Six ways to structure your contract fee? That’s a lot. But as you start pricing out jobs you may find that one method does not always fit what you’re trying to do for a client. Alternatively, if you’re the customer you should at least understand these contract pricing methods. Maybe you’ll negotiate a different payment method.
While these methods come from my construction law experience, they can be used in most any other kind of contract proposal.
Let’s go:
COST PLUS FEE
Just what it sounds like. Take the costs of contract performance, generally labor and materials and contract supervision. Add a fee on top. You’re done. Now, the fee can be a set fee, such as $5,000; or it can be a percentage of the cost to complete, for example 15%. Often the practice in your industry leans one way or the other. The fee is generally invoiced as “overhead and profit” and that’s what it is.
These are frequently used where the project scope is not fully developed, but the client wants to get started. Make sure all costs are discussed with the client. I had a construction client get into a dispute because he was charging a fee for his supervision, then putting profit and overhead on top. It’s perfectly valid (his supervision is considered labor, just as if he hired a project manager) but the client didn’t understand why he had to pay the owner for labor and profit.
FIXED PRICE / LUMP SUM
Think of this as the “out the door” price of the contract. Client wants a certain number of widgets, you agree to sell them at the fixed price. If you go over the fixed price, you lose on profit; if you come in under, you win on profit. The are good to use when the fee can be accurately priced out, and the client needs to know what the project is going to cost in advance.
Be sure to read my blog posts on change orders here: Scope Creep is Killing Your Bottom Line. How to Stop It and Scope of Work: Why You Aren’t Getting Paid
NOT-TO-EXCEED PRICE
Similar to the fixed fee contract, but often used where performance of the contract can be fairly but not entirely estimated. The not-to-exceed contract sets a maximum dollar amount for the contract. If the cost to complete goes over that amount, the contractor has to complete at its own cost. But if the cost to complete comes in under, the client will be impressed at paying less than the maximum price, and the contractor makes a fair profit.
TIME AND MATERIAL / UNIT PRICE
This looks like the cost plus contract, but overhead and profit are built into the pricing for the labor and material. Called “markup”, the performing party takes its cost and adds a markup diretly to it. That markup is the profit for the contractor. Public construction jobs often use this model (allowing for a line-item for overhead and profit) when the scope of the project is well-defined.
For example, a road builder knows the project will take 1,000 yards of concrete. It can then contact its suppliers and negotiate a price for the concrete, add on the markup, and hope his negotiated price and markup are competitive with other bidders.
TARGET PRICE / INCENTIVES
This one is fun. The contracting parties set a target price for the project. They also agree in advance to any bonuses to be paid for coming in under the target price; or penalties for coming in over. The underlying pricing is as agreed on (e.g., cost plus)
UNIT PRICE
Better for clearly defined deliverables in manufacturing, some kinds of services, or smaller phased projects. Each widget is given a price. The client then determines how many it wants to purchase.
CONCLUSION
Most contracts are some variation and combination of these pricing methods. Figure out what’s standard in your industry, but don’t be afraid to try something new.
Let me help you draft your commercial contract, no matter which method you choose. Call me at (312) 671-6453 or email me at palermo@palermolaw.com
And here’s a link to my LinkedIn profile because SEO says to have outbound links: MY LINKEDIN PROFILE