In this episode of The Real Build, I wanted to hit on a topic that I face daily—fixed cost projects versus cost-plus projects. We, as custom builders, prefer cost plus. But there are many people that question it. I wanted to explain a few pros and cons to both cost-plus and fixed cost pricing.
What are they?
Cost Plus Contracts
the contractor estimates the base cost of the project. The base cost includes the price of materials, labor, and overhead. The “plus” is the profit. In a cost-plus contract, the profit is calculated separately before construction and written into the contract as an additional fee.
Fixed Price Contracts
A fixed-price contract establishes a single lump sum cost for a construction project upfront. This type of contract is an agreement to complete a project at a set price that includes all costs and profits.
Pros of Cost plus:
The biggest advantage is more transparency of costs and fees;
there really is no inflation of costs.
More decisions can be made by clients during the building process. This allows for more input into the build process and purchases.
The contractor has less incentive to save money and cut project costs, and there are far fewer quality control risks related to materials and labor.
With a fixed cost contract, many contractors aim to keep the material costs as low as possible in order to make a profit on the work done.
Peoples Fears:
Cost-plus pricing is a pricing strategy that generally doesn’t establish a price before the construction starts.
Another drawback of cost-plus pricing is that there’s no incentive for the contractors to control or monitor building costs.
Positives of Fixed Cost
Fixed price pricing gives both the client and contractor a predictable cost of the construction project before it starts
The builder is looking to keep overall costs low with this method since he or she has also committed to a specific price. This can often translate into better costs for the client in addition to a smoother build process.
Downside
The estimated cost for the construction project is only perceived, and what if a greater contingency occurs? For contractors, if actual costs exceed estimated costs, they may take a huge financial hit.
A bad contractor might be tempted to spend as little as possible in order to make more profit. Contractors are rewarded and earn profit by keeping the cost of the construction project down.
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FAQs
The base cost includes the price of materials, labor, and overhead. The “plus” is the profit. In a cost-plus contract, the profit is calculated separately before construction and written into the contract as an additional fee. A fixed-price contract establishes a single lump sum cost for a construction project upfront.
What percentage do contractors charge for cost-plus? ›
How much do contractors charge for cost-plus? The profit in a cost-plus contract is typically set as a fixed amount or a fixed percentage of the project's total costs. The percentage typically ranges from 10% to 20% of the total cost of the project.
What are the disadvantages of a cost-plus construction contract? ›
One of the biggest cons is the potential for project costs to spiral out of control. Since the contractor's fee is fixed regardless of expenses, there may be little incentive to keep costs under control. Another downside is that it can be challenging to accurately estimate the total cost of a project upfront.
Who pays for mistakes in a cost-plus contract? ›
Who pays for those mistakes? The owner doesn't want to because it's not the owner's fault. But mistakes and rework are just part of the costs. In a cost-plus contract the owner agrees to pay the costs.
What are the advantages of cost-plus contract to the contractor? ›
Cost-plus contracts are generally used if the party drawing up the contract has budgetary restrictions or if the overall scope of the work can't be properly estimated in advance. In construction, cost-plus contracts are drawn up so contractors can be reimbursed for almost every expense actually incurred on a project.
How do you calculate cost-plus fee? ›
Cost-plus pricing is a basic pricing strategy that involves determining the cost of goods or services, and then adding a fixed percentage (the margin) as the markup. For example, if your total costs are $100 and you want a 20% profit margin, you would add $20 to arrive at a selling price of $120.
What is an example of a cost-plus construction contract? ›
Q: What is a cost-plus pricing example? A: As an example, a cost-plus contract may establish that the total estimated cost of a building project is $10 million plus a fixed fee of $1.5 million, roughly 15% of the total cost, as the contractor's profit.
What is the main disadvantage of cost-plus pricing? ›
One drawback of cost-plus pricing is potential profit loss. If you switch suppliers or get cheaper materials, your costs will get lower. Strictly cost-plus pricing would require you to lower your selling price. If consumers are willing to pay more for the product, you'd be missing out on revenue.
Is a cost-plus contract risky? ›
To wrap up, cost-plus contracts are a useful tool for contractors and property owners, but they also expose both parties to significant risks. However, these risks can be minimized by having clear and effective communication, proper documentation, and effective risk management strategies.
What are the drawbacks of using cost-plus pricing? ›
Cost-plus pricing can also lead to overpricing when demand is low and underpricing when demand is high. As the volume of production increases, the cost of manufacturing decreases. Thus, your price impacts how much you sell, which then affects your unit cost and can cause a chain reaction of miscalculations.
Cost-plus pricing doesn't take consumers into account.
Perhaps the biggest downfall of a cost-plus pricing model is that it completely disregards the customer's willingness to pay. To make money, a customer must be involved. Customers are essential to selling anything.
Is cost-plus pricing effective? ›
This can save you time and money, and reduce the risk of underpricing or overpricing your products or services. Another benefit of cost-plus pricing is that it ensures that you cover your costs and make a profit. You can adjust your markup according to your financial goals and market conditions.
What is the cost-plus markup rule? ›
Cost-plus pricing is a pricing strategy by which the selling price of a product is determined by adding a specific fixed percentage (a "markup") to the product's unit cost. Essentially, the markup percentage is a method of generating a particular desired rate of return.
What percentage of construction cost is a fee? ›
Core consultant fees
| Construction cost (excl contingencies and VAT) | Under £1.5m | £3m - £10m |
|---|
| Architect | 9% | 7% |
| Cost consultant | 2% | 1.5% |
| Services engineer | 2% | 1.5% |
| Structural engineer | 2% | 1.8% |
1 more rowDec 30, 2022
Project Scope
Beyond drawing up house plans and blueprints, architects cost between 5% and 15% for new construction management and between 12% and 20% for renovations.
Why is a cost-plus percentage of cost contract bad for the buyer? ›
RISKS OF A COST-PLUS CONTRACT. Cost controls lacking: The contractor has no economic incentive to control costs, always a difficult task on construction sites. Perverse incentives: The contractor has a perverse incentive to increase costs and job duration – especially on a cost plus-percentage job.
What is cost plus pricing renovation? ›
If you're using cost-plus pricing in your remodeling business, you are charging clients a percentage markup on top of each dollar spent on labor, materials, and trade partners on a construction project. To a client, this means: "For every dollar we spend on your behalf, we charge $1.
