Picture this: you’re knee‑deep in red Michigan clay when the forecasted drizzle turns into a three‑day downpour—will your contract save your profit or sink it?
Quick Summary
Picking between a fixed‑price contract and a cost‑plus contract is like choosing between a tightrope and a wide sidewalk. A fixed‑price deal can bring bigger profits if you stay on budget, but one bad surprise can knock you off balance. A cost‑plus deal is steadier because the owner pays for most surprises, yet your fee is usually smaller. The key difference lies in overhead—the everyday costs of running your company. In a fixed‑price job you must guess those costs early and hope they fit; in a cost‑plus job you can bill many of them each month. Let’s break it all down.
Why Contract Type Matters for Profit
Your contract sets the rules for:
- Who pays for overruns.
- When cash shows up in your bank account.
- How well you recover overhead, like office rent, insurance, and the superintendent’s truck.
Industry surveys show residential builders target a gross margin of 15 %–22 % on fixed‑price homes and 10 %–13 % on cost‑plus work (NAHB 2024 Builder Survey). Getting there—or falling short—starts with the contract you choose.
Fixed‑Price Contracts in Plain Words
A fixed‑price (or lump‑sum) contract says, “We will build this house for $X, no matter what it costs us.”
Pros for Builders
- Higher upside. If you buy materials cheaper than planned or finish early, you keep the savings .
- Simple billing. Banks and owners like one number; draws are easy to approve .
- Clear scope. Fewer gray areas if plans are final.
Cons for Builders
- You eat overruns. Material spikes, bad soil, or weather delays shrink your margin .
- Cash‑flow squeeze. Overhead recovery comes late, so you bankroll the project up front .
- Change‑order battles. Any scope gap can spark a fight .
Cost‑Plus Contracts in Plain Words
A cost‑plus contract says, “The owner reimburses our true costs and pays us a fee.” The fee can be a percentage (say 15 %) or a flat dollar amount.
Pros for Builders
- Lower risk. Big price swings land on the owner, not you .
- Steady cash. You bill costs and fee monthly, so overhead is covered as you go .
- Easy upgrades. Owners can add fancy finishes without re‑pricing the whole job.
Cons for Builders
- Smaller headline margin. Because costs are open, owners push fees down .
- Admin load. You must track every receipt for audits .
- Perception. Some owners think cost‑plus means “blank check.”
Overhead: The Hidden Cost That Can Make or Break You
Two Kinds of Overhead
| Kind | Examples | Why It Matters |
|---|---|---|
| Job‑site overhead | Superintendent pay, dumpsters, portable toilets | Increases every extra day on site |
| Home‑office overhead | Rent, office staff, insurance, software | Fixed costs that must be spread across all jobs |
A 2024 NAHB study found the average U.S. builder spends about 10 % of sales on total overhead .
How Fixed‑Price Handles Overhead
- Baked into the bid. You guess how much overhead a job will use, add a markup (often 10 %–15 %), and hope reality matches the guess .
- Delay danger. If weather adds two months and your job‑site overhead burns $50 k per month, that $100 k hits your profit .
- Late recovery. Overhead dollars usually arrive in later draws, which strains cash.
How Cost‑Plus Handles Overhead
- Job‑site overhead = reimbursable cost. AIA A102 and similar forms let you bill these items at actual cost .
- Home‑office overhead = part of fee. Your percentage or fixed fee should cover this .
- Even cash‑flow. You recover overhead each month, helping pay bills on time .
- Audit trail. Keep tight logs, or you may face a pay‑app dispute .
Real‑World Margin Scenarios
| Scenario | Contract Type | Target Margin | Final Margin / Outcome |
|---|---|---|---|
| A | Fixed‑Price | 22 % | 18 % |
| B | Cost‑Plus | ≈15 % (fee 18 %) | 15 % |
| C | GMP Hybrid | Shared savings, goal 14‑18 % | $30 k savings; blended margin |
Scenario A: Semi‑Custom, Fixed‑Price
- House size: 3,000 sq ft
- Contract price: $825,000
- Target gross margin: 22 % ($181,500)
- Reality: Lumber spikes add $40,000; two rain weeks add $20,000 in job‑site overhead.
- Final gross margin: 18 % ($148,500)
Takeaway: One material jump and weather slip cut margin by 4 points.
Scenario B: High‑End Custom, Cost‑Plus
- Direct costs (initial): $1,200,000
- Fee: 18 % ($216,000)
- Owner upgrades: $120,000 (wine cellar, marble floors)
- Builder impact: Fee rises by $21,600 (if percentage) and overhead is fully reimbursed.
- Gross margin: About 15 %, steady despite upgrades
Takeaway: Upgrades boost fee; risk stays low.
Scenario C: Hybrid GMP (Guaranteed Max Price)
- GMP: $1,400,000
- Shared savings: 60 % builder / 40 % owner
- Actual cost: $1,350,000
- Savings split: Builder keeps $30,000.
- Effective margin: Blends fixed‑price upside with cost‑plus security .
Scenario A: Semi‑Custom, Fixed‑Price
- House size: 3,000 sq ft
- Contract price: $825,000
- Target gross margin: 22 % ($181,500)
- Reality: Lumber spikes add $40,000; two rain weeks add $20,000 in job‑site overhead.
- Final gross margin: 18 % ($148,500)
Takeaway: One material jump and weather slip cut margin by 4 points.
Scenario B: High‑End Custom, Cost‑Plus
- Direct costs (initial): $1,200,000
- Fee: 18 % ($216,000)
- Owner upgrades: $120,000 (wine cellar, marble floors)
- Builder impact: Fee rises by $21,600 (if percentage) and overhead is fully reimbursed.
- Gross margin: About 15 %, steady despite upgrades
Takeaway: Upgrades boost fee; risk stays low.
Scenario C: Hybrid GMP (Guaranteed Max Price)
- GMP: $1,400,000
- Shared savings: 60 % builder / 40 % owner
- Actual cost: $1,350,000
- Savings split: Builder keeps $30,000.
- Effective margin: Blends fixed‑price upside with cost‑plus security .
Decision Checklist
- Risk appetite. Can you absorb overruns?
- Design clarity. Is the plan fully baked or changing weekly?
- Market volatility. Lumber futures crazy? Think cost‑plus or GMP with escalation clause .
- Cash reserves. Fixed‑price needs more working capital.
- Owner trust. Cost‑plus needs transparency and strong paperwork.
Tips to Protect Profit—Whatever You Choose
- Break out general conditions in your estimate so overruns pop early .
- Use escalation clauses for key materials in fixed‑price jobs, and include a clear trigger formula so both sides know when the clause activates. For example: Sample Escalation Clause: “If the market price of #2 southern yellow pine lumber, as published in the Random Lengths ‘Framing Lumber Composite,’ increases more than 8 % above the baseline price of $450 per MBF between the date of this contract and the date the lumber purchase order is issued, the Contract Sum shall be adjusted upward by the amount of the increase for the affected lumber quantities.”
- Right‑size your fee. If home‑office overhead runs 8 %, set percentage fee above that or lock a fixed fee with cost‑index adjuster .
- Review cost‑to‑complete weekly. Small course corrections beat end‑of‑job surprises .
- Communicate. Monthly budget walks with owners reduce change‑order fights .
Closing Thoughts
Contracts are more than paperwork; they are profit maps. A fixed‑price map has higher peaks but deeper valleys. A cost‑plus map is flatter but safer. Overhead—the fuel that keeps your business running—sits at the center of the choice. If you can predict and control costs, a fixed‑price deal can boost your bottom line. If you value steady cash flow and less sleepless‑night risk, cost‑plus (or a GMP hybrid) may fit better. Use the checklist above at your next bid meeting, and pick the path that matches your profit goals and peace of mind.