its conclusion. This means the owner is not agreeing to a set budget for things like materials and labor, but rather, agreeing to pay whatever it takes to get the job done. Additionally, the contractor is guaranteed a set profit in the form of a flat fee or a percentage.
At first, this can sound like a precarious situation for both parties. Employers are trusting contractors to use good judgment and contractors are trusting employers to reimburse them. Despite this, there are many situations in which a cost-plus contract is the best fit. Construction projects, for one, largely use them because owners are hiring experts to build something outside of their capabilities.
When Should One Be Used?
Cost-plus contracts are the best choice when quality is more important than time spent or costs. Now, you might be thinking, isn’t quality always key? Yes, of course. But these contracts are used when the end product takes priority over how much of something can be made or how quickly it can be churned out.
The construction industry commonly uses cost-plus contracts. The engineering industry comes in at a close second. Experts in these fields are hired to do something their employer doesn’t have the skillset to do.
What is Included in a Cost-Plus Contract?
A cost-plus outlines how both direct and indirect costs will be covered and how they will be reimbursed to the contractor. But these costs only make up a portion of the agreement. This type of contract also includes an additional, predetermined amount to be paid to the contractor on top of expenses.
This additional amount can be a flat fee, a fixed rate (determined by the cost of labor, supplies, etc.) or a combination of the two. For example, a contractor may stipulate that the employer pays them a percentage of labor costs, on top of being compensated for the cost of labor itself.
Cost-plus contracts are most successful when they’re specific, and there’s no such thing as too much detail. The most well-written contracts also outline things like how expenses should be documented by contractors and how any disagreements between contractor and employer should be handled. These details — even if they’re ultimately not needed — can save the project.
Three Key Parts of a Cost-Plus Contract
Regardless of the type of project or the specific details of the agreement, every cost-plus contract should be made up of three core components — direct costs, indirect costs and a fee. These three make up the bones of the contract.
- Direct Costs: Direct costs include things like labor, supplies, materials and equipment. These are hard costs that go directly into the end product.
- Indirect Costs (Overhead Costs): Indirect costs are the “invisible” cost of doing work. The cost of accident insurance, for example, is a major indirect cost of doing business in the construction industry.
- Fee (Profit): A fee is essentially the price employers agree to pay contractors for fronting direct and indirect costs.
Variations of a Cost-Plus Contract
A cost-plus contract covers the costs of materials, labor, equipment, etc. plus a base fee or a percentage of overall costs. But how are these additional fees and rates determined? Here are four of the most common methods:
Cost-Plus Incentive Fee
A cost-plus incentive fee variation includes an incentive fee awarded to the contractor for a job well done. The specific terms of this incentive should be clearly stated in the contract.
Cost-Plus Award Fee
A cost-plus award fee variation includes built in fees specifically stated in the contract. Unlike a cost-plus incentive fee contract, these fees are awarded for meeting a specific criteria or deadline. These fees can also be charged to contractors or deducted from their earnings.
Cost-Plus Fixed Rate
Cost-plus contracts cover both direct and indirect costs. One of these direct costs is labor. A cost-plus fixed-rate fee sets a fixed rate for labor. This variation is often seen when contractors are hired for a very specialized task and can accurately estimate labor costs.
Cost-Plus Fixed Fee
A cost-plus fixed fee variation also accounts for direct and indirect costs, but it also includes a flat fee that is determined before the contract is finalized.
What are the Advantages?
Cost-plus contracts are a favorite among contractors, but they’re just as beneficial to employers, as well. The old saying is true: no risk, no reward. And the rewards of using one can be great.
- They shift the focus from quantity to the quality: Because contractors are not confined to a set budget with a cost-plus contract, they’re much less likely to cut corners in order to get the work done. Contractors know their expenses will be covered and are far more likely to choose the best materials and people for the job.
- They mean expenses go down with prices: While a cost-plus contract might seem like a big risk (employers agreeing to cover all expenses) this agreement ensures that employers will be charged fairly. If the price of a certain material goes down, they will pay the new lower amount. Pricing changes all the time, and this way there’s no risk of paying more than something is worth.
- They are more flexible than other types of contracts: Because cost-plus contracts mean employers are committing to paying contractors for direct and indirect expenses, contractors have more freedom to hire experts, choose the best materials and take enough time to get the work done right. This is especially important in construction projects, where cutting corners can harm the longevity of the finished product.
What are the Disadvantages?
For as many advantages as there are to using a cost-plus contract, there are a few disadvantages. When we’re aware of these “danger zones” they’re easier to avoid.
- They require a high level of trust: Cost-plus contracts require a large degree of trust from both the employer and the contractor. Employers are trusting contractors to make smart spending decisions and choose fairly priced options. On the other side of the coin, contractors are trusting employers to reimburse them for these expenses. Cost-plus contracts are a popular option when employers and contractors have a positive history together and/or the contractor has worked successfully with other employers under this type of contract.
- They make budget estimates difficult: Cost-plus contracts are best suited for projects with flexible budgets. As you can imagine, the cost of supplies and materials is constantly fluctuating. This means contractors might have to pay more for something than they initially anticipated in order to do the job well. This isn’t to say projects cannot have any type of budget, but there should be some “wiggle room”.
- They require thorough documentation: Without the proper documentation of costs and expenses, it’s impossible for employers to reimburse contractors accurately. This can create distrust and conflicts down the road, not to mention confusion. If records are kept and organized correctly, this isn’t a problem, but it is a common pitfall to be aware of.
Cost-Plus Contract Example
NASA is a popular example of an organization that commonly chooses to use cost-plus contracts. As you can imagine, quality of work is literally life or death for this organization, so they’re willing to let the experts decide exactly which materials should be bought, how much time things should take, etc.
One recent example was between NASA (National Aeronautics Space Administration) and Boeing in 2019. In this instance, Boeing was hired to build rockets for NASA and it became Boeing’s responsibility to design and build the vessels with the materials they deemed best.
How ProjectManager.com Helps With Cost-Plus Contracts
ProjectManager.com is an award-winning software that allows you to keep all your important project documents in one location with unlimited file storage. This includes your cost-plus contract. Odds are, you’ll want to refer back to this document at some point, and you need to know exactly where to find it.
With ProjectManager.com, core documents like these live in the same place as your Gantt chart, along with other powerful features used to manage projects. This means no more jumping back and forth between pdfs. and your project management software.
If you need to point out certain details of the contract to team members, simply tag them in a comment and keep the conversation going. No more emailing documents back and forth and retracing your steps through messy email chains. Now, your discussions about documents like contracts are attached to the documents themselves.
ProjectManager.com is a cloud-based project management software that organizes tasks, teams and projects for greater productivity. Plan, monitor and report on your construction project while giving your crew the collaborative tools they need to work better together whether on the job or off-site. Join the tens of thousands of teams already using our software to boost efficiencies and take this free 30-day trial today.