Fixed price or cost-plus?

[pudding]

I'm just about to send over drawings to my proposed builder for my extension. He's asked if I'd like a fixed price for the works, or to go with a cost-plus arrangement?

 

Any advice on which could be better and why? I've never heard of cost-plus so some googling is about to happen!

 

Ta.

Edited February 10, 2020 by pudding

[Jeremy Harris]

There are three basic forms of contract pricing, fixed price, firm price and cost plus.

 

Fixed price isn't fixed, variation is allowed for things outside the contractors control, like exchange rate variations etc.

 

Firm price is fixed, in that it is the actual price that should be paid at the completion of the contract.

 

Cost plus is basically what it costs the contractor to do the job, plus a specified profit element.  For example, it could be actual costs plus 20% profit.  The snag with cost plus is that there is no incentive for the contractor to get a good price for materials, as the cost will be passed on in full.  There's also not much incentive with cost plus to finish by an agreed date, unless this is specified in the contract.

[andyscotland]

17 hours ago, Jeremy Harris said:

Cost plus is basically what it costs the contractor to do the job, plus a specified profit element.  For example, it could be actual costs plus 20% profit.  The snag with cost plus is that there is no incentive for the contractor to get a good price for materials, as the cost will be passed on in full.  There's also not much incentive with cost plus to finish by an agreed date, unless this is specified in the contract.

 

The flip side of course is that on fixed price the incentive is for the contractor to quote on worst-case estimates for materials and labour. There is then a strong incentive for them to try and drive that down, but the savings come to them so make no real difference to you (except perhaps they may be happier/more attentive if they're making more profit than expected).

 

Equally on fixed price if the contractor isn't making as much profit as they expected you can find any changes you request cost a lot more than they should. Indeed, some contractors actively quote low and hope to claw it back through later additions (especially big firms, that's one reason public sector contracts of every type end up costing way over the original budget).

 

If you're doing a competitive tender with sealed bids that can help to get a realistic fixed price at the outset, the contractors won't want to seem unreasonably cheap or unreasonably expensive.

 

But if you're just approaching one firm and they know that, you may have similar pricing risk whether fixed price or cost plus, just one is baked in at the start and one creeps in as you go.

 

I have heard of hybrid models where e.g. there's a fixed maximum price but if it comes in cheaper the client and contractor split the difference which creates at least some incentive to get the costs down.

 

My MiL's builder actually works on a fixed maximum price but the client gets the whole of any savings. Personally I think that's a slightly bonkers business model, as he gets all the risk but no reward, but he values being able to take away references that the job came in a bit under budget.

 

At the end of the day it really depends on how much you trust the contractor to price fairly and do a good job.

 

I would probably always lean to cost plus, as at least then it's transparent, and you may be able to agree that you'll do some materials sourcing to get the prices down. I'd also ideally want the contractor to allow for their labour/profit separately e.g. including a standalone project management fee or whatever. If they're relying on making their money from a percentage markup on the materials that can be difficult - ideally you want them to make the same amount for their time even if you can get the wood cheaper.

[ProDave]

I try to price my jobs on cost plus and just give my customers an hourly rate and an estimate of the time it will take.  Those that insist on a fixed price usually pay more, because I have to assume the worst case and that the job is going to be a pig, and every problem I can imagine is going to happen.

[Jeremy Harris]

Firm price contracts are always going to contain a fair bit of risk contingency, they have to in order to allow for unforeseen problems.

 

Fixed price contracts (which, as above, are not really fixed at all) will also have some risk contingency built in, but this can be less, as a fixed price contract allows price variation for some aspects outside the contractors control (like exchange rate variation hitting materials pricing).

 

 

It seems that people often confuse firm price and fixed price contracts.  Worth remembering that a fixed price contract does not define the exact price that will be paid, whereas a firm price contract does.

[andyscotland]

1 hour ago, Jeremy Harris said:

 

It seems that people often confuse firm price and fixed price contracts.  Worth remembering that a fixed price contract does not define the exact price that will be paid, whereas a firm price contract does.

 

Very true and you're right that fixed price has less built-in contingency than firm price. All the same I suspect things like exchange rate contingency have a lower impact (on domestic jobs) than the kinds of internal risks @ProDave mentions which are fairly common/predictable and mostly would be expected to be covered even on a fixed price - likely therefore to attract a decent premium in the quote.

 

[Jeremy Harris]

The only reason I emphasised exchange rates was because we purchased our house from Ireland, and it was shipped from there in large prefabricated panels, so having a contract that was firm and priced in pounds, rather than Euros was reassuring.  A fair few people here buy fairly expensive stuff from Europe, too.  We bought our MVHR from Denmark, and it seems as if the UK installers for this make also buy units in from Denmark to order, so there may be an exchange rate risk there.

[SteamyTea]

If new to self build I would have thought firm price was the way to go.

If it is too high a price, then look at what is needed to reduce it.

Better to take the risk at the start than two thirds of the way through.

[Jeremy Harris]

4 minutes ago, SteamyTea said:

If new to self build I would have thought firm price was the way to go.

If it is too high a price, then look at what is needed to reduce it.

Better to take the risk at the start than two thirds of the way through.

 

 

That was my view, too. 

 

The first three contracts we placed were for the groundworks, the borehole and the house foundations, frame supply and erection.  All were firm price, and I suspect we paid over the odds for the ground works contract, but at the time I was insufficiently confident to feel able to manage any other sort of contract.  By contrast, I believe that the firm price contract for the foundations and frame supply and erection was a pretty good deal, and I doubt I'd have been able to do better by choosing another option.

[SteamyTea]

16 minutes ago, Jeremy Harris said:

the borehole

And for that.

[andyscotland]

7 hours ago, SteamyTea said:

If new to self build I would have thought firm price was the way to go.

If it is too high a price, then look at what is needed to reduce it.

Better to take the risk at the start than two thirds of the way through.

 

Fair point. Guess it depends on approach to risk and how much headroom is in your budget. Definitely for a full build I can see the advantage of having it nailed down even if that means possibly overpaying a bit. I'd possibly still want to aim for something with a bit of flexibility e.g. an overall firm price but the ability to reallocate within for example to spend more on the kitchen if the early works come in less than expected.

 

For a smaller project like the OP's extension though then it may be there's less scope for things to go wrong / more cash to cover contingencies and so less value in locking it all down at the start.

[pudding]

Thanks for all the replies and comments, I didn't notice them all yesterday.

 

Their should be very little uncertainty and variation with the extension. I've designed it all pretty much apart from the structural elements and there should be no surprises along the way, unless building control come back with a load of issues! I'd already obtained a quote for glazing (bifold/2 full height fixed units/2 top hung windows) which should be the biggest cost item. No plumbing involved, just electrics, which should be minimal. As I've designed and specced so much and will be part time soon, I did want to get involved and do a bit of the work on site and arrange a few subbed items (glazing/matching zinc rainwater goods/a2a heat pump), however the builder replied saying everything needs to go through them with the 'plus', otherwise they couldn't afford their overheads. Which I kind of understand, but it will slightly galling to have to send my glazing quote through them and them add 10% to it when I've done all the leg work and got quotes and visited the company. 

 

I've replied to the builder and said to go ahead with a quote using a cost-plus basis. He sent me his terms of business, so i can see their markup etc. It is an extra 15% markup on materials, and an extra 10% on sub-contractors fees, all added prior to VAT. Then these costs will be added to the on site timesheet x labour costs for each bill. Does this sound reasonable?

 

 

 

 

[Roundtuit]

In principle the numbers sound reasonable.  My concern is that there is no incentive for your builder to buy better; the opposite in fact.  I'm convinced a lot of trades, over time perhaps, end up being price-takers and just accept whatever their preferred builders merchant charges.  I'd want to retain more control and do some work myself as you suggested. Sounds like  they want to have their cake and eat it...