Fixed-Price Contracts: What Are They, How They Work, and When to Use One
In the construction industry, contracts are a must.
And fortunately, there are various contract options to fit the circumstances of individual construction projects.
Fixed-price contracts are one of those options, but you may be asking the following questions:
- What is a fixed-price building contract?
- When to use a fixed-price contract?
- What are the types of fixed-price contracts?
Find out what you need to know about fixed-price contracts in this article and come away with the information to decide what the best option is for your particular construction project.
Table of Contents
- Flexbase: Manage Your Fixed-Price Contract With Our Software
- What Is a Fixed–Price Contract?
- Benefits of Fixed-Price Contracts
- Disadvantages of a Fixed-Price Contract
- 5 Types of Fixed-Price Contracts
- #1: Firm Fixed-Price Contracts
- #2: Fixed-Price Incentive Contracts
- #3: Fixed-Price Contracts With Economic Price Adjustments
- #4: Fixed Ceiling Price Contracts With Price Redetermination
- #5: Firm Fixed-Price Level-of-Effort Contracts
- What Is the Difference Between Fixed-Price and Lump Sum Contracts?
- When Should a Fixed-Price Contract Be Used?
- Create and Manage Your Fixed-Price Contract With Flexbase
Flexbase: Manage Your Fixed-Price Contract With Our Cash Flow Management Software
Managing cash flow and compliance forms are two of the most challenging facets of the construction business. Companies can do all the work themselves, but it can be incredibly challenging.
Since there are many and varied details to pay attention to, it’s easy to:
- Forget some important details of a contract
- Omit crucial compliance forms
- Find yourself in financial straits when payments are late
Successful construction companies use tools to aid them in all the administrative steps that are so common in this industry.
Flexbase has all the tools construction companies need to see to every detail and stay cash flow positive.
Flexbase tools include:
Automated paperwork and compliance forms, including:
- AIA forms
- Lien waivers
- Schedule of values
- Insurance documents
And when it comes to contracts, Flexbase provides templates that can be customized to fit the specifics of your project — whether you need a fixed-price contract or one of the many other contract options.
What Is a Fixed-Price Contract?
A fixed-price contract is a construction contract that sets a price for the construction aspects of a project. The price of the job is fixed, meaning that the price will not change even if:
- The job is finished early
- The job is finished later
- All the materials are not used
- More materials are required
Because of the nature of a fixed-price contract, some fixed-price contracts may include incentives to finish the work on time and within scope.
Benefits of Fixed-Price Contracts
Understanding the advantages and disadvantages of fixed-price contracts can give you some direction as you choose which type of contract will best suit your needs given the type and size of the project.
Fixed Price Contracts Come With a Pricing Guarantee
Fixed-price contracts are straightforward and spell out the pertinent details for the owner and the general contractor.
- The owner knows how much the price will be for the work.
- The contractor knows what funds are available to him and can create a budget based on that amount.
With fixed-price contracts, the owner doesn’t have to worry about prices of services or supplies increasing, and the contractor can avoid the hassle of keeping up with numerous invoices and bills.
In addition, if the contractor can finish the job under budget, he walks away with a little extra profit.
Fixed-Price Contracts Have a Well-Defined Process
Fixed-price contracts typically come with the entire process laid out step-by-step which allows for the entire process to be streamlined and helps keep unforeseen issues to a minimum.
Because the contractor will want to estimate the price of the entire project as accurately as possible, he will need to thoroughly think through every detail of the project, including supplies, materials, and labor.
And with all of this planning on the front end, the project details will be clear and exhaustive, leaving little room for surprises and uncertainties.
Flexbase software makes it easy to create fixed-price contracts with the ability to add all subcontractors to a project to help keep the project on track.
Disadvantages of a Fixed-Price Contract
Fixed-Price Contracts Take Longer to Prep
Because fixed-contract details need to be so detailed and thorough, there is little room for error or flexibility, so an extensive amount of time needs to be spent on the front end to include all the costs involved.
Even with a careful plan and estimation of cost, unforeseen issues inevitably occur which can eat into the budget set by the contractor.
For example, if the price of wood skyrockets, since the contractor can’t charge the owner for the extra expense, he’ll need to adjust his budget in other ways or deal with his own loss of income.
Fixed-Price Contracts Cost More Than Other Contracts
Because of the risk the contractor takes with the unforeseen costs mentioned above, he may decide to include a markup in the total cost of the project. If unexpected expenses occur, the markup ensures he has the funds he needs and still makes a nice profit.
On the other hand, if all the work is completed without unexpected problems or extra expenses, the owner may end up paying more than he needs to while the contractor leaves with a handsome profit.
5 Types of Fixed-Price Contracts
Because every construction job is unique, having some leeway in how a fixed-price contract is composed is a great benefit. The Federal Acquisition Regulations (FAR) delineates the five types of fixed-price contracts available.
#1: Firm Fixed-Price Contracts
These types of fixed-price contracts are exactly what they describe in their title — they are firm.
This means there is very little flexibility and the contract cannot be altered. The contractor agrees to do the job for the agreed-upon price and must accept either a profit or a loss either way.
What Is the Difference Between Fixed-Price and Firm Fixed-Price?
The difference between a fixed-price and firm fixed-price contract has to do with:
- The level of adjustment allowable
- The amount of administrative burden
- The risk to the contractor
A fixed-price contract may allow for adjustment where a firm fixed-price contract does not.
The administrative burden is minimal with a fixed-price contract, but with a firm fixed-price contract, the contractor accepts the greatest risk if costs unexpectedly rise.
For this reason, the contractor will be highly motivated to get the job done on time and within the budget.
#2: Fixed-Price Incentive Contracts
Fixed-price incentive contracts take the following things into account …
- Target cost
- Target profit
- Actual cost
- Actual profit
… and use a formula to determine a target price.
A fixed-price incentive contract will then use this target price and the formula to submit a negotiated final price.
The contractor will aim to keep the costs of the project as close to the target price as possible allowing him to claim a higher percentage of the profit.
What Is the Difference Between Fixed-Price and Fixed Price Incentive?
With most fixed-price contracts, it generally benefits contractors to finish jobs on time and under budget — that’s where they make the most profit.
The biggest difference between these types of contracts is that the incentive itself is spelled out in the contract, and a formula is used to come to a final price which gives the contractor an accurate picture of what his profit will look like in the end.
#3: Fixed-Price Contracts With Economic Price Adjustment
These types of contracts provide the most safety for the contractor because he has the ability to adjust the price up or down if necessary because of changes outside of his control.
For example, when costs of materials increase drastically, the contractor can adjust the price to take these escalated costs into account.
What Is the Difference Between Fixed-Price and Fixed Price With Economic Price Adjustment?
In most fixed-price contracts, adjustments are not allowed, and if they are, they must be spelled out in the contract.
Fixed-price with economic price adjustment contracts give the contractor a sort of insurance that is not normally allowed in other fixed-price contracts.
#4: Fixed Ceiling Price Contracts With Price Redetermination
There are two types of these fixed ceiling contracts:
With both types of contracts, the ceiling must be determined at the beginning of the project.
Prospective redetermination contracts allow for adjustment at specific times or at certain pricing periods during the contract. These pricing periods are usually 12 months long.
Retrospective redetermination contracts allow for a price adjustment after the project is completed.
Prospective redetermination contracts are used more in construction than retrospective redetermination contracts.
What Is the Difference Between Fixed-Price and Fixed Ceiling Price With Price Redetermination?
The major difference between these two kinds of contracts is the ability to make adjustments and to set a ceiling price.
#5: Firm Fixed-Price Level-of-Effort Contracts
Firm fixed-price level-of-effort contracts are not particularly common in construction, but it is helpful to understand what they are and how they work.
These contracts “require the contractor to provide a specified level of effort, over a stated period of time, on work that can be stated only in general terms, and (they) require the Government to pay the contractor a fixed dollar amount.”
What Is the Difference Between Fixed-Price and Firm Fixed-Price Level-of-Effort?
The primary difference between these two contracts is that level-of-effort contracts are based on performance while fixed-price contracts are not.
In addition, level-of-effort contracts require performance evaluations and standards that are not spelled out in other fixed-price contracts.
What Is the Difference Between Fixed-Price and Lump Sum Contracts?
In general, lump sum and fixed-price contracts are considered the same types of contracts, and their names are interchangeable.
Speaking of AIA fixed-price contracts, the American Institute of Architects explains, “A stipulated sum contract, also called a lump sum or fixed price contract, is the most basic form of agreement between a contractor and owner.”
Whatever title is used, all of these contracts refer to the same terms — a set price for the work done on a project.
When Should a Fixed-Price Contract Be Used?
A fixed-price contract should be used when the scope and timeline of the project are clearly defined so that the contractor can accurately estimate the cost and duration of the project.
A fixed-price contract is also a good option when:
- The owner wants the contractor to take on the risk and avoid change orders.
- The project is well-defined.
- The contractor has adequate experience in pricing and work timelines.
- Market conditions are steady.
- Financial risks are insignificant.
Create and Manage Your Fixed-Price Contract With Flexbase
Choosing the best type of contract for your project and creating it are among the many important and crucial steps on the front end of a construction project.
Get them wrong and you will pay for it in both time and money.
Flexbase can help create and manage your fixed-price contract so you can concentrate on growing your construction business and getting the job at hand done.
With processes that are completely integrated, you won’t have to worry if you missed any details, and you won’t have to enter the same data various times.
We integrate everything:
- Construction ERP
- Project management software
- Accounting software
And the best part is that our system is essentially free to use — you don’t pay us until you receive payment.
There are no licenses or subscriptions to worry about, and our platform is available to use immediately. Click here to get started.