Cost Plus Fee

Cost-plus-fee contracts reimburse contractors for actual project costs plus a fee compensating for overhead and profit, creating a cost-reimbursement relationship where owners assume cost risk while gaining transparency through open-book accounting. This contracting approach suits HVAC projects with significant scope uncertainties, fast-track schedules requiring early contractor engagement, or collaborative delivery methods emphasizing shared risk rather than adversarial cost allocation.

Overview

Unlike fixed-price contracts where contractors assume cost risk and profit from efficiency, cost-plus structures compensate contractors for verified actual costs regardless of productivity or estimating accuracy. The fee component provides contractor compensation independent of project costs, though fee structures vary between fixed amounts, percentage-based calculations, or hybrid approaches combining both elements.

Cost-plus contracts require rigorous cost accounting systems segregating project costs from other work, documenting expenditures through verifiable records, and distinguishing allowable costs from unallowable expenses. Owners review cost documentation before reimbursement, auditing contractor accounting to verify proper cost allocation and prevent excessive charges.

Cost Reimbursement

Reimbursable costs encompass all legitimate project expenses including:

• Direct labor wages and fringe benefits for workers dedicated to the project
• Materials, equipment, and supplies purchased for project installation
• Subcontractor and supplier invoices for project-specific work
• Equipment rental costs for project use
• Project-specific insurance and bonding costs
• Permits, fees, and testing charges
• Temporary facilities and job site overhead directly attributable to the project

Contractors maintain detailed cost records with supporting documentation—payroll records, vendor invoices, rental agreements, bank statements—allowing owner verification before reimbursement. Monthly payment applications itemize costs by category with backup documentation attached.

Fixed Fee vs. Percentage Fee

Cost-plus contracts employ different fee structures affecting incentive alignment:

Cost Plus Fixed Fee (CPFF)

Fixed fee arrangements establish a predetermined dollar amount compensating the contractor for services, home office overhead, and profit. The fee remains constant regardless of actual project costs, creating alignment between owner and contractor to minimize expenses. If efficient execution reduces costs below estimates, the contractor maintains the full fee while the owner benefits from lower overall project costs.

CPFF provides cost predictability for contractor compensation while incentivizing efficient cost management. However, contractors lack profit motivation for extraordinary cost reduction efforts since fee amounts remain fixed.

Cost Plus Percentage of Cost (CPPC)

Percentage fee structures calculate contractor compensation as a percentage of actual project costs, typically ranging from 3-15% depending on contractor services scope, project risk, and market conditions. This approach scales fee to project size but creates perverse incentives where contractor profit increases with project costs rather than efficiency.

CPPC arrangements prove controversial and prohibited for many government projects due to inherent conflicts encouraging cost escalation. Private sector use requires owner oversight preventing unnecessary scope expansion or inefficient execution that inflates costs and fees.

Open Book Accounting

Open book accounting requires contractors to disclose all project costs, maintain transparent records, and provide owners full access to cost documentation. This transparency enables:

• Real-time cost monitoring and budget tracking
• Verification of contractor cost allocations
• Informed decision-making about scope changes and design alternatives
• Detection of cost shifting between projects or inappropriate charges

Open book requirements include periodic audits, documentation retention, and standardized cost coding allowing owners to analyze spending patterns across cost categories. Contractors maintain dedicated project accounting systems segregating costs by work category, phase, or subcontractor.

Allowable Costs Definition

Contract documents explicitly define allowable reimbursable costs versus unallowable expenses borne by the contractor. Allowable costs typically include:

• Direct labor at agreed wage rates plus burdens
• Materials at actual purchase prices (excluding contractor volume discounts or rebates)
• Subcontractor invoices at actual billed amounts
• Project-specific equipment rentals at reasonable market rates
• Field supervision and project management salaries allocated to the project
• Job site overhead including temporary utilities, trailers, and tools

Unallowable costs commonly include:

• Home office overhead beyond agreed general conditions
• Corporate executive salaries and administrative staff not project-assigned
• Marketing and business development expenses
• Financing costs and interest charges
• Uninsured losses or damages from contractor negligence
• Entertainment, gifts, or lobbying expenses
• Costs not properly documented or allocated to the project

Allowable cost definitions prevent contractors from shifting corporate overhead, indirect costs, or unrelated expenses to cost-plus projects, protecting owners from excessive charges.

Fee Structure Options

Beyond simple fixed or percentage fees, hybrid structures provide nuanced incentive alignment:

Cost Plus Fixed Fee with Incentives: Base fixed fee plus bonus payments for meeting schedule, quality, or cost targets. Incentivizes superior performance beyond basic contract requirements.

Cost Plus Fee with Guaranteed Maximum Price: Combines cost-plus transparency with a cost ceiling, creating a hybrid approach. Contractor receives reimbursement plus fee up to the GMP, absorbing overrun risk above that threshold.

Sliding Scale Fees: Fee percentages that decrease as project costs increase, partially aligning contractor interests with cost control while scaling compensation to project size.

Performance-Based Fees: Variable fees tied to achieving specific project outcomes—energy performance, schedule milestones, quality metrics—rewarding results rather than costs incurred.

Cost Controls and Oversight

Cost-plus contracts demand rigorous owner oversight to maintain cost discipline absent contractor risk:

Budget Authorization: Require owner approval before incurring costs exceeding authorized budget amounts or initiating work outside defined scope.

Periodic Cost Reviews: Conduct regular cost review meetings analyzing spending patterns, identifying variances from estimates, and authorizing continued work.

Independent Cost Estimating: Engage third-party cost estimators to validate contractor pricing proposals, equipment quotes, and subcontractor bids.

Audit Rights: Reserve contractual rights to audit contractor cost records, interview project staff, and inspect documentation supporting reimbursement requests.

Prequalified Subcontractors: Require competitive bidding among prequalified subcontractors rather than sole-source selection, maintaining pricing discipline despite cost-reimbursement.

Cost Benchmarking: Compare incurred costs against industry standards, published cost databases, and similar project expenditures to identify anomalies.

Engineering Considerations

Cost-plus contracts enable early contractor involvement during design development, providing constructability review, value engineering, and cost feedback as designs evolve. This collaborative approach often produces more efficient HVAC system designs than traditional design-bid-build where contractor input arrives after design completion.

Fast-track schedules benefit from cost-plus structures allowing construction to commence on early-bid packages while design progresses on later phases. Fixed-price contracting requires complete design before bidding, preventing the schedule overlap that cost-plus accommodates.

However, cost-plus eliminates contractor incentives for efficiency, innovation, and cost minimization that competitive fixed-price bidding creates. Absent competitive pressure, contractors may select familiar but expensive solutions rather than exploring economical alternatives.

The administrative burden of cost-plus management—reviewing invoices, auditing costs, approving expenditures—exceeds fixed-price contract administration where owners simply verify work completion against contract sums.

Best Practices

Establish detailed budgets before authorizing work, creating cost targets despite reimbursement structures. Budgets enable variance analysis and early identification of cost overruns requiring intervention.

Define allowable costs explicitly in contract documents, specifying included items, excluded expenses, markup limitations, and documentation requirements. Ambiguous definitions invite disputes and inappropriate charges.

Implement cost authorization thresholds requiring owner approval before incurring expenses exceeding specified amounts, maintaining spending control despite reimbursement obligations.

Require competitive subcontractor bidding for major trade packages, preserving market-driven pricing despite prime contractor cost-plus relationship.

Negotiate fixed fees rather than percentage-based fees where practical, aligning contractor and owner interests in cost minimization.

Assign experienced owner representatives or third-party project managers to review costs, approve invoices, and oversee contractor performance. Unsupervised cost-plus contracts lack cost discipline.

Consider converting to guaranteed maximum price once design progresses sufficiently for reliable cost estimating, capturing early-involvement benefits while establishing cost certainty.

Establish key performance indicators beyond cost—schedule milestones, quality metrics, safety performance—creating accountability for outcomes despite cost-reimbursement structure.