Which contract type is best - Fixed Price or Cost Plus Contract

In the realm of residential building contracts, there are two commonly used methods: the cost plus contract and the fixed price contract. Each approach has its own set of advantages and disadvantages that homeowners should carefully consider before committing to a particular type of agreement. In this article, we will delve into these differences and highlight the pros and cons associated with cost plus contracts versus fixed price contracts in New South Wales.

The Cost Plus Contract

A cost plus contract is an agreement between a homeowner (client) and a builder or contractor (service provider), where the final payment is determined by adding up all costs incurred during construction along with an agreed-upon profit margin or fee. This Profit margin can be a percentage of the overall costs or a set fee (Cost Plus Fixed Fee)

Pros:

• Transparency: With a cost plus contract, clients have access to detailed records of all expenses incurred during construction. This transparency ensures that clients can track every dollar spent on materials, labor, subcontractors, permits, etc., leading to increased trust between both parties.
• Flexibility: Cost plus contracts offer more flexibility when it comes to design changes or modifications during construction. Clients can make adjustments without facing significant change order fees that might be encountered in fixed price contracts.
• Potential Savings: In some cases where material prices fluctuate significantly over time or unforeseen circumstances affect project scope or duration (e.g., weather delays), clients may benefit from potential savings as they only pay for actual incurred costs without having predetermined prices locked in.
• Quality Focus: Contractors are incentivized to prioritize quality and efficiency as their profit is not tied to the project's overall cost-effectiveness.
• Enhanced Collaboration: With a shared interest in controlling costs, builders and homeowners may collaborate more closely to find cost-effective solutions.
• Fairness: Homeowners only pay for the actual work performed and materials used, ensuring fairness in pricing.

Cons:

• Budget Uncertainty: The open-ended nature of a cost plus contract can lead to budget uncertainty as the final cost is not determined upfront. This lack of certainty might cause anxiety for some clients who prefer to have a fixed price at the outset.
• Potential Cost Overruns: While cost plus contracts provide transparency, they also carry the risk of potential cost overruns. If unforeseen complications arise during construction, such as unexpected structural issues or delays, these additional expenses will be passed on to the client.
• Dispute Potential: Disputes may arise if there is disagreement over the reasonableness of certain costs or the extent of the scope changes.
• Dependency on Trust: Homeowners must trust the contractor to accurately report costs and avoid unnecessary expenditures to prevent disputes.

The Fixed Price Contract

A fixed price contract sets an agreed-upon total amount that covers all construction costs and fees associated with completing a residential building project. This type of contract provides clients with an upfront fixed price that remains unchanged throughout the project's duration unless both parties agree on modifications through change orders.

Pros:

• Budget Certainty: One significant advantage of a fixed price contract is that it offers homeowners budget certainty from the beginning. With predetermined prices in place, clients know exactly how much they need to allocate for their residential building project without worrying about potential increases along the way.
• Negotiation Opportunities: In order to secure a competitive bid and win projects under fixed price contracts, contractors often engage in negotiations with suppliers and subcontractors beforehand.
• Predictability: A fixed price contract allows for better predictability in terms of project timelines and completion dates. Since the scope of work and associated costs are determined upfront, there is less room for unexpected delays or extensions. 
• Incentive for Efficiency: Contractors have a strong incentive to complete the project within budget and on schedule to maximize profits.
• Reduced Administrative Burden: Since the contract sum is predetermined, the Builder has less administrative overheads associated with tracking and documenting project expenses.

Cons:

• Change Order Costs: Any modifications or changes requested by the client during construction that go beyond the initial agreed-upon scope will generally result in additional charges through change orders. These extra costs can add up quickly, potentially impacting the final project budget.
• Limited Flexibility: Fixed price contracts offer limited flexibility compared to cost plus contracts when it comes to making design changes or adjustments once construction has commenced. Clients may face higher change order fees if modifications are required due to strict adherence to predetermined prices.
• Risk Allocation: Under a fixed price contract, contractors bear most of the risk associated with unforeseen complications or cost fluctuations during construction. Builders may include contingency allowances in the contract sum to mitigate their risk, which could result in higher initial costs for the homeowner.
• Quality Concerns: Fixed price contracts have the scope of works, quality of finishes and associated costs with these are pre-determined, reducing the ability to gain higher quality without re-negotiation and additional costs.

In Conclusion

When considering residential building projects in New South Wales, Australia, homeowners must carefully analyse their priorities and objectives before choosing between a cost plus contract or a fixed price contract. While both options have their own advantages and disadvantages as outlined above, it ultimately depends on individual preferences regarding budget certainty versus flexibility during construction. Regardless of which type of agreement is selected, engaging experienced professionals and legal counsel throughout the contracting process is crucial for ensuring a successful residential building experience.