Types of construction contracts

The two basic types of construction contracts are fixed price and cost plus. The features of each contract type are as follows, with variations from the basic concepts also noted:

  • Fixed price contract. The price to be paid to the contractor is fixed in advance. A contractor only accepts this type of contract when costs can be reliably estimated and the contractor has experience with this type of work. If there is any uncertainty regarding costs to be incurred, the contractor submits a high bid in order to ensure that it still earns a profit.
  • Cost plus contract. The price to be paid consists of reimbursement for costs incurred, plus a profit percentage. This contract shifts risk to the customer, which bears the burden of cost overruns, and is used when the contractor is uncertain of the costs to be incurred or does not have a large amount of experience in this type of work. Variations on the concept are:
    • Guaranteed maximum price. The total amount paid by the customer is capped, so the customer bears the risk of cost overruns up to the cap, after which the contractor bears the risk. The cap amount may be adjusted with a change order if the project scope changes.
    • Cost plus fixed fee. The contractor earns a fixed amount of profit, which removes the incentive to keep adding expenses on which a profit percentage is paid.
    • Cost plus performance incentives. The contractor can receive bonuses for meeting certain objectives, usually involving more rapid completion of a project.

Contractors generally prefer cost plus contracts, since the risk of cost overruns is shifted to the customer. However, a contractor may prefer a fixed price contract when it understands the risks and can build a substantial profit into its price.