The five main types of construction contracts are lump sum, time and materials, cost-plus, unit price, and guaranteed maximum price (GMP). Because there are so many different types of construction projects, each type of construction contract exists to satisfy the varying needs of all parties involved.
Knowing which contract suits the project best helps owners, contractors, and suppliers manage risk and ensure the work and payment go as smoothly as possible.
5 common construction contract types compared
|Lump sum contract||A fixed total price is set for the entire project rather than individual aspects. Usually reserved for straightforward projects with a clear scope of work.|
|Time and materials contract||Contractors are reimbursed for the cost and materials as well as labor at an established pay rate. Often used for projects without a well-defined scope of work.|
|Cost-plus contract||Owner pays the contractor for costs (materials, labor, overhead) incurred during the project as well as a preset profit margin. Can offset contractor risk for projects that involve design changes throughout.|
|Unit price contract||Divides the work to be completed into separate units, which the contractor bills for individually. Best for repetitive construction tasks without an estimate of the amount of work required.|
|Guaranteed maximum price (GMP contract)||Establishes an upper limit for construction costs, and contractors absorb costs above this set point. Best for projects with relatively few unknown variables.|
1. Lump sum contracts
Lump sum contracts, also known as fixed price contracts, are the most basic type of construction contracts. That’s because they outline one fixed price for all the work done under them. For this reason, lump sum contracts are extremely common in construction. Odds are most contractors have entered into multiple lump sum contracts in the past.
Learn more: Lump sum contracts explained
However, as simple as the one price formula seems, lump sum contracts aren’t so cut-and-dry. There are a few key benefits and drawbacks of lump sum contracts.
|Simplified bidding: Naming a total price rather than submitting multiple bids simplifies the selection process for owners and GCs.||Miscalculations are costly: Since there’s one set price, unexpected setbacks or changes during a project cut directly into your profit margin.|
|Potentially high profit margins: Because the price for the project is set in stone, finishing under-budget means you pocket the savings.||Bigger projects amplify risk: The cost of missteps and setbacks from subcontractors comes right out of the lump sum price.|
As you can see, lump sum contracts involve a fair amount of risk for contractors because they don’t account for unexpected costs or delays after the project is started. Missteps mean you make less money, or, even worse, lose money on a project.
Best for: Smaller projects with predictable scopes of work.
2. Time and materials contracts
As opposed to lump sum contracts, time and materials (T&M) contracts work best for projects in which the scope of work is not well-defined. Time and materials contracts reimburse contractors for the cost of materials and establish an hourly or daily pay rate.
Dive deeper: The ins and outs of time & materials contracts
Here’s an overview of the pros and cons of time and materials contracts.
|More agile: Since the customer reimburses for time and materials, unexpected delays, roadblocks, and changes to scope are covered.||Potentially time consuming: Logging each and every material cost on a project is no small task, and failure to provide an accurate number upon completion means lower profit margins.|
|Simple negotiations: Setting rules for what materials will be covered and what the hourly wage will be is straightforward.||May not reward efficiency: Since time and materials contracts pay by the hour or day, there’s no real incentive to finish a project early. Therefore, it’s common practice to stipulate a bonus for finishing ahead of schedule.|
When you consider the unpredictable nature of any given construction project, the owner bears a considerable amount of risk with time and materials contracts. That’s because they’re required to pay the contractor for any unexpected costs, changes, or time overruns that take place over the course of the project, costing them more than they initially planned for.
Best for: Projects without a well-defined scope of work.
3. Cost-plus contracts
Cost-plus contracts, otherwise known as cost-reimbursement contracts, involve the owner paying the contractor for the costs incurred during the project plus a set amount of money for profit, which can be determined by a percentage of the total price of the project.
Learn more: How cost-plus contracts work
The costs covered by cost-plus contracts can involve direct costs like labor and materials, indirect costs like travel, insurance, or overhead, and profit.
Here are the advantages and disadvantages of using a cost-plus contract for a construction project.
|Flexible and adaptable: Owners can make design changes along the way, and contractors know they’ll be paid for the extra time or materials those changes incur.||Difficult to justify some costs: Contractors must account for all costs, and some (like administrative expenses or mileage) can be hard to justify for reimbursement.|
|Handles miscalculations Inaccuracies in the initial bid aren’t as detrimental as they are with lump sum contracts.||Must front materials costs: Since cost-plus contracts operate through reimbursement, paying more than you expected for materials could mean you’re spread thin for the remainder of the project.|
When it comes to cost-plus contracts, the majority of the risk is placed on the owner. That’s because the contractor is paid for all costs incurred during the project, and any unforeseen expenses come out of the owner’s pocket.
Best for: Projects in which a lot of creative flexibility is needed.
4. Unit price contracts
Unit price contracts divide the total work required to complete a project into separate units. They are also known as measurement contracts, measure and pay contracts, or remeasurement contracts. The contractor provides the owner with price estimates for each unit of work, rather than an estimate for the project as a whole.
Dive deeper: What you need to know about unit price contracts
Unit price contracts are useful for projects in which the work is repetitive, heavily dependent on material costs, and the amount of work needed isn’t clear before the project is started.
Here are some of the pros and cons of using unit price contracts.
|Simplified invoicing: Owners can easily understand each cost that goes into the final price of the contract because the price of each unit is predetermined.||Difficult to predict total volume: Owners may pay more than expected if the amount of units needed to complete the project isn’t immediately known.|
|Consistent profit margin: Any extra work that’s needed is simply added on as another pre-priced unit, making it easier to manage change orders and other alterations to the scope of work.||Remeasurement can delay payment: The owner’s ability to compare the price of each unit with the total cost of the project can slow down payment.|
When it comes to unit price contracts, the majority of the risk lies with the owner because they must reimburse the cost of unexpected units that are added. However, the transparency they afford is a massive benefit to all parties involved.
Best for: Projects with repetitive tasks without a clear estimate of the amount of work required.
5. GMP contracts
Guaranteed maximum price (GMP) contracts establish a cap on the contract price. With this type of construction contract, the property owner won’t exceed the contract price. Any material or labor costs above that price should be covered by the contractor.
Sometimes, another type of construction contract may also include a GMP provision. For example, a cost-plus contract could include a clause that limits total costs to a guaranteed maximum price.
Learn more: How GMP contracts work
Guaranteed maximum prices are a common feature in construction contracts, and they’re best suited to projects with few unknowns. For example, the construction of a retail chain with plans that have been used over and over.
Here are the pros and cons of using guaranteed maximum price contracts.
|Quicker bidding and financing: Having a final contract price accelerates the bidding process, and it makes financing projects easier because lenders know the maximum amount a given project will cost early on.||Can be tough for contractors: These contracts force the party doing the work to absorb cost overages in the event the contract price maximum is exceeded.|
|Incentivize savings: Having a fixed price overhead incentivizes contractors to reduce costs and finish ahead of schedule. Owners usually agree to share cost savings with their contractors.||May take longer to negotiate In order to protect themselves from exceeding the price cap, contractors may try to increase the maximum price of the contract, potentially extending negotiations|
Since the owner won’t pay for any cost overruns, guaranteed price contracts shift a lot of risk onto contractors. Considering that risk, one thing contractors can do is use a good cost estimating software. Job costing is an important accounting process on any construction project, and having a solid estimate will minimize risk by helping contractors avoid overcharging or undercharging the owner.
Best for: Projects with relatively few unknown variables, and for incentivizing contractors to complete work under budget and ahead of schedule.
Contract Types: Ideal use, benefits & risks [Infographic]
Standardized construction contract
At its core, every construction contract is an agreement. You and the hiring party should discuss the project parameters to reach a shared conclusion about the best type of contract to use. Ultimately, a good construction contract benefits both parties equally.
The American Institute of Architects (AIA) produces standardized contract documents in a variety of formats, including the contract types listed in this article. Working from an existing, professional contract template can give you peace of mind that many other construction parties are using the same terms and provisions.
Read more about AIA contracts
- Pros & Cons of AIA Contract Documents
- Contractor’s guide to the AIA A201 General Conditions
- AIA A401 Progress Payment Clauses
- AIA A401 Final Payment Clauses
Within every type of construction contract, you’ll still want to watch out for problematic clauses.