Cost Plus Construction Contract: Everything You Need to Know

Unrealistic budgets, shifting project scopes, and relentless pressure to stay under cost — these are everyday realities for construction firms. When corners get cut to preserve margins, the result is often rework, delays, or disputes that erode profitability and client trust.

In fact, contractors worldwide lost an estimated $1.8 trillion in 2020, with avoidable rework alone costing some companies up to $7.1 million^[?]. A significant share of these losses stems from rigid contracts that fail to adapt when project realities shift.

While the industry grapples with these staggering losses, one contributing factor is often overlooked: the structure of the contract itself. Poorly chosen contracts can lock teams into rigid expectations that don’t reflect the evolving nature of real-world construction projects.

That’s where cost-plus contracts come in. By reimbursing actual costs plus a contractor fee, this flexible model can ease the pressure that drives shortcuts and rework. It’s especially valuable for projects with unclear or changing scopes.

In this article, we’ll explore how cost-plus contracts work, how they differ from fixed-price and lump-sum agreements, and the key components that make them effective or risky.

What Is a Cost-Plus Contract in Construction?

A cost-plus contract means the client pays for all project costs — labor, materials, and more — plus an additional fee for the contractor's profit. This fee can be fixed, a percentage, or tied to performance. They're often used for projects with uncertain scopes, like renovating historical buildings , fast-track projects needing quick starts, or complex tasks where costs are hard to predict upfront.

They offer flexibility, allowing adjustments as the project evolves, and reduce risk for contractors by ensuring they're paid for actual costs. This fosters collaboration, especially when trust between parties is high.

Example of a cost-plus percentage of cost contract in construction

During a major villa renovation project, the contractor and the customer decided to use a cost-plus percentage of cost contract, given the unpredictable nature of certain costs involved in luxury fittings and custom architectural features.

Midway through the project, the decision was made to add a high-end indoor pool and marble statuary, items whose prices fluctuate significantly based on market availability. The final bill from the contractor included AED 100,000 for the pool installation, AED 75,000 for the marble, and AED 45,000 for additional structural changes, totaling AED 220,000.

With a 20% markup for overhead and labor costs, the final payment due was AED 264,000. The labor, calculated at AED 500 per hour for 300 hours, totalled AED 150,000, leaving a remaining AED 36,000 to cover the contractor’s operational costs and provide a margin of profit.

This transparent arrangement enabled the customer to manage expenses effectively while ensuring high-quality enhancements to their property.

How is it Different from Fixed-Price and GMP Contracts?

Fixed-price contracts set a total, agreed-upon cost before construction begins, placing the risk of cost overruns entirely on the contractor. This model provides cost certainty for the client and works best when the project scope is clear and unlikely to change.

Cost-plus contracts shift this risk to the client, offering more flexibility but potentially higher costs. This makes cost-plus better for unpredictable projects, while fixed-price suits those with clear scopes.

However, when clients prefer fixed-price contracts for complex projects, even though they are unsuitable, contractors face a dilemma. They must protect themselves from financial risks, such as unforeseen cost escalations or scope changes, which cost-plus contracts naturally handle. This often results in higher initial bids, frequent change orders, and internal adjustments to manage increased uncertainty, which highlights why cost-plus contracts are better suited for truly complex work.^[?]

Consider a client renovating a historic building. A fixed-price contract might lead to a high bid to cover unknowns like hidden damage, while a cost-plus contract adjusts costs as issues emerge, potentially saving money if fewer surprises occur.

Guaranteed Maximum Price (GMP) contracts offer a middle ground, capping costs at a predetermined maximum with any overruns absorbed by the contractor. This gives clients flexibility to make changes within the budget while maintaining cost control through the maximum price guarantee.

In contrast, cost-plus contracts lack this cost cap, providing contractors with greater flexibility to handle project changes but offering clients less cost certainty. Therefore, GMP contracts suit clients who want flexibility with budget protection. Cost-plus contracts, however, fit clients open to cost uncertainty for maximum adaptability on unpredictable projects.

Key Components of a Cost-Plus Agreement

The structure of a cost-plus contract includes several key components:

Direct cost. Labor (wages and benefits for workers), materials (supplies and equipment), and subcontracts (payments to specialized subcontractors).
Indirect costs. Overheads such as office rent, utilities, and administrative salaries support the contractor’s operations.
Fee. The contractor’s profit, which can be a fixed sum, a percentage of total costs, or tied to performance incentives.
Contingencies. Allowances for unexpected expenses, if specified, to cover unforeseen challenges.

Practical aspects are critical for successful implementation. Clear definitions of reimbursable costs are essential to prevent disputes, especially regarding overheads, which clients may challenge. Profit margins are negotiated upfront, reflecting the project’s risk and complexity.

Contingencies in cost-plus contracts are typically handled either through a separate fund or included in the contractor’s fee, depending on contract terms. A separate fund provides a clear buffer for unexpected costs like design changes or site conditions, improving transparency and cost control.

When contingencies are built into the fee, they’re harder to track, increasing the risk of disputes. To mitigate this, contractors must maintain detailed records — such as invoices and receipts — to justify expenses and ensure accountability.

Types of Cost-Plus Contracts You Can Use

Cost-plus contracts come in various forms, each tailored to different project needs. Below is a detailed breakdown:

CPFF. The fixed fee is determined based on estimated costs and desired profit, ideal for projects needing flexibility without encouraging cost inflation.
CPPC. The fee calculation means profit rises with costs, suitable for high-risk projects but potentially discouraging cost control, as noted in construction analyses.
CPIF. The incentive mechanism rewards contractors for cost efficiency, with examples like earning a $50,000 bonus for completing a $1 million project at $900,000, fostering cost management.
CPAF. Award fees are determined based on performance criteria, with a case study in a government building project where quarterly fees were awarded for exceeding safety and schedule targets, boosting compensation while ensuring high standards.

Advantages and Disadvantages

Cost-plus contracts offer significant benefits but also present challenges, as detailed below:

Advantages

Flexibility. Allows for scope changes without renegotiating the entire contract, ideal for projects with evolving requirements, such as unexpected site conditions or mid-project design changes, as noted in recent construction blogs.
Transparency. Requires detailed documentation of all costs, providing clients with clear visibility into labor, materials, subcontractor invoices, and equipment rentals, fostering trust.
Reduced risk for contractors. Contractors are reimbursed for actual costs, lowering the risk of underestimating expenses and encouraging a collaborative relationship, as highlighted in project management guides.
Encourages collaboration. Shared risk fosters a partnership approach, prioritizing project success over cost-cutting, especially in projects requiring trust, as discussed in inventory management resources.
Suitable for complex projects. Ideal for scenarios like historical renovations or infrastructure upgrades where the full scope is hard to define upfront, reducing initial estimation errors, as exemplified in recent project examples.

Disadvantages

Potential for higher costs. Without a cost cap, total project expenses can escalate, which may concern clients, especially if contractors lack incentives to control costs, as noted in contract management resources.
Requires detailed oversight. Clients must monitor the project closely to ensure costs are justified, increasing administrative workload, as emphasized in construction cost analyses.
Risk of delays. Contractors may have less incentive to finish quickly since they are paid based on costs rather than completion, potentially extending timelines, as discussed in building contract guides.
Administrative burden. Both parties must maintain meticulous records, which can be time-consuming and costly, especially for large projects, as noted in construction management blogs.
Possibility of disputes. Disagreements can arise over what constitutes a reimbursable expense, particularly regarding indirect costs or overhead, potentially leading to legal challenges, as highlighted in recent contract analyses.

Mitigation Strategies

To address these challenges, several strategies can be employed:

Set a GMP. Capping total costs while retaining flexibility, balancing client risk and contractor adaptability, as suggested in construction management resources.
Use incentive fees. Encourage timely completion and cost control through bonuses for efficiency, aligning contractor and client interests, as discussed in contract management guides.
Leverage software. Tools like FirstBit ERP can streamline cost tracking and documentation, reducing administrative burdens and ensuring transparency, as noted in ERP solution reviews.

How FirstBit ERP Supports Cost-Plus Construction Projects

ERP system for construction directly addresses the core problem — poor data management that led to massive contractor losses. The system will help you centralize all project data, from financial tracking to resource management. This will eliminate the data silos that cause miscommunication and errors, leading to rework.

Some contractors use tools like FirstBit ERP to streamline cost documentation, ensuring clarity in reimbursements and minimizing disputes in cost-plus projects. For example, its real-time dashboard can track labor costs down to the hour, while reporting tools generate itemized expense breakdowns for clients, helping justify indirect costs.

The system automatically calculates fees for automated compliance and generates detailed reports for client transparency, reducing disputes that often lead to project delays.

Contractors using FirstBit ERP can leverage cost-plus contracts more effectively while maintaining the data accuracy and financial transparency that prevents the massive losses plaguing the industry.

Final Thoughts

When used with care and discipline, cost-plus contracts can strike a fair balance between client adaptability and contractor compensation. They aren’t a one-size-fits-all solution, but for projects where uncertainty is the norm, this model offers a practical way forward. With the right systems in place to manage documentation and communication, cost-plus contracts can support collaboration rather than conflict, helping both sides navigate complexity with clarity.

Anna Fischer

Construction Content Writer

Anna has background in IT companies and has written numerous articles on technology topics.

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