A Cost Plus Contract is a pricing arrangement where one party (typically a contractor or service provider) is reimbursed for all documented, legitimate expenses incurred in performing the work, plus an additional agreed-upon markup or fee on top of those costs. This markup can be structured as a fixed percentage (e.g., 15% of costs), a fixed dollar amount, or a sliding scale that varies based on total project cost. The clause matters because it shifts financial risk differently than fixed-price contracts: the client bears the risk of cost overruns, while the contractor has less incentive to control expenses since profits increase as costs increase. This structure is common in research, development, construction, and consulting work where scope or requirements are uncertain at the outset.
The primary concern with Cost Plus arrangements is the potential for moral hazard—the contractor may lack motivation to minimize costs since higher expenses directly increase their profit. Additionally, disputes frequently arise over what constitutes a "legitimate" or "reimbursable" expense, and clients may feel they're subsidizing contractor inefficiency. Without careful definition and oversight mechanisms, these contracts can become expensive and difficult to manage.
If you're the client, insist on detailed definitions of what costs are reimbursable (labor rates, materials, subcontractors, overhead allocation methods) and require itemized invoices with supporting documentation before reimbursement. Implement a cost-monitoring process with regular reporting and budget caps or "not-to-exceed" limits. If you're the contractor, ensure the markup percentage is clearly stated and consider whether a fixed fee component might be more predictable than a percentage-based markup. Include a change order process to address scope creep and clarify that only pre-approved expenses will be reimbursed.
Frequently Asked Questions
What does this clause mean in simple terms?
A Cost Plus Contract is a pricing arrangement where one party (typically a contractor or service provider) is reimbursed for all documented, legitimate expenses incurred in performing the work, plus an additional agreed-upon markup or fee on top of those costs.
Why should I care about this clause?
This markup can be structured as a fixed percentage (e.g., 15% of costs), a fixed dollar amount, or a sliding scale that varies based on total project cost.
What are my options?
The clause matters because it shifts financial risk differently than fixed-price contracts: the client bears the risk of cost overruns, while the contractor has less incentive to control expenses since profits increase as costs increase.
How does this affect small businesses?
This structure is common in research, development, construction, and consulting work where scope or requirements are uncertain at the outset.