A Cost Plus Contract in Construction involves reimbursing all expenses related to a construction project, along with an additional fee to cover the contractor’s overhead and profit. This contract is typically chosen by construction project owners aiming for a swift project start or when the scope of work is uncertain, making it challenging to estimate the overall cost. However, it’s important to note that the total cost for a Cost Plus Contract in Construction might end up being higher compared to other types of contracts.
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How Cost Plus Contract in Construction function
A Cost Plus Contract in Construction is a construction arrangement that necessitates reimbursement for project expenses along with an additional amount to cover the contractor’s overhead and profit. Simply put, the name serves as a shorthand way of summarizing what the contract entails: project costs plus the contractor’s markup.
This type of contract is most commonly utilized between a project owner and a general contractor, although it may also be employed between general contractors and specialty contractors.
The contract, endorsed by the project owner and general contractor, explicitly outlines the costs considered as project expenses. Also known as direct costs, project expenses typically encompass all costs directly linked to construction activities, with the majority originating from labor, materials, and subcontractors’ markup.
The contract also details how the contractor’s markup is determined. Several common methods for calculating the contractor’s fee include:
- Percentage of cost: The contractor receives a markup equivalent to a specified percentage of the total project cost. This percentage fee can vary among projects and industries but is usually set between 5 and 25 percent.
- Fixed fee: The contractor is awarded a flat fee established during contract formation.
- Incentive fee: The contractor receives additional incentives beyond the predetermined fee if they achieve contract targets, such as cost savings or a quicker timeline.
- Award fee: The contractor is granted an award on top of the predetermined fee if they surpass performance expectations outlined in the original contract and construction documents.
Notably, Cost Plus Contracts in Construction are often more negotiable due to reduced risk for contractors. Unlike lump-sum contracts, where contractors may face diminished profits if project costs exceed expectations, cost-plus contracts ensure that the contractor will be reimbursed for costs and still receive their fee.
However, a Cost Plus Contract in Construction is not an unlimited authorization from a project owner to a general contractor. Generally, the contract includes a clause requiring the contractor to provide the owner with a good faith estimate for the total project cost. Additionally, the contractor provides a schedule of values indicating the estimated cost for each aspect of the project, which is later used as subcontractors submit applications for progress payments based on the completion percentage.
It is in the general contractor’s best interest to offer a realistic project estimate. If the general contractor adheres to or comes in under the estimated budget, the project owner is more likely to trust and collaborate with them in the future. Moreover, a general contractor that fails to provide a realistic estimate may encounter challenges with denied change orders, resulting in unreimbursable project costs that cut into the contractor’s fee.
Hence, while a Cost Plus Contract in Construction presents a favorable financial situation for the general contractor, they ultimately benefit more by delivering substantial value to the project owner over time. Finally, it’s crucial to note that cost-plus contracts do not cover costs arising from a contractor’s mistakes or negligence, although they may address situations related to estimating errors.
Advantages of Cost Plus Contract in Construction
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Owners |
Contractors |
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Facilitates smoother negotiations |
Reduces risk |
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Projects can commence more swiftly as the contractor is assured that costs are accounted for. |
With covered costs and a predetermined fee, contractors face diminished risk. |
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Allows for hybrid contracts |
Potential inclusion of incentives |
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Through a guaranteed maximum price clause, owners can avoid exceeding the budget. |
Certain contract types may feature performance incentives to promote superior work or cost savings. |
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Enables project initiation without a clear scope |
Ensures guaranteed profit |
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Contractors, aware of guaranteed payment irrespective of the final scope, are willing to undertake projects on a cost-plus basis. |
Contracts, with an embedded fee, assure profitability for the project. |
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Enhances transparency |
Improves cash flow |
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Owners gain insight into the actual project costs as they unfold. |
The reimbursement structure often eases cash flow burdens with this contract type. |
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Potentially results in higher quality |
Builds trust |
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Contractors have little incentive to compromise quality, potentially leading to a higher-quality project. |
The transparency and relational aspects integral to cost-plus contracts foster trust, paving the way for future partnership opportunities. |
Disadvantages of Cost Plus Contract in Construction
To begin with, a standard Cost Plus Contract in Construction leaves the owner uncertain about the final construction cost, potentially resulting in a project exceeding the budget. Moreover, cost-plus contracts are most effective when there is an established trust between both parties. Therefore, owners engaging in this contract type with unfamiliar entities may encounter disputes regarding project scope or cost.
Furthermore, general contractors are obligated to furnish comprehensive documentation of costs and the percentage of completion throughout the project to facilitate reimbursement. This demands a more sophisticated cost management system compared to what many construction companies use with other types of construction agreements. Additionally, change orders in cost-plus projects can potentially lead to disputes, especially if the project owner is already grappling with escalating costs.
One strategy to mitigate these disadvantages is to incorporate a guaranteed maximum price (GMP) into the original contract. While GMP contracts exist independently, it is also feasible for a cost-plus arrangement to include a guaranteed maximum price, alternatively known as a cost cap provision or not-to-exceed clause. This provision protects owners by capping the total amount they are responsible for paying, thereby incentivizing contractors to control overall project costs while ensuring the owner remains under a predetermined budget ceiling.
Furthermore, trust plays a pivotal role in cost-plus contracts. In cases where a long-term partnership develops between a project owner and a general contractor, both parties are motivated to maintain good faith, ensuring the continuation of the partnership in future projects. The short-term gains of exploiting the owner on a single project are outweighed by the long-term benefits of ongoing projects and collaborations.
Comparison with Other Contract Types
While Cost Plus Contract in Construction prove advantageous in various scenarios, they are not the sole construction contract option available to project owners and contractors. Depending on the project specifics and the owner’s approach, different contract types may be more suitable.
For instance:
- Lump sum contracts stipulate a fixed fee for services at the project’s outset, providing project owners with a more predictable budget compared to a cost-plus contract.
- Guaranteed maximum price (GMP) contracts establish an upper cost limit for the project owner. Any additional costs beyond this limit are absorbed by the construction manager at risk (CMAR), making GMP contracts less risky for project owners than cost-plus contracts.
- Time and materials (T&M) contracts set a fee for labor and material costs, similar to cost-plus contracts. However, contractors must exercise caution in accurately calculating their fees to maintain profitability.
- Unit price contracts bill for repeatable units of work, such as framing a patterned residential home. The similarity with cost-plus contracts lies in both allowing project costs to increase if the scope of work expands during the project.
Selecting the right contract for a project enables contractors and project owners to balance financial risk with the potential for larger profit margins. There is no universally superior contract type, and many construction projects involve hybrid contracts or different contract types for various project aspects.
Asia Pacific Projects: Your Trusted Advisor in Construction
Are you navigating the intricate landscape of Cost Plus Contract in Construction and seeking expert guidance? Look no further than APPMVN, a company at the forefront of providing valuable insights and advice in the construction industry. Specializing in a range of contract types, including the nuanced Cost-Plus Contracts in Construction, APPMVN stands out as a reliable partner for both project owners and contractors.
As the construction industry evolves, understanding various contract options becomes paramount. APPMVN’s comprehensive expertise extends to Lump Sum Contracts, Guaranteed Maximum Price (GMP) Contracts, Time and Materials (T&M) Contracts, and Unit Price Contracts. Our seasoned professionals guide you through the complexities of each, ensuring informed decision-making tailored to the unique needs of your project.
At APPMVN, we believe in empowering our clients with the knowledge and guidance necessary to navigate the intricacies of Cost Plus Contract in Construction successfully. Trust us to be your partner in building a solid foundation for your construction endeavors.
Please send information or requests that you need to consult for Asia Pacific Projects via:
NGUYEN THI HIEU | Local Relations
Mobile phone: +84 918 331 489
Email: hieu.nguyen@appmvn.com
