A cost plus fee contract can be good for your company and good for your client. It can allow work to proceed when the scope is difficult to define, without asking the contractor to guess a fixed price for something that nobody yet fully understands.
However, you need to be clear about what the fee means.
In this lesson, I mean reimbursement of agreed project costs plus a negotiated fixed dollar fee. I do not mean adding a percentage fee to whatever the project happens to cost. That difference matters, because it changes how the contractor benefits from higher spending.
I believe this arrangement can work well when both parties agree on the costs that can be charged, keep accurate records, and actively manage the work. It should be an open book project, with the client able to understand where their money is going.
Problem: The Wrong Fee Structure Can Reward Higher Costs
A percentage fee increases when the costs increase
Suppose a contractor is reimbursed for project costs and receives an additional fee of 15% of those costs. If the reimbursable costs are $100,000, the fee is $15,000. If the costs increase to $150,000, the fee increases to $22,500.
The client pays more, and the contractor receives a larger fee.
This does not mean every contractor working under a percentage arrangement will deliberately increase costs. Many will do good work and try to save the client money. However, the payment structure gives them a financial benefit when costs rise, even if the agreed scope has not changed.
With a fixed dollar fee, the fee remains the same for the agreed work whether the reimbursable costs are higher or lower. The contractor does not automatically receive extra fee income because more hours were booked or more expensive materials were purchased.
That is the arrangement I am discussing here.
A fixed fee does not automatically make the project efficient
Fixing the fee removes one reason to increase costs. It does not, by itself, give the contractor a direct share of every dollar saved. The client generally receives those savings, while the contractor receives the agreed fee.
There can still be reasons for costs to grow unnecessarily. A company might allocate more people than the work needs, hold too many meetings, or leave staff on the project after their main tasks are complete.
This is particularly important where staff utilisation is measured. A reimbursable project can become a convenient place to book hours that would otherwise be charged to company overheads.
The company might recover those staff costs, but the client is paying for work they did not need. Charging unnecessary hours at cost does not make them good value.
If you are the contractor, don’t use the project to keep otherwise underutilised staff busy. You might improve this month’s figures, but you will damage the trust that could bring you the next project.
Unclear costs create arguments over invoices
What does “at cost” actually include? Is it just salary, or salary plus employment costs? Are office overheads included? What about travel, software, equipment hire and subcontractors?
If these questions are left until the first invoice, the parties may discover that they have agreed to different things.
The client also needs enough information to check the charges. A single invoice line saying “engineering services” does not explain who did the work, what they did, or how the amount was calculated.
Without agreed rules and supporting records, an open book arrangement can quickly become a disagreement about which book everyone is reading.
Solution: Agree a Fixed Fee and Manage the Reimbursable Costs
1. Choose the arrangement for the right reasons
A cost plus fixed fee contract can suit work where the effort is genuinely difficult to estimate. Examples might include investigating equipment failures, developing a solution to an unusual technical problem, or assessing an existing asset before deciding what repairs are needed.
Trying to obtain a firm lump sum too early can result in large allowances for uncertainty, extensive exclusions, or a price that does not really cover the work required.
However, uncertainty should not become an excuse to avoid defining the project. Describe the objective, initial tasks, deliverables, known constraints and exclusions. Agree how decisions about further work will be made.
For example, authorise an investigation and recommendations report first. Use its findings to decide whether to proceed with design or construction under a further agreement.
My post on The Importance of Good Specifications covers why clear requirements matter. A flexible payment arrangement still needs a clear description of what you are trying to achieve.
2. Fix the fee for the agreed work
Agree the fee as a dollar amount and record the work to which it applies. You might reimburse allowable costs and pay a fixed fee of $15,000 for a defined investigation and design package.
For an illustrative comparison, assume the same work attracts either a $15,000 fixed fee or a fee calculated as 15% of reimbursable costs. All figures below exclude tax.
| Reimbursable costs | Fixed fee | Total with fixed fee | Percentage fee at 15% | Total with percentage fee |
| $80,000 | $15,000 | $95,000 | $12,000 | $92,000 |
| $100,000 | $15,000 | $115,000 | $15,000 | $115,000 |
| $150,000 | $15,000 | $165,000 | $22,500 | $172,500 |
This example does not prove that a fixed fee is always cheaper. It shows that the fixed fee does not increase simply because the costs increase.
The fee is also not necessarily the contractor’s final net profit. Unrecovered overheads, disputed costs and other expenses can reduce what the company actually earnings. You need to get an agreement regarding whether overheads are reimbursed separately or must be covered by the fee, and avoid charging for them twice.
The US Federal Acquisition Regulation description of cost-plus-fixed-fee contracts provides a useful reference. It distinguishes a negotiated fixed fee from actual costs and recognises that changes to the work may justify adjusting that fee. It also notes the limited direct incentive to control costs. Those rules concern US federal procurement, but the distinction is useful for understanding this lesson. This is why you need good controls of the project costs as below.
3. Define which costs can be reimbursed
Agree the cost rules before work starts. Important items include:
- Labour costs and the method for calculating agreed employment on-costs.
- Whether agreed labour rates are actual costs or defined reimbursement rates.
- Materials, subcontractors, equipment, travel and accommodation.
- Treatment of overheads, overtime, discounts, rebates and credits.
- Costs requiring separate approval, including major purchases.
- Treatment of errors, rework, idle time and costs outside the agreed scope.
Do not assume that all rework is reimbursable, or that none of it is. Agree how responsibility and entitlement will be assessed under the contract. A client-requested redesign is different from correcting the contractor’s own mistake.
This is very important, if a labour rate already includes profit, adding a separate fee may undermine the intended arrangement. Both sides should understand what is included in each rate and charge.
4. Make the project genuinely open book
The client should be able to trace claimed costs to appropriate evidence. Establish this process with the project manager and finance team before the first claim.
For labour, record the person or agreed role, task, hours and applicable cost basis. For purchases, retain orders, invoices and evidence of delivery where appropriate. Connect subcontractor charges to the work they actually performed.
Set up clear project and task codes, and tell the team which codes to use. Include a way to record non-billable work, so staff do not have to put unrelated time against the client’s project merely to complete their timesheets.
Agree how confidential payroll evidence will be verified. The client needs a reliable basis for checking staff costs; that does not require circulating everyone’s personal salary details throughout the project team.
Open book reporting should explain the costs clearly enough that the client can check them without reconstructing the whole project each month. It also needs to be managed efficiently such that it doesn’t create an unreasonable administrative burden (for both the contractor and the client).
5. Select the contractor on capability and management
Where the scope is uncertain, the lowest initial estimate may tell you very little about the eventual cost. Consider the proposed team’s relevant experience, availability, technical approach and history of delivering similar work.
Also examine their cost systems. Can they supply accurate reports? Can they separate project work from company overhead activities? Will the proposed project manager actually be available?
Compare the fee, labour cost basis, exclusions and management approach together. A lower fee can be outweighed by unnecessary staffing or higher reimbursable rates. My post on Evaluation of Tenders discusses the importance of comparing what suppliers are actually offering.
6. Set spending authority and review the forecast
A fixed fee does not fix the total contract price. Reimbursable costs can still increase, so agree a spending limit and a process for further approval.
State whether the limit includes the fee, expenses and tax. Also clarify whether it limits the work currently authorised or requires completion of the entire scope within a maximum price. Those are different commitments.
My lesson Why Hourly Rate Contracts Need a Spending Limit explains this distinction in more detail. Cost plus contracts need the same attention to spending authority.
Report costs incurred, outstanding commitments not already counted, and the additional forecast cost to finish. Include the fixed fee separately so the client can see the expected total payment.
If costs incurred are $50,000, remaining commitments are $20,000, and other work to finish is forecast at $40,000, the expected reimbursable cost is $110,000. With a $15,000 fee, the forecast total is $125,000. If only $115,000 has been authorised, raise the shortfall before further commitments exceed that authority.
Give the client enough time to decide whether to approve more funding, reduce the work, or pause under the agreed arrangements. Sending a higher forecast is not the same as receiving approval to spend it.
7. Manage hours and progress together
Review what the project has achieved alongside what it has spent. A timesheet can show that someone worked for eight hours without telling you whether those hours moved the project forward.
Check staffing against upcoming tasks. Remove people who are no longer needed, use the right skills for the work, and avoid meetings that require everyone to attend regardless of their contribution.
The project also needs appropriate reviews, testing and safety measures. Saving money by skipping necessary checks can create much larger costs later.
Set out these responsibilities in your Project Management Plan. The contractor should manage the work efficiently, while the client should provide timely decisions and avoid repeated unnecessary changes. Both parties can waste money if they are poorly organised.
8. Record changes and agree their effect on the fee
An increase in actual cost does not automatically justify an increase in the fixed fee. A genuine change to the agreed work may justify reviewing it, depending on the contract.
For example, investigating a second facility is different from spending longer than expected on the original facility. Record the additional work, cost estimate, schedule effect, proposed fee adjustment and revised spending authority before proceeding with the change.
As I noted in Document All Changes, Variations and Agreements, paying reimbursable costs does not remove the need to control scope.
Agree fee payment milestones, claim review periods and final reconciliation too. Resolve disputed items promptly rather than leaving them to accumulate until project completion.
Lesson: A Fixed Fee Works Best with Transparent Costs and Active Management
I believe a cost plus fixed fee arrangement can benefit both the contractor and the client when the scope is difficult to price upfront. The client pays the agreed allowable costs, and the contractor receives a negotiated fee that does not automatically grow with those costs.
However, the arrangement still needs clear scope, accurate cost records, spending authority and regular forecasts. It also needs a project manager who checks that the people and purchases charged to the job are genuinely needed.
If you are the contractor, treat the client’s money carefully. Deliver the required work efficiently, explain the costs openly, and raise problems early. That gives the client a reason to trust your company with future work.
The fixed fee is only one part of the arrangement. Good management is what makes it work.
