Cost-Plus Contracts: Pros and Cons
When to use cost-plus percentage of cost in a contract
When drafting a contract, contractors use the cost-plus percentage of cost when it is difficult to predict the exact cost of the work before it is finished. There are two times when this may be the case:
When doing custom work
It can be challenging to foresee in advance what materials and work a project will require when it involves customer work. Even if the contractor has general industry experience, each custom project is unique. Because they need the client’s specific approval more often than a standard job might, they can have a wider range of variations and quality checks. Since the materials and labor won’t be known until after the project is finished, the contractor can use the cost-plus model to create the contract.
When the cost of supplies fluctuates
Sometimes a contractor will use the cost-plus percentage model because the cost of the materials changes. A fluctuating final cost may be caused by a changing economy, a disruption in the supply chain for a particular material, or a shortage of qualified labor. When drafting the contract, a contractor might not want to commit to a price if they can’t predict the cost of labor and supplies due to these factors. In these circumstances, they can instead determine the cost of materials and labor after the project is finished by using the cost-plus percentage model.
What is the cost-plus percentage of cost in a contract?
When drafting contracts with clients, contractors will often use the cost plus a percentage of cost method of pricing if they are unable to provide a final cost at the time of the contract. These contracts detail how they can estimate the project’s cost without doing any cost calculations. The client agrees to pay all materials the contractor purchases to complete the project at the beginning of the project. Additionally, the client consents to pay a predetermined portion of those expenses as profit to the contractor directly. The contractor then divides those funds between labor and overhead expenses.
Pros of cost plus a percentage of cost in a contract
Some benefits of a cost plus a percentage of cost contract include the following:
Eliminate risk for the contractor
Contractors risk overcommitting their resources to a project that doesn’t turn a profit if they agree to a project’s price before they have a clear idea of what it might cost. A cost-plus percentage of cost contract ensures that the payment is proportional to the contractor’s costs. By doing this, the chance that the customer will underpay the contractor for their work or run out of money before the project can be finished is eliminated. Without this risk, the relationship between the client and the contractor might be easier and result in a more adaptable construction process.
Focus on quality of work
A client may benefit from a cost-plus percentage of cost contract because it gives them more freedom to make decisions about the construction process. They may be more free to concentrate on the caliber of the supplies the contractor is using if they feel comfortable paying for the supplies. They can concentrate on the project’s advancement as opposed to the contractor’s strict adherence to the terms of the contract. Additional features or components can be added if the client so chooses.
Cover all expenses
This type of contract relies on the cost of supplies. When the project is finished, the contractor must provide the client with a thorough list and breakdown of all expenses that were incurred.
Because they are keeping a close eye on the costs and looking for inconsistencies, this can help a project save money. It can also benefit the contractor because they get paid for all costs once they give the customer the final bill. The more materials they use, the more money they can make, which motivates contractors to take on bigger projects and use better materials.
Cons of cost plus a percentage of cost in a contract
The drawbacks of a cost-plus-percentage-of-cost contract are as follows:
Doesnt address final cost
The risk may be transferred to the client because this type of contract doesn’t address the total cost. Because the total cost is unknown when they sign the contract, it might be more difficult to stay within a budget. However, they can avoid being shocked by the cost at the end of the project if they maintain good communication with the contractor to keep track of the cost of supplies. They can also decide on a budget cap for the project and work to keep track of every expense to ensure that it stays within that limit.
May not account for additional time
There is no consideration of time in these types of contracts because the contract considers the cost of supplies and uses the percentage to cover the labor cost. It can be more difficult to account for in this kind of contract if a certain technique takes longer than another but consumes the same quantity of materials. However, extra time frequently also entails extra materials to use during that time, in which case the percentage rises in relation to the amount of work completed.
Example of a cost-plus percentage of cost contract
Here is an example of a cost-plus percentage contract:
The Kirchick family accepts Samson Construction’s offer to work with them to remodel their kitchen. The family wants full input into the unique design of their new kitchen. They want to install custom built-in shelves throughout the kitchen and import rare marble. The family also wants to add a walk-in freezer, which might necessitate updating some of the home’s plumbing. The contractor is unsure of the final cost because of the rare marble’s fluctuating price, the custom shelves’ unknown dimensions, and the possibility of repiping the kitchen.
For custom home renovations, Samson Construction typically requires 20% of the project’s cost. The Kircheck family concurs, and a cost-plus-percentage-of-cost agreement is created. According to the agreement, the Kircheck family must pay the full cost of the rare materials as well as an additional 20% for labor and overhead. The Kirchecks get an itemized bill from Samson Construction after the project is finished:
Marble: $25,000Lumber: $10,000Piping: $30,000Walk-in Freezer 5. Materials: $87,2500% Cost: $17,450Total: $104,700 0: $15,000Hardware: $5,000Floor tile: $2,000Paint: $250Total materials: $87,250
Samson Construction is owed $17,450 for labor and administrative expenses. A four-person construction crew would need to spend $12,480 on labor if they worked 40 hours per week for three weeks:
40 hours a week at $26 an hour equals $1040 per week.
$3,120 per crew member ($1040 per week x 3 weeks).
4 crew members at $3,120 each equals $12,480 in labor overall.
Samson Construction is now left with $4,970 to spend on equipment purchases, administrative staff salaries, and utility costs. This is the revenue generated by this construction project for Samson Construction.
How are cost plus contracts calculated?
The client will pay: 1,100 + 100 + (1,000 – 1,100) * 0 if the Actual Cost is greater than the Target Cost, for example, 1,100. 2 = 1,180 (contractor earns 80). The client will pay: 900 + 100 + (1,000 – 900) * 0 if the Actual Cost is, for example, 900 less than the Target Cost. 4 = 1,040 (contractor earns 140).
Why is the cost-plus a percentage of cost type of contract not used to a great extent?
A cost-plus-percentage contract means that the fee will increase as project costs do. Because the contractor has no incentive to control costs, this is rarely used. In fact, this type of contract is not permitted by federal government agencies.
What does cost-plus 10% mean?
Cost plus is about as simple as it sounds. Consumers are simply charged 10% of their entire basket at the checkout. Retailers set shelf pricing for every item in the store at their cost, which includes the item, transportation and warehousing costs, and labor to get it on the shelf.
What is percentage fee contract?
Contracts with a cost plus percentage charge the cost of the materials plus a percentage of the total cost of the materials used. These are frequently used for custom work and in situations where it is difficult to estimate the amount of materials required.