The Difference Between Cost-Plus and Fixed Cost Contracts

By Doug Hanna, principal, S+H Construction, Inc.

Recently I attended a three-day retreat with a group of contractors from different areas of the United States. This was an introductory meeting to see if our company would "make the cut" and be voted into this advisory group of contractors. We were indeed voted into the group and so will attend a couple of meetings a year going forward. We regularly meet with local contractor/competitors involved in residential renovation and building at networking and trade association events, where we always have an interesting exchange of ideas and experiences. However this retreat allowed for more direct and honest criticism to be exchanged (along with the excuse to eat and drink more than usual). The contractors in the group come from non-competing markets, giving them the ability to share experiences and advice in a more open manner, without giving away all the state secrets.

The Difference Between Cost-Plus and Fixed Cost Contracts

I took notice that a large amount of the contractors in this group work on a "fixed cost" contract basis with their customers. This sparked discussion, since our team uses a different model- namely "cost-plus" or "time and materials."  Having used this model for over thirty years, I am somewhat biased towards the "cost-plus/time and materials" basis and its benefits. Interestingly, the only other contractors at the retreat who also work on a similar basis are, like S+H, primarily involved in renovation projects of older homes and apartments.

I can see the allure of a fixed-price contract for both the owner and the contractor.  Fixed cost is most appropriate with a very thorough, well-defined set of construction documents (plans and specifications) and even more so if those complete documents are produced for new construction. In a less defined job with vague plans, or in an older home, cost-plus/time and materials may be more appropriate simply because there is too much that is unknown to be able to confidently estimate how much it will take to perform the work.

Despite the differences, there are still contractors who will perform work on older homes and jobs with a poorly defined design on a fixed-price basis.  This is where the more you know, the better choice you can make when hiring a contractor.  Here are some points to keep in mind:

1. A contractor may "bid to the plans", meaning the bid is based strictly on the plans, even if they are just rough sketches. If you proceed with the work on fixed cost basis, having only rough sketches or incomplete plans, it is very likely there will be multiple changes (change orders). The more changes there are, the more things cost, with an attendant extension of schedule.  If you have precise, professionally drawn plans and a complete set of specifications, you may experience some changes throughout the process that will add cost to the original estimate, but they should be minimal, or hopefully limited to the unknowable defects in the existing structure.

2. If you get multiple bids and a contractor comes in significantly lower, you may want to resist the urge to automatically hire the low bidder. In renovation work, as with most other things, you get what you pay for. A radically lower estimate, can sometimes indicate the contractor is using subcontractors that are not up to par, or ones the firm never used before and never plan to use again. It may mean that the contractor did not understand the plans or take good care in estimating. There are reasons why most reputable contractors' estimates are in the same ballpark. 

3. As stated before, it's our opinion that Cost Plus/Time and Materials is the best choice if you are renovating an older home. Renovation of older homes is not like producing widgets in a controlled factory setting. There are many moving parts and it's important to have someone on the job that is on the lookout for existing issues with the building, who also has the customer's best interest at heart, and is not rushing through to get the job done for a fixed cost. 

The best advice is to become as educated as possible on the contract options available; get a good set of plans and do your homework when it comes to contractors you invite to bid on your project.