Cost Plus Fixed Fee Contract Vs. Time & Materials Contract: A Brief Guide
When a client works with a vendor to develop a contract, they can structure the cost in various ways. The unit rate-based approach can use Time-and-Material (T&M) contracts or Cost Plus Fixed Fees (CPFF) contracts. The latter is based on the actual costs incurred by subcontractors along with the proven job costs reports, such as labor fringes, actual labor costs, equipment, and material invoice. It also considers the agreed-upon fees, either a fixed% or nominal fee on top of the actual costs.
Keep reading to find out more details about each contractual approach. To make things easier to understand, let’s use the example of a large online retailer, X, who is preparing to build a new distribution center, and Y, a general contractor working on two different proposals curated using the different approaches being discussed for the same project.
Cost Plus Fixed Fee Contracts
As the name suggests, this method involves the clients being charged a fixed fee in addition to the project’s overall cost. The fee is typically decided when the contract is negotiated and rarely changes, even if the project costs less or more than anticipated. The costs generally include the cost of labor and materials. It is easier to estimate the cost of materials in CPFF contracts. Still, the labor costs can be challenging to establish as vendors must account for indirect costs along with direct labor costs.
Since the overall price is guaranteed in CPFF contracts, as long as the project does not go beyond the defined scope of responsibilities and tasks, the costs will not change. The scope, deadlines, and specific phases are also usually clearly well-defined in such contracts. However, vendors often include the padded buffer zone means the client will probably pay considerably more for services than T&M contracts.
Moreover, these contracts are complex and take longer to prepare, leaving little room for flexibility or errors. The vendor will have to reprice the project based on the new expectations if the client comes down with a new set of requests beyond the initially defined scope.
Time & Material Contracts
The primary billing unit translates into labor hour, and materials are billed at cost when the contract is prepared using T&M costing approach. Since Y would not profit from materials, all their direct labor, administrative, transportation, and other costs must be included in the stated hourly rates.
Additionally, just because time is the primary billing unit, it does not mean that there would only be one rate. Y can have a billing rate for managers, architects, supervisors, and each laborer type, like excavator and plumber. Electrician, and so on. This is how vendors keep track of the materials purchased and the time spent on a project. Y can bill X using the schedule outlined in the contract, typically when a certain amount of costs gets accumulated or monthly.
Sometimes, T&M contracts include NTE (Not-To-Exceed) Maximums, agreed as per the needs of vendors and clients. An overall budget amount is set by the vendor that cannot exceed. For instance, if X has put a $90 million NTE in the T&M contract signed with Y, and as vendors, Y think the project can be completed in $75 million, they might have the incentive to increase their rates a little or earn the extra $15 million by taking a little longer on the project.
While this is always a possibility to consider, this flexibility comes with several risks. It is easier for such contracts to drift out of scope. X’s six-month project can turn into nine months if the vendor is not credible or the client keeps adding expectations to the list. Conversely, the high level of flexibility enables the compensation for unanticipated changes or unprecedented overages. Clients prefer T&Ms as it allows them to pay precisely for the services they get, not a dollar more. Moreover, since expenses and time are tracked in this pricing model, they are relatively easier to audit and offer seamless transparency, which flat fees do not.
Comparing The Two
If Y chooses to prepare a T&M contract, they get paid for each work hour. If they get the work done quickly, they are not likely to earn anything extra. The longer they take, the more likely they will earn, up to the NTE, whenever applicable. But with CPFF contracts, they earn a fixed fee no matter the time it takes to complete the project. In this case, completing the project quicker will be more profitable.
As for X, it generally depends on the nature of the project and several other factors that can be discussed when you book a consultation with experts at ADDMORE Services. Whether you operate in the Republic of Ireland, the USA, the UK, the Middle East, Australia, New Zealand, or any other country worldwide, we assure you of the provision of the best quality services at incredibly cost-effective and customized packages.
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