Cost plus construction contract can be defined in any of the following ways.

• It’s a contract where the revenue/fee of the general contractor is a specific percentage of the total construction cost. For instance, in a case where GC is entitled to 5% of the total construction cost, and, if the project is constructed for $100,000, the GC is entitled to receive $5,000 ($100,000 x 5%).
• Cost plus contract protects contractor in terms of construction price fluctuation. This risk of overprice is bear by customer. On the contrary, fixed price contract protects the customer and overpricing risk is bear by general contractor.

Let’s discuss the situations when it’s a good idea to use a cost-plus contract.

Situations when cost plus contract is a blessing

1. Project scope – It’s unclear and project cost cannot be predicted reliably.
2. Unclear project design/clarity– The customer is not certain about quality/design of the project to be constructed.
3. Price volatility– The project is to be constructed in an economy where the market is volatile. And, it’s challenging to predict the cost.

You may like – QuickBooks for General Contractors!

Types of cost-plus contract

Broadly, there are two types of cost-plus contracts,

1. Cost plus a fixed fee– This type of contract pre-defines the fee for the contractors. The fee is fixed and protects the contractor in terms of inflation and changes in project design etc.  
2. Cost plus specific percentage– The contractor’s fee is dependent on the total project cost. The contractor fee keeps increasing with increasing project cost. In this case, contractor has clear incentive to inflate project price. Hence, there is a need to mange potential mis-use in this case.  

Benefits of cost-plus contract

Following are the benefits of using a cost-plus contract.

• Detailed cost tracking
• Higher flexibility
• Encounters market volatility

Best practices for using cost plus contract system

Following are the benefits of using a cost-plus contract.

1. Use AIA clauses– To ensure sustained project quality and satisfaction, it’s a good idea to use AIA clauses. It helps ensure the customer is satisfied with the project’s quality.   
2. Use cap provisions for liability purpose– Cap provision can be good idea to protect the customer. However, project scope must be defined to ensure win-win for both contractor and customer.
3. Clearly define project scope– The scope/design/layout of the project must be clear and concise. The scope must be understood and agreed upon by both parties in the contract to ensure risk is effectively managed/mitigated.

Risk mitigation strategies for cost-plus contracts

The following may be an effective risk mitigation strategy for using a cost-plus contract.

1. The clause for the Guaranteed Maximum Price may be implemented. It means the contractor agrees to cap on the total project cost. It can be a relief for the customer while working on cost plus model.
2. The customer must have audit rights. It means the customer should have full access to invoices, bills, receipts, timesheets, logs, and all other documents related to the construction project under consideration. Further, it’s a good idea to analyze the detailed breakdown and locate fluctuations.
3. Make sure to include contingency costs in the project budget. This budget line item can be used for unforeseen costs/expenses.
4. Keep detailed record for change order – Organized change orders help ensure the record is accurate, error-free, and all of the modifications/changes are pre-approved.
5. Define reimbursable cost – Clearly define the costs included in the agreement. Also, try to define the costs that should be reimbursed.

Case study for cost plus construction contract

A historical home renovation in Florida using cost-plus contract included $2 million Guaranteed Maximum price. The renovation accompanied real time budgets, expense tracking, periodic reviews, collaborative change orders etc. The project completed $1.9 million (under GMP).

Despite there was 2 months delay but all disputes resolved as delay was concluded based on unavailability of quality concrete in that area. This fact was agreed as project was backed by rigorous documentation, labor logs, trust building audit, enhanced financial controls, and contingency planning.

The compliance with procedural formalities and strong documentation helped both customer and GC to remain calm, composed, and successfully renovate the project.

Conclusion

Cost plus contract is when the GC is entitled to receive certain percent/fee for constructing the project. In case of cost + fixed fee, the contractor is protected in terms of profitability. On the contrary, in case of cost + percent, the fee is dependent on the total project cost.

Cost plus is blessing when the project scope is not clearly defined, material price is volatile, or project design is not clear.

Best practices when using cost plus include using AIA contract, use price cap clause, guaranteed maximum price, detailed cost tracking, keeping organized records for logs, invoices/bills, receipts, and other documents that support the project construction.

Frequently asked questions

Why we should use GMP – (Guaranteed Maximum Price) in the construction project? And how it’s effective?

Using GMP in the construction project provides relief to the customer that they are safe against unexpected price inflation. However, project scope needs to be well-defined for effectively using GMP.

When is a cost-plus contract more desirable than a fixed one?

The fixed price contract is highly desirable in volatile market, uncertain scopes, hidden risks, and when there is potential for the unexpected changes in the project.