What is a Cost-Plus-Percentage Contract?
A cost-plus-percentage contract is a type of agreement used in construction projects where the contractor receives a predetermined percentage of profit over and above the total construction costs. Though straightforward, this model often lacks incentives for cost control, leading to higher expenses for the project owner.
Why This Contract Model Can Be Problematic
In a scenario where holding down costs is crucial, cost-plus-percentage contracts may not align with the project owner’s best interests. Since the contractor benefits directly from higher costs (due to the percentage-based profit), there is little motivation for efficient cost management.
Example of a Cost-Plus-Percentage Contract
Consider the fictional FutureBuild Construction Company, tasked with constructing a new shopping complex. They enter into a cost-plus-percentage contract that grants them 12% over the actual construction costs. If the project expenses reach $15 million, FutureBuild would secure $16.8 million at completion.
Alternatives: Exploring Better Contract Options
One primary alternative is the Cost-Plus-Fixed-Fee Contract. Here, the contractor receives a fixed fee in addition to the construction costs, regardless of the project’s expense fluctuations. This model inherently motivates contractors to manage costs efficiently, as their profit doesn’t increase with project expenses.
Example of a Cost-Plus-Fixed-Fee Contract
ABC Contractors engage in a contract to construct a government office building. They agree on the actual costs plus a fixed fee of $1 million. If the project’s total cost is $20 million, they will receive exactly $21 million, promoting meticulous cost management.
Additional Examples for Better Understanding
- GreenRegal Builders: Engages in a cost-plus-percentage contract at 8% for building a residential complex costing $5 million. Total payout: $5.4 million.
- Urban Struct: Opts for a cost-plus-fixed-fee contract for a public library construction, costs amounting to $6 million plus a fixed fee of $700,000. Total payout: $6.7 million.
- BrighterLines Ltd.: Mothers Earth Housing selects them for a solar community project with a cost-plus-fixed-fee contract, total outlay of $9 million plus a fee of $800,000. Total payout: $9.8 million.
- SpeedDome Inc.: For a sports arena, engages with a cost-plus-percentage agreement at 10%, costs running to $12 million. Total payout: $13.2 million.
Frequently Asked Questions (FAQs)
What are cost-plus-percentage contracts most typically used for?
These contracts can be common in large and complex construction projects where it’s difficult to estimate costs upfront. They allow more flexibility concerning resource allocation and project scope adjustments.
Why do some businesses prefer the cost-plus-fixed-fee model?
Businesses favor the cost-plus-fixed-fee model for its predictability and incentive alignment. It encourages contractors to manage the project efficiently and deter cost inflation because their profit doesn’t change with varied expenses.
Are there any hybrid contract models?
Yes, Guaranteed Maximum Price Contracts are a blend where the contractor is reimbursed the cost plus a fixed fee, but there’s a ceiling price ensuring the owner won’t pay more than the maximum capped amount.
How can project owners manage risks in cost-plus-percentage contracts?
Implementing rigorous project monitoring and clear cost-reporting structures can help. Establishing benchmarks and performance incentives outside the fee percentage can also ensure cost discipline.
Related Terms: cost-plus-fixed-fee contract, time and materials contract, fixed-price contract, incentive contracts.
