When it comes to construction, there are two popular methods of creating contracts with clients: cost-plus and fixed fee. Each contract type has its own advantages/disadvantages and each can have a major effect on what the customer relationship will likely be for that particular project. Prior to covid, most construction companies preferred the fixed fee method of contract. However, covid has not only created uncertainty in the world around us, but it has also created uncertainty in the construction industry as we whole when it comes to estimating project costs.
In a fixed fee structured contract, you and your customer are both well aware of the budget and total cost of completion on the project before it’s even started. Meaning, contractors estimate what the project will cost them, such as in materials and labor, in order to configure what their profit will be once completed. They then discuss this with their client and once approved the client proceeds to signing the contract and the project can begin. As for cost-plus pricing, there is a set price for the project at hand PLUS additional expenses that could come from materials, rentals, and labor hours to name a few. The price of materials can change from one day to the next and obtaining tools and equipment can also take longer than expected which then pushes back the completion date. The project not being completed when anticipated can then cause more labor hours for the customer to pay or a profit percentage drop for the contractor depending on how the contract is set up.
The advantage of a fixed contract with customers is trust. The customer trusts that the project will be completed within their budget and on time. There are usually no underlying fees, and if any do occur, they are usually minimal and are discussed. Most customers also find it very important that the project be finished within the time frame that was detailed in the contract. In fixed price contracts, customers and contractors tend to be on the same page throughout the process which creates a solid foundation and provides a better customer experience with the potential for referrals and repeated business. The disadvantages of a fixed contract is that there is no room for change on the contractor’s side. If the price of materials change drastically you are still under contract to complete the project based on the amount you priced out. If it takes longer to complete a project than expected and you need to provide more labor hours than expected, you end up potentially losing some of the profit you had previously figured.
The advantage of cost-plus is protection for the contractor during times of uncertainty. In the last few years there have been unpredicted shipping delays, supply and demand issues, overbooked rental equipment, extreme price changes on materials, and many more. With all of this to consider, setting a fixed price and being able to stick to it has become difficult. Cost-plus allows more flexibility when beginning and being able to complete a project. The disadvantage of using a cost-plus contract is the fact that every little thing needs to be documented and discussed with the customer which can also lead to a strained relationship. Cost plus customer invoicing requires a seamless process for managing job costs to ensure that material, subcontractor and direct labor is tagged to the proper customer. When expenses fall through the cracks of job costing, this means that they aren’t going to be charged back to the customer, causing builders to affect their company’s bottom line. Being diligent in this cost plus invoicing system, and having checks and balances in place to be certain nothing gets missed is crucial to making this workflow successful.
In recent years, cost-plus is the direction that many contractors are being forced to go whether they prefer to or not. Sometimes we have to change with the world changing around us and unfortunately, in the post-covid era, change has been inevitable. The number one priority is always to make sure the customer is happy, comfortable, and has trust in your service. However, as a business owner, it is equally important to protect yourself and create contracts that you can stick to without it causing a financial loss to you and your company.
