In theory, cost-plus contracts (also known as Time and Materials contracts) are a win-win for the contractor and the owner.
The contractor’s risk is lowered because the price the owner pays is the cost the contractor incurs plus a predetermined rate. This “plus” is exactly what the contractor needs to cover the overhead expenses and make a profit.
The owner saves money because she doesn’t have to pay for anything not related to her job and avoids all the “fluff” that contractors add to their fixed-price contracts to cover the unknowns.
Sounds great, right?
Remember, I said in theory. Reality is a different story.
*NOTE: Nothing in this article should be considered legal or financial advice. All contracts should be reviewed by a legal professional familiar with your business.
In this blogcast, I discuss the issues involved with executing a cost-plus contract.
In my previous post, I listed 10 provisions you should include in all your contracts. A cost-plus contract will not allow several of these provisions to be met prior to the start of construction. Some of these missing provisions are:
Length of contract – if the costs are unknown, then how can the schedule be known.
Project Scope – most cost-plus contracts have a general scope of work developed, but the scope has not been developed enough to provide a fixed price. If the project scope is complete, then why would a cost-plus contract be needed?
Payment Schedule – The contractor can define the payment schedule for the progress payment, but since the length and scope of project is not known, then the payment schedule will keep increasing along with the project.
Change Orders – If the project scope cannot be determined before the contract begins, then how can change orders be determined? Technically, everything is a change order since there is not fixed-price or pre-determined scope of work.
WHY USE A COST-PLUS CONTRACT?
A cost-plus contract is an attractive option for a contractor for these two reasons:
The contractor cannot produce a proposal for the work because of incomplete information about the project, and therefore transfers the risk of the cost of the project to the owner.
The contractor does not have the estimating experience or systems in place to produce a fixed price.
A cost-plus contract is an attractive option for an owner for these reasons:
The plans are not complete.
The owner wants to get started.
The owner thinks that a cost-plus contract will save money.
These are horrible reasons to enter into a construction project.
All of these reasons involve a lack of information. Proceeding with a construction project without the proper information defined is a recipe for disaster.
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