Cost-Plus Construction Contracts Explained: Advantages, Types and Best Practices

In construction, a cost-plus contract is an agreement where the project owner pays the contractor all the allowable expenses for the project plus an additional fee for the work. Hence the name, cost-plus contract.

Construction contractors receive a fixed fee or a percentage of the total project costs, depending on the agreed terms. Contractors are reimbursed for the total cost of the project, including labor, materials, subcontractor work, and any costs incurred to complete it.

Construction projects often use cost-plus contracts if they are complex or need to be completed quickly. Cost-plus contracts are also used if there are variables that prevent the project from having a fixed price upfront. This could be for large-scale projects with fluctuating costs on materials, technology, labor, or incremental changes that need to be made during construction.

This provides flexibility for contractors to make the best judgment call on what is needed best for the project. Cost-plus contracts also ensure that contractors are making a profit on their work, no matter how big or small the project is.

The key points of a cost-plus contract should include:  

• Direct Costs 
• Indirect Costs 
• Profit  

Direct Costs:  

Direct costs are any costs related to the project's construction, including labor, materials, equipment, subcontractors, and any other costs during the construction process.  

Indirect Costs:  

Indirect costs are costs indirectly related to the construction. These can include overhead and administrative costs, office expenses related to the contractor, and any other materials used.  

Profit:  

The profit is what the contractor is to receive from the entire project. It is either a fixed fee or a percentage of the total cost of the project. 

A cost-plus contract allows for flexibility because the contractor taking on the project is reimbursed for the project. Transparency should also be key in a cost-plus contract since the contractor has to provide receipts, invoices and documents to be reimbursed by the project owner.  

Let's say, for example, a project owner comes to a contractor with a project estimate of $5 million for an office building. 

The total direct costs for labor, materials, and subcontractor agreements are $4,800,000, and the indirect costs for administrative and overhead are $200,000.  

The contractor's fixed fee will be a percentage of the total costs. Let's assume the contractor takes a 10% fee for the project, which turns into $500,000.  

The fee will be paid to the contractor in addition to the reimbursed costs for all the direct and indirect costs, totaling $5,500,000 for the project owner.   

Cost-plus contracts are widely used in construction projects because they are a faster and more efficient way to move projects forward. However, there are different types of cost-plus contracts, each paying contractors for their work differently.  

1. Cost-Plus Percentage of Cost Contracts 

Under this type of contract, the contractor is paid a percentage of the project costs.  

For example, let's say a project costs $3 million, and the contractor fee is 10%. This ensures the contractor will get paid an additional $300,000 for the project work on top of the reimbursement.  

2. Fixed Fee Contracts 

These contracts reimburse the contractor for all the work costs plus a fixed fee agreed upon before the project begins.  

This provides contractors with a guaranteed fee, and the project owner pays the project costs.  

3. Cost-Plus Incentive Fee Contracts 

Cost-plus incentive fee contracts are focused on the costs of the project. This type of contract reimburses for all the direct and indirect costs, plus the contractor receives and incentive based on the total costs. 

For example, if the contractor goes under budget, a share of the leftover costs is given to the contractor. This encourages contractors to manage the project budget carefully.  

4. Cost-Plus Award Fee Contracts 

Cost-plus award fee contracts include performance-based awards. This type of cost-plus contract reimburses the contractor for all direct and indirect costs, plus the contractor's profit based on quality, delivery by deadline, and any other targets outlined in the contract.  

A cost-plus contract should include key components to ensure the contractor gets reimbursed, such as the detailed project scope, the cost breakdown, the type of contractor fee, what is allowed to be reimbursed, and the contractor's responsibilities.  

The cost-plus contract should outline all the expectations and details for the project owner.  

Project Scope  

A cost-plus contract should include a detailed outline of the construction work that the contractor will complete. This should clarify what the contractor is responsible for and the materials and equipment that will be used since the contractor will assume all the costs upfront.  

Cost Breakdown  

This is where direct and indirect costs are detailed. Direct costs include labor, subcontractor fees, materials to be used, and equipment. Indirect costs include permits, office, administrative fees, and so on. This should be clearly explained in the cost-plus contract.  

Contractor Fee  

The type of cost-plus contract and the fee to pay the contractor should be included. This will either be a fixed fee, a percentage fee, or any other type of fee structure, along with the reimbursement.  

Reimbursement  

This part of the cost-plus contract should outline the costs and clearly outline which types of costs are reimbursable and which are not.  

Record Keeping  

Contractors should keep detailed records of receipts, invoices, and project costs that can be available for project owners to review. This will ensure transparency from the contractor. A cost-plus contract should outline how this will be recorded and open for transparency.  

Contractor Responsibility 

The cost-plus contract should lay out all the contractor's responsibilities and ensure both parties agree on the terms and conditions. It should also include what the contractor is responsible for and what type of ethics should be followed if that is important to the project owner.  

Having a cost-plus contract in place offers several advantages. These advantages include flexibility within the project, quicker project streamlining, cost transparency between the project owner and contractor, and quality work.  

1. Flexibility  

A cost-plus contract offers flexibility because it's easier for the contractor to adjust the project scope and budget without having to go back to the project owner for renegotiation. If variables change, such as the price of materials or labor costs, then cost-plus contracts are an advantage.   

2. Timeliness 

Cost-plus contracts are an advantage if you want to move your construction project quickly and efficiently. They allow contractors to be reimbursed, so contractors have the freedom to incur costs and don't wait around for approvals from project owners.  

3. Cost Transparency  

An advantage to cost-plus contracts is the transparency in the cost breakdown. To be reimbursed, contractors are required to maintain detailed records of their expenses and receipts to ensure the costs are legitimate. Any detailed records will offer the project owner transparency and trust and ensure the project is completed within budget.  

4. Incentives for Quality Work  

Another key advantage of a cost-plus contract is the incentive for the contractor to produce quality work. Fewer hands in a project allow the contractor to execute the work and complete the project to quality standards.  

The absence of negotiating every cost, material, subcontractor, and so on also helps ensure the contractor is only focused on delivering quality work.

While a cost-plus contract has several advantages, it also has several disadvantages that can be unappealing to the project owners.  

1. Potential Cost Overruns 

Cost-plus contracts can result in going over budget since there is no capped price the contractor is given in advance. Contractors are reimbursed for the project, along with their fee, so the total cost of the project could end up being higher than originally quoted.  

This can be an unappealing component for project owners who want to complete the project within a certain budget.  

2. Detailed Record Keeping 

If a detailed documenting system is not in place or a component of the contractor's business, a cost-plus contract disadvantages both the contractor and the project owner. Cost-plus contracts require extensive and detailed documentation to ensure all the costs are legitimate and can be reimbursed to the contractor.  

If a system is not in place to ensure that every direct and indirect cost is reimbursed, this can be an administrative burden for contractors.  

4. Less Control for Project Owners 

In a cost-plus contract, project owners are allowed to monitor expenses but still have less control over the project and how costs are incurred. For example, if the contractor favors one subcontractor with a higher fee, this is outside of the project owner's control.