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Cost-Plus Pricing Contracts vs. Value-Based (What’s the Difference + Pros and Cons of Each)

Karine Woodman
CEO

Deciding how to price your services as a construction company is one of the toughest decisions you’ll make in the early days of your business. 

Should you try and position yourself as an affordable option? Depending on who your target demographic is and the style of homes/remodels you’re offering, this could work. Sometimes, consumers may perceive a cheaper option as one that has lower quality services or products.

Maybe you are going for very high-income clients and so you price your services higher than the competition with the guarantee that your quality is superior to your competitors. 

When it comes to figuring how to set your contracts up — whether it’s for a home build, remodel, or landscaping — there are two main methods for figuring out the cost to the client. 

These are cost-plus and value-based pricing. 

Today we’ll break down what these two methods are and the differences between them. We’ll also offer some pros and cons for both options to help you decide which is best for your business. 

First, let’s talk about cost-plus. 

Cost-Plus Pricing 101

A cost-plus contract is an agreement between the contractor and the client in which the contractor will be paid for all construction-related expenses in addition to an agreed-upon profit. 

This is a solid pricing strategy for the contractor, as it allows them to cover all their risks while all the expenses are likely to be paid. 

However, the contractor must present enough evidence for the costs related to the job. In most cases, these contracts will also include a clause where the contractor will be denied recovery of associated costs if a negligent act or error causes the price to go up. 

Some cost-plus contracts will also include a stipulation where the price cannot exceed a certain amount. 

There are three main components of a cost-plus contract:

Direct costs: Labor, materials, supplies, equipment

Overhead costs: Business-related expenses that are necessary to perform the contract — such as a percentage of labor costs, office rent, insurance, mileage, etc. 

Pros of the Cost-Plus Method

-Rather than worrying about the cost, you can focus on the quality

-Your risk is minimized 

Cons of the Cost-Plus Method

-You need to produce evidence and justify all related costs

-Might lead to disputes when trying to recover construction-related expenses

-The final cost cannot always be easy to determine

Value-Based Pricing 101

Value-based pricing is all about pricing your services at the point in which your customers are comfortable paying. 

Value-based pricing is centered on the idea of ‘willingness to pay’ from the perspective of your target demographic. So, in order to figure out what to price your services — based on this method — you should be doing research as to what your closest competitors are doing in terms of their offering. In addition, find the most successful in terms of profits. 

However, you don’t simply want to copy your competitors. You want to actually be different from the competition — in other words, provide more value. 

You also need to do some sort of market research to determine how high your ideal customers are willing to pay. This is easier for businesses that sell products, as a construction businesses total cost for their services will always vary project to project. 

This is what makes value-based pricing so difficult for construction businesses. However, you do get a better understanding of your customers because your prices are based on what they would spend. 

Pros of the Value-Based Method

-Achieve a better understanding of your ideal customers

-Can raise prices if customers have shown that they value your services

-Potential for more profits

Cons of the Value-Based Method

-Takes time to develop — especially for construction businesses

-Not 100% reliable — price sensitivity will vary for many reasons

Which Should You Use? 

For the most part — due in large part to the variability from project to project — construction businesses will use the cost-plus method, or methods similar to that one. This is because that pricing method does take into account the variability factor. 

If you’re in need of some assistance with your construction business’s accounting, then give 24hr Bookkeeper a call today! 

We offer construction software integration, monthly bookkeeping, and QuickBooks training services. Learn more about our services here

To get in touch with us, call (218) 885-3100 or fill out this brief form on our contact page. 

We’re looking forward to hearing from you!

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