Cost Plus Fee Contract

Throughout the course of my extensive career I have watched as the ‘Cost Plus Fee Contract’ has not only been gaining traction, but has slowly become the preferred contractual method for residential construction. Whenever considering hiring a contractor, I always like to discuss the different types of contracts at our disposal, simply due to the impact each different route can have on the timeline. For example: projects that are competitively bid often don’t involve the contractor until the very end of the documentation process and after the build has been successfully depicted in the drawings and project specifications. Alternately, the ‘Cost Plus’ contract involves the contractor early on in the design process, and can often be as soon as the schematic design phase is completed when all we have is a floor plan. But before we dive into all the advantages of the ‘Cost Plus’ contract, let’s discuss the process.

When you enter a ‘Cost Plus Fee Contract’ it includes exactly what you would imagine- the cost of the build in its entirety plus a management and coordination fee for the general contractor. This additional fee for management and coordination is typically a predetermined percentage of the actual cost, which is often around 15% regardless of the general contractor’s skill level. It may seem logical to assume that the “best” general contractors are able to demand a higher percentage fee than those that are less skilled, but that is not the case. The best contractors in the business are able to make larger margins while charging the same percentage rate simply by working with better subcontractors who in turn charge a higher fee for their work. A more skilled sub with higher fees will in turn generate a larger margin for the general contractor based on that same percentage, and after working in the industry for years, experience makes it quite easy to weed out the poor performing subcontractors.

One of the largest advantages to the ‘Cost Plus Contract’ that I cannot stress enough, is how early the contractor is brought on board, allowing them to be a valuable member of design and construction documentation. Many homeowners have bought into the idea that the only way to receive the best price for the final product is to have contractors competitively bid over a project, creating a scenario where contractors find themselves locked in a bidding war until the lowest bid is finally settled upon. From this approach the idea of paying a contractor his price PLUS a management and coordination fee can appear ludicrous, but by implementing the ‘Cost Plus’ contract most contractors can start providing “budget” pricing immediately as well as at different stages throughout the build. This allows homeowners to work with the contractor at various points of the creative process to manage the expectations of the finished product, and keep their finger on the pulse of the set budget throughout the build. Using the “Cost Plus” approach the contractor also becomes an invaluable asset to the architect by helping to solve problems as they play out on paper rather than in the field where it would have to be built, then tore out and rebuilt. This latter alternative is much less cost effective for both the contractor and the financier. While the contractor is left to pay for their mistakes out of pocket, the homeowner is often left to deal with interest accruing on bank loans in order to finance their project while the contractor is fixing the problem, and as we all know time is money.

Another huge advantage to the ‘Cost Plus’ method is that project costs are completely transparent throughout the process. Unlike competitively bid projects where the actual cost of things is a complete mystery, ‘Cost Plus’ requires the contractor to submit a bill or invoice for every single expenditure of the project. Say the contractor has to run to Home Depot for nails, painter’s tape, or any number of small items, the homeowner will then see the receipt for those items when processing the application for payment. These payment applications on a ‘Cost Plus’ contract are frequently very extensive, because in order for the contractor to submit purchases as an expense they are required to produce a bill of sale. The homeowner is then given a copy of all payment applications providing them with the name of every contractor and product on their project. This way, if something needs to be repaired or modified years later it is easy to go back to find the name of the person who originally performed the work.

Another aspect of “Cost Plus” contracting that is frequently overlooked is the fact that the contractor is actually bidding the work far more extensively than one would in a competitively bid contract. Contractors are constantly providing budget estimates throughout design and construction documentation, and when the contract is executed and the homeowner is acquiring their bank loan they are doing so with the final budget bid provided by the contractor. This same budget bid document is then used to track the progress of the project and measure percentages of the billed work completed when payment applications from the contractor are being processed. The budget bid allows the homeowner to comprehend how large the scope of the project is before committing to construction.
One huge downside to competitively bid projects that is often overlooked is that competitive bids tend to create a lot of change orders for every possible modification along the way (move an outlet- that’ll be an additional $125). More often than not, when the scope of work changes in a ‘Cost Plus’ job there aren’t any changes whatsoever in the total cost of that scope, and any changes that may occur are miniscule. For example, since the electrician is being paid time and materials to install the electrical box, and moving or adding said box generally takes but a few minutes, the homeowner doesn’t get billed for such necessary revisions. Imagine that you are having 100 electrical boxes installed in your home for an installation fee of $6,000. The majority of the time if you need to add 10 additional outlets you will still only pay the $6,000 (or a slightly higher number to cover the added materials) rather than a $1,250 upcharge for 10 outlets at $125 per outlet.

Finally I would like to highlight what I find to be the single most valuable aspect of ‘Cost Plus’ contracting, and that is the emphasis on teamwork. A huge issue in competitive bidding is the adversarial environment created when each party is only concerned with maintaining margins on their bottom line. It is in this shortcoming for competitive bidding that ‘Cost Plus’ contracts truly excel. The contractor knows that they will be compensated for the full extent of the work that they are asked to complete, and since they won’t be penalized for a task that may have been overlooked in the bidding process, they are far more likely to fix genuine mistakes as they arise rather than cutting corners to maintain their initial estimate. Over the years contractors have developed a bit of a bad reputation, and I believe this is in response to a faulty system rather than ill-will on the contractor’s part. Mistakes happen and the majority of contractors have no problem fixing those mistakes, but when the scope of a project yields an honest mistake or a necessary revision and the contractor is then required to cover such a task out of his own pocket it is essentially expecting something for nothing. ‘Cost Plus’ contracts transparently reveal all costs so that the owner can be confident that they are paying for what they receive, and the contractor is sure that they will be duly compensated for their work. That way, when the architect isn’t required to search out what the contractor may be trying to get away with on the build, they are often more open to input creating a scenario involving three parties with a shared interest- a professionally managed and completed project where everyone got not only what they wanted, but what they expected to begin with.