COST-PLUS BIDS

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Cost-plus, or time-and-materials bids are often used on jobs with a lot of unknowns and hidden conditions, such as repair work. While generally used for smaller jobs, these contracts are sometimes used for large jobs as well. Whenever the plans and specs are fuzzy for whatever reason (never a good idea), cost-plus may be the only way to proceed.

On jobs with many unknowns, the client can benefit from cost-plus pricing, in theory, because the contractor does not have to add big “fudge factors” into his fixed bid to cover the unknowns. The homeowner pays only for the actual work completed. Without adequate protections built into the bid, however, the owner is taking on an enormous risk that job costs will spiral out of control. There is little incentive for the contractor to get the job done quickly and cheaply.

The two main variations of this approach to bidding are cost-plus-a-percentage and cost-plus-a-fixed-fee.

Cost-plus-a-percentage. In this scenario, the contractor bills the client for  his direct costs for labor, materials, and subs, plus a percentage to cover his overhead and profit. This should be an open book process where the client sees documentation of all hard costs. The problem with this approach is that the contractor has no real incentive to complete the job quickly or cheaply – the longer he takes and more he spends, the larger his profit.

Cost-plus-a-fixed-fee. In this scenario, the contractor bills the client for direct costs, plus a fixed fee for  overhead and profit. In this case, the contractor is motivated to complete the job quickly and cheaply, or his overhead and profit percentage keeps dropping. If the customer increases the scope of work through change orders or a changed scope of work, then the customer and contractor would need to renegotiate the fixed fee or follow a prescribed formula.

Estimates. Nearly all cost-plus work comes with an estimate of costs. As with a  fixed-price bid, the estimate should contain detailed plans and scope of work, and material specifications, along with an itemized breakdown of costs. An exception would be an emergency repair, where there is no time for a detailed estimate, so a ballpark estimate will have to do.  However, it should be made clear that all cost-plus “estimates,” are a best guess, not a fixed bid. The greater the unknowns, the less precise the estimate will be.

Guaranteed maximum. When clients are concerned that job costs will spiral out of control, some contractors will provide a guaranteed maximum price.  In one version, the contractor will split the savings with the customer if the job comes in below the maximum. In this case the contractor has an added incentive to beat the maximum price (or the set the maximum price high enough that he can easily beat it).

Defining job costs. For this approach to work, it’s essential that the contractor make it clear to the owner which costs will be considered direct job costs – and therefore reimbursable. The obvious costs are subcontractors, materials and supplies used on the job, such as lumber and nails, along with consumables such as plastic sheeting, bits, and blades used up on the job. For labor, the reimbursable rate typically includes “labor burden” of employee taxes, benefits, and insurance.  Incidental costs like dumpster fees, permit fees, and equipment rental are typically included. Other costs are subject to negotiation: rental/usage fees for equipment owned by the contractor, vehicle expenses, insurance costs. As an owner, I would expect these to be covered by the contractor’s overhead, but either way, it should be clear what you will be billed for as a job cost.

Pros of cost-plus-a-percentage

  • For jobs with a lot unknowns, contractor does not have to pad the price for uncertainty.
  • Can get started quickly on jobs with many unknowns and incomplete plans.
  • You pay only for work completed, with open books, at a known rate.

Cons of cost-plus-a-percentage

  • Contractor has little incentive to keep costs down.
  • Owner assumes all the risk of cost overruns
  • Requires high level of trust in contractor

Pros of Cost-plus-a-fixed-fee

  • Same advantages as Cost-plus-a-percentage”
  • Contractor has a greater incentive to complete job on time and on budget.

Cons of cost-plus-a-fixed-fee

  • Owner assumes most of the risk of cost overruns

MY RECOMMENDATIONS
Some people love cost-plus work, some hate it. In theory, it can save the owner money on jobs with a lot of unknowns, since the contractor does not have to pad his estimate to cover the unknown potential costs. In some cases, it probably does save money, but you will never know ahead of time – and you absorb most of the risk of cost overruns. However, with certain safeguards, cost-plus can work well for those jobs with a lot of unknowns. To protect yourself, I recommend the following:

  • Start with a detailed scope of work, with detailed plans and specs, so both parties have a clear understanding of the work to be donw.
  • Use a cost-plus-a-fixed-fee contract, not a percentage.
  • Get a guaranteed maximum for peace of mind.
  • Get a clear list of reimbursable, to avoid misunderstandings.

 

 

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