Cost plus contract definition
/What is a Cost Plus Contract?
A cost plus contract is an arrangement under which a contractor is reimbursed for all costs incurred on a project, plus a profit that is typically calculated as a percentage of the costs incurred. This arrangement is most commonly used for one-time projects or research projects where it is difficult to determine what the total cost will be. For example, contractors being asked by the federal government to develop a new type of rocket might refuse to engage in the work unless a cost plus contract is provided, on the grounds that the work is too experimental, and so presents a high risk of losses being incurred.
Given the risk of being overbilled by contractors, customers routinely audit the books of their contractors to ensure that they are being billed the correct amounts.
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Advantages of a Cost Plus Contract
A cost plus contract is quite favorable for the contractor, since there is no risk of loss. Instead, the contractor has an incentive to encourage the buyer to continually expand a project, since doing so allows the contractor to generate a larger guaranteed profit. This arrangement may be the only possible contracting option when a project has a highly uncertain outcome that would otherwise be too risky for the contractor to undertake.
Disadvantages of a Cost Plus Contract
From the perspective of the buyer, there are several disadvantages to a cost plus contract, which are as follows:
Lack of cost control. Since the contractor is reimbursed for all allowable costs plus a fee, there is little incentive to minimize expenses. This can lead to inefficiencies or unnecessary spending during the project. The final cost to the client may be significantly higher than initially expected.
Uncertain final price. Unlike fixed-price contracts, cost-plus agreements do not offer a guaranteed total project cost. Clients may face budgeting challenges because the total cost is only known after the project is completed. This uncertainty can be problematic for projects with limited funding.
Requires detailed monitoring and documentation. Clients must closely monitor all incurred costs and require extensive documentation from the contractor. This increases administrative workload and may require additional internal resources or third-party oversight. Without proper oversight, the risk of overbilling or misallocated costs increases.
Potential for disputes over allowable costs. There may be disagreements between the client and contractor regarding which expenses are considered allowable under the contract terms. This can lead to delays, disputes, and strained working relationships. Clear definitions and oversight are necessary to prevent conflict.
Longer project timelines. With less emphasis on cost efficiency, contractors may also be less motivated to complete the project quickly. Delays can increase overhead and further raise costs for the client. Time extensions may also be more easily justified under the flexible terms of the contract.