Fixed Price vs Cost-Plus vs Time & Materials

1. The three contract types in plain English

Every construction agreement is, underneath the legal language, a decision about who pays when the job costs more than expected. Here are the three you’ll actually use:

• Fixed price (lump sum). One agreed price for a defined scope. If it costs you less, you keep the difference; if it costs more, you eat it. You hold the cost risk. See the fixed-price contract definition.
• Cost-plus. The client pays your actual costs plus an agreed fee (a percentage or a fixed amount). Your overhead and profit are protected by the fee; the client holds most of the cost risk — unless you add a cap. See cost-plus contract.
• Time & materials (T&M). You bill labor at agreed hourly rates plus materials (usually with a markup). The price floats with the work done; the client holds the cost risk, bounded only by trust and documentation. See time & materials.

There’s a fourth worth knowing: unit price, where you price per unit of work (per square foot, per fixture). It’s ideal when the type of work is known but the quantity isn’t — see unit-price contract.

2. Side by side

The table makes the core trade visible: fixed price maximizes your upside and the client’s certainty but punishes a bad estimate; cost-plus protects your margin and trust at the cost of heavy documentation; T&M is the most flexible and the hardest for a client to accept on a big number.

3. Fixed price: when it wins, when it kills your margin

Fixed price is the right tool when you can estimate the scope accurately — a kitchen with a settled layout, a deck, new construction from complete plans. The client gets one number, and a tight, well-burdened estimate becomes your margin.

It turns dangerous on uncertain scope. Old homes, structural unknowns, “we’ll figure out the basement later” — every surprise becomes a loss you absorb or a change-order fight that costs you the client’s trust. The failure mode isn’t the contract type; it’s using it on a job you couldn’t actually price. Before you commit to a lump sum, pressure-test the estimate and confirm the margin survives a realistic overrun — the profit calculator is built for exactly that check.

4. Cost-plus and the GMP

Cost-plus protects you when the work is genuinely unpredictable: you’re paid your real costs plus a fee, so an overrun doesn’t erase your profit. The trade is transparency — you must track and justify every cost, cleanly, or the client’s “show me the receipts” turns adversarial.

The version most clients will accept is cost-plus with a guaranteed maximum price (GMP): cost-plus-fee up to a ceiling, above which you absorb the overage. It gives the client a worst-case number while still sharing the risk of the unknown fairly. The catch: a GMP only protects you if your cost tracking is real-time. If you discover you’ve blown the cap at month-end, the protection came too late — which again comes back to disciplined job costing.

5. Time & materials: when it’s right

T&M fits work whose scope you honestly cannot define yet: diagnostic work, emergency repairs, small evolving changes, the “open it up and see” portion of a renovation. It’s the fairest format for both sides when nobody can price the job.

It lives or dies on documentation discipline. Clear hourly rates (burdened, not raw wages), a defined material markup, and detailed daily logs are what keep a T&M job from becoming a “why did this cost so much?” dispute. Many contractors get the best of both worlds by writing the defined base scope as fixed price and the genuinely-unknown portion as T&M or unit price.

6. How to choose: a simple framework

Don’t pick by habit. Pick by how certain the scope is:

1. Is the scope fully defined and plannable? → Fixed price. Tight estimate = your margin.
2. Is the scope mostly known but with real unknowns (old home, structural risk, evolving design)? → Cost-plus, ideally with a GMP, so surprises are shared, not eaten.
3. Is the scope genuinely undefined or very small? → Time & materials, with clear rates and logs.
4. Is the work type known but the quantity uncertain? → Unit price.
5. Mixed? → Combine: fixed price for the defined base, T&M or unit price for the unknowns.

Whichever you choose, the contract only protects your margin if the numbers underneath it are real. Start from a properly burdened, well-structured estimate (how to write a construction estimate), match the contract type to the job’s certainty, and track costs as they happen — so the format you picked actually holds up when the work surprises you.