Fixed Price vs. Cost Plus Bid Strategies
Pros and Cons or Fixed Price or Cost Plus Bidding for Builders
To stay profitable, builders must be able to land projects while maximizing profits. Many times, this depends on deciding between a fixed price bid or cost plus proposal. To better determine which might be right for a particular situation, it pays to know the pros and cons of each.
Fixed Price Bids
A fixed price proposal requires a builder to give a guaranteed price for a completed home. The builder sets aside allowances for certain selections with the understanding that the home buyer will need to pay more if his or her selections exceed allowance amounts. Otherwise, the home buyer will know exactly how much the project will cost. This type of contract works well for clients with strict budgets who are uncomfortable with not knowing exactly what they will be paying. It’s also a good option for less complicated homes, in inflationary environments, and in instances where most selections have been made prior to breaking ground.
Cost Plus Bids
A cost plus bid is an arrangement where the homeowner is charged the actual cost of a home plus a builder fee. With these contracts, the builder provides a line item accounting of every project facet, including anything from materials to labor to insurance. Instead of paying an agreed-upon price, the customer is billed for the actual cost of the construction. Cost plus contracts are often used on projects with various unknowns and hidden conditions. They are also good for complex houses, remodels and home owners who are more interested in getting exactly what they want rather than adhering to a strict budget.
The Pros and Cons of Each
For the contractor, the cost plus contract provides the advantage of guaranteed money. The contractor receives reimbursement for every single cost and still generates a profit. With fixed price contracts, on the other hand, there is always the risk that costs will exceed the price, resulting in a loss.
From a buyer’s point of view, cost plus contracts offer a better product, since the builder has no incentive to reduce overhead by using lower end materials. There is also no inflation of costs, which sometimes happens when builders overestimate costs to prevent expenses from consuming potential profits.
The main problem with cost plus contracts is potential disputes over identifying and calculating actual costs. From a buyer’s perspective, cost plus contracts produce cost uncertainties which can result in unpleasant surprises that lead to disputes. For this reason, it’s very important to create a comprehensive contract that covers every potential contingency, while clearly explaining – in great detail – what should be identified as a cost.
Making a Cost Plus Contract Work
Without some protections worked into a bid, a homeowner could be taking a big risk that costs will spiral out of control. Builders can allay these fears a number of ways. One is to protect the buyer from surprises by inserting clauses in the contract aimed at maximizing the total cost plus feature of the project. Another is for the homeowner to offer a bonus if the builder is able to finish the project under a target dollar amount.
The builder can also stress the benefits of less costly changes and the ability to make more decisions during the build process. The builder should also demonstrate transparency of costs with an open book process where bills include documentation of all hard costs. With good planning, it’s much easier to land a bid and avoid disputes down the road.
Reduce your risk with 2-10 Structural Warranties for Home Builders, become a member today!