Cost-Plus Contract: How It Works, Types, and Pros & Cons

A cost-plus contract reimburses a contractor for all project costs—materials, labor, and overhead—plus an additional fee for profit. This contract type is often used when a project needs to start quickly or when the exact scope of work is difficult to define upfront. While it offers flexibility, it can also lead to higher overall costs compared to fixed-price contracts.

Below, we’ll break down how cost-plus contracts work, explore a real-world example, and weigh the pros and cons to help you determine if this contract structure is the right fit for your project.

What is a Cost-Plus Contract?

A cost-plus contract is an agreement where a project owner reimburses a contractor for actual project costs, such as materials and labor, plus an additional payment for profit. This profit is typically a fixed amount or a percentage of the total project cost.

Cost-plus contracts fall under the broader category of Construction Contracts. They are commonly when the full scope of work is uncertain, giving contractors flexibility while ensuring they are compensated for unforeseen expenses. In return, the contractor must provide detailed cost records to maintain transparency.

Unlike a time and materials contract, which pays the contractor based on hourly labor rates and material costs, a cost-plus contract includes a predetermined fee to cover profit and overhead. They are also referred to as cost-reimbursement contracts due to their structure.

How Cost-Plus Construction Contracts Work

As mentioned, a cost-plus construction contract ensures the contractor gets reimbursed for materials, labor, and other direct costs while also earning an agreed-upon markup for overhead and profit. The name itself is a simple way to remember how it works: project costs plus a contractor’s markup.

What’s Covered in a Cost-Plus Contract?

A cost-plus building contract typically includes:

• Project Costs: Direct costs related to construction, including labor, materials, subcontractor fees, equipment, and approved change orders.
• Contractor Markup: A percentage of total project costs or a fixed fee that accounts for overhead and profit.

These contracts are most common between project owners and general contractors but can also be used between general contractors and specialty subcontractors. The contract outlines what costs are reimbursable, ensuring that all direct construction expenses—mainly labor and materials—are covered.

How the Contractor’s Markup is Calculated

Cost-plus contracts specify how a contractor’s fee is structured. Common fee structures include:

• Percentage of Cost: The contractor earns a percentage (typically 5-25%) of total project costs.
• Fixed Fee: A pre-agreed flat fee, independent of the final cost.
• Incentive Fee: Bonus payments for meeting targets like cost savings or early completion.
• Award Fee: Additional compensation for exceeding performance expectations.

These contracts are often easier to negotiate because they shift financial risk away from the contractor. Unlike lump sum contracts—where overruns cut into the contractor’s profit—cost-plus contracts ensure the contractor is reimbursed, protecting their bottom line.

However, they are not a blank check. Contracts usually require a good faith estimate for the total project cost, along with a schedule of values detailing cost breakdowns. This helps owners manage budgets and approve payments based on work completed.

Lastly, while cost-plus contracts protect contractors from unexpected costs, they do not cover expenses due to errors, negligence, or poor workmanship. Owners still expect contractors to manage resources efficiently and deliver value.

When to Use a Cost-Plus Contract

A cost-plus contract is best to use when project details are uncertain or the scope is still evolving. This model lets you pay for actual costs and then add a fixed fee or percentage for profit, offering flexibility and reducing risk for both parties.

• Undefined Scope: Use it when blueprints or specifications are still in flux.
• High Uncertainty: Ideal for R&D, innovative projects, or complex construction.
• Quick Start: Kick off projects fast without needing precise cost estimates upfront.
• Transparency: Build trust by tracking all expenses openly.

For example, if you're constructing a new facility with incomplete designs, a cost-plus contract lets you begin work immediately. You and the contractor can adjust the budget as changes occur, ensuring that both parties share the risk fairly.

Types of Cost-Plus Contracts

Cost-plus contracts come in different structures, each offering varying levels of risk and reward for both contractors and project owners. Understanding the differences helps in choosing the right contract for a given project.

Cost-Plus Award Fee Contracts

These type provides the contractor with a performance-based award fee in addition to reimbursed costs. The award is typically tied to quality, safety, or efficiency benchmarks set by the project owner. This structure motivates contractors to exceed expectations while maintaining cost transparency.

Cost-Plus Fixed-Fee Contracts

In this arrangement, the contractor receives a predetermined fixed fee on top of direct and indirect costs. The fixed fee remains constant regardless of total project expenses, ensuring the contractor gets paid fairly while keeping cost overruns from affecting their earnings. This setup provides stability for both parties, as the contractor has a guaranteed profit.

Cost-Plus Incentive Fee Contracts

These contracts include financial incentives for the contractor based on performance metrics such as cost savings, timely project completion, or meeting specific quality standards. If the contractor delivers beyond the agreed-upon targets, they receive an additional fee. This encourages efficiency and accountability throughout the project.

Cost-Plus Percent-of-Cost Contracts

Under this model, the contractor’s fee is calculated as a percentage of total project costs. While this structure ensures that all costs are reimbursed, it can sometimes encourage higher spending, as the contractor’s profit increases with rising costs. To manage this risk, project owners may include cost-control measures such as audit requirements or spending caps.

Advantages of Cost-Plus Contracts

Cost-plus contracts offer flexibility and financial security for both project owners and contractors. They are especially useful for projects with evolving scopes, where accurate cost estimation is difficult upfront. Below are some key benefits for both parties.

For Owners:

• Faster project start: Contractors are more willing to begin work knowing their costs will be covered.
• Greater flexibility: Changes can be made without the need for lengthy renegotiations.
• Cost control: Owners can set a cost ceiling to prevent excessive expenses.
• Transparency in spending: Owners have visibility into actual costs throughout the project.
• Potentially higher quality: Since contractors aren’t pressured to cut costs, they are more likely to focus on quality.

For Contractors:

• Lower financial risk: All direct project costs are reimbursed, reducing the contractor’s exposure to cost overruns.
• Guaranteed profit: The contractor earns a predetermined fee, ensuring a stable return.
• Improved cash flow: Regular reimbursements prevent cash flow issues common in fixed-price contracts.
• Incentive opportunities: Some cost-plus contracts offer bonuses for meeting performance targets.
• Stronger client relationships: The transparency required in these contracts fosters trust, increasing the likelihood of repeat business.

Cost-plus contracts work well when both parties value flexibility, transparency, and collaboration, making them a preferred choice for complex or fast-moving projects.

Disadvantages of Cost-Plus Contracts

While cost-plus contracts provide financial security for contractors and flexibility for owners, they also come with challenges. Without careful cost tracking and clear contract terms, they can lead to disputes or unexpected expenses.

For Owners:

• Uncertain final cost: Since expenses are reimbursed as they occur, the total project cost is only an estimate.
• Trust required: Owners need confidence that the contractor is not inflating costs.
• Potential disputes: Owners may need to audit expenses to ensure they align with the contract.

For Contractors:

• Detailed cost tracking required: Every expense must be documented for reimbursement.
• Reimbursable costs must be reviewed: Some costs may not qualify, cutting into the contractor’s expected profit.
• Change order complications: If scope changes aren’t properly handled, disagreements may arise.

Most risks associated with cost-plus contracts can be mitigated through clear contract terms, regular cost reporting, and strong communication between owners and contractors. When managed effectively, these contracts can lead to successful outcomes for both parties.

How Do You Protect Yourself in a Cost-Plus Contract?

Project owners can protect themselves in a cost-plus contract by setting clear guidelines from the start and keeping a close eye on expenses. You can protect yourself from unexpected cost overruns and disputes by using these key measures:

• Set a Guaranteed Maximum Price (GMP): Limit total spending so that even if costs rise, they won’t exceed a set maximum.
• Define Allowed Costs: Clearly specify which expenses will be reimbursed and which will not.
• Require Detailed Documentation: Insist on receipts, regular audits, and progress reports to track every expense.
• Use Written Change Orders: Ensure that any changes to the project scope or work are approved in writing before extra costs are added.
• Negotiate Fee Limits: Cap any increases in the contractor’s fee so that profit only grows when costs are justified.

‍Pro Tip: Project owners and managers can benefit from Mastt by streamlining cost tracking and contract administration in cost-plus contracts. Mastt’s tools ensure transparency and control over every expense, making it easier to manage unpredictable costs.

Here's how Mastt can help:

• Real-Time Cost Tracking: Monitor actual expenses against budgets instantly.
• Automated Reporting & Dashboards: Visualize cost data and trends to spot overruns early.
• Integrated Change Order Management: Approve and document any changes before extra costs are added.
• Standardized Progress Claims: Generate accurate payment schedules and progress reports with ease.

These features help maintain control over the contract, reduce disputes, and keep projects on track by providing clear, up-to-date financial insights.

Cost-Plus Contract Example

Let’s look at how a cost-plus contract works in a hypothetical scenario.

A commercial developer wants to transform an old warehouse into a modern office space. Given the building’s age, unexpected issues—like structural reinforcements and outdated utilities—are likely. To ensure the project moves forward smoothly while maintaining cost transparency, the developer enters into a cost-plus contract with Titan Builders, a trusted general contractor they’ve worked with before.

Titan Builders provides a good-faith estimate of the total project cost along with a schedule of values, outlining projected costs for labor, materials, and subcontractor work. Since Titan Builders subcontracts most work, they base their estimate on price quotes from specialty contractors. The contract states that the developer will reimburse all direct project costs and pay Titan Builders an additional 10% fee to cover overhead and profit.

As work progresses, subcontractors submit pay applications to Titan Builders, who then request payments from the project owner, providing documentation that verifies the percentage of work completed. Some costs—like material price fluctuations—may exceed the initial estimate, but as long as they fall within the contract’s scope, they are reimbursable. If a major design change or unexpected challenge arises, a change order is issued to amend the contract and avoid disputes.

Once the project reaches substantial completion, the developer processes final payments, covering all outstanding costs and Titan Builders’ fee within 30 days of signing the Certificate of Substantial Completion. Titan Builders then wraps up punch list items and releases final payments to subcontractors.

By using a cost-plus contract, Titan Builders secures a steady profit with minimal financial risk, while the developer benefits from a faster project timeline by avoiding drawn-out pricing negotiations upfront.

Final Notes on Cost Plus Contracts

A cost-plus contract ensures that a contractor is reimbursed for all project-related expenses, plus a predetermined profit based on the total contract value. This structure offers flexibility, making it ideal for construction projects where costs are difficult to estimate upfront or when budget constraints require careful cost tracking.

However, successful execution requires detailed documentation and strict financial oversight. Contractors must provide proof of all direct and indirect expenses to ensure transparency and maintain trust with the project owner. When managed properly, cost-plus contracts create a balanced approach, allowing projects to move forward efficiently while ensuring fair compensation for the contractor.