A Guide to the 8 Types of Construction Contracts

As construction projects vary in terms of scope, delivery, schedule, budget, and the parties involved, there isn’t a one-size-fits-all approach to contracts between owners and general contractors. Using the right contract for the right kind of project is critical to ensuring you stay profitable.
  November 29, 2023
construction contract
As construction projects vary in terms of scope, delivery, schedule, budget, and the parties involved, there isn’t a one-size-fits-all approach to contracts between owners and general contractors. Using the right contract for the right kind of project is critical to ensuring you stay profitable. You want to set the foundation for mutual satisfaction — for you and for the owner — as well as ensure that the contract protects you and your company’s interests.

Each contract type has its own benefits and drawbacks but the standard eight types of construction contracts include:

  • Lump sum 
  • Cost-plus 
  • Time and materials 
  • Unit price 
  • Guaranteed maximum price
  • Design and build
  • Incentive construction
  • Integrated project delivery

The first five are the most common and we’ll dive into how each of them work, along with their pros and cons below.

Construction Contract Type Comparison

 

Contract Type Pros Cons
Lump Sum
  • Easy for the owner to compare bids of a lump sum cost versus an itemized list. These types of contracts also don’t usually dictate as much owner supervision.
  • Don’t factor in issues like site conditions, material cost fluctuations or change order requests from the owner. A contractor will be locked into a target profit margin and more inclined to submit change orders for any deviations from the original design.
Cost-plus
  • Contractors can track and report expenses as they occur on the job site. Your risk is lower because even if costs rise you’ll be protected.
  • You must meticulously track expenses for reimbursement.
  • Some of these contracts include “not to exceed” clauses which hamper how much you can spend.
Time and Materials
  • Mitigates the risk for contractors as it takes into account fluctuating material and labor costs. And since the owner will see costs of both, it limits any cost-cutting methods.
  • Disputes also can arise between owner and contractor if prices of materials or labor rises.
  • If the you put an initial allowance in a budget, it can also eat into your profit margin.
Unit Price
  • Tracking and billing is much easier than in other types of contracts.
  • Useful for jobs that have an unknown duration or scope.
  • Doesn’t allow for flexibility in raising any of the units during the project.
Guaranteed Maximum Price
  • Owners appreciate the clear definition of how much they will have to pay
  • The risk is mostly on your shoulders and the preconstruction phase and estimating are critical here.

 

👉🏼 Contracts rely on an accurate scope of work to be effective. Read how to write an effective scope of work for construction projects to make sure yours are setting you up for success.

Lump Sum

For projects with a well-defined scope of work, lump sum (also called fixed price) contracts are mutually beneficial for both general contractors and owners. This type of contract establishes, you guessed it, a lump sum price for all materials and labor to complete the job and typically favor the owner over the contractor, because unforeseen costs can eat into your profit margin. It’s the Price is Right game of bidding as high as you can without losing it.

PRO – On the owner’s side, this type of contract is beneficial in the bidding phase because it’s easy to compare bids of a lump sum cost versus an itemized list. These types of contracts also don’t usually dictate as much owner supervision.

CON – Lump sum contracts don’t factor in issues like site conditions, material cost fluctuations or change order requests from the owner. Because the scope is more defined at the time of contract a contractor will be locked into a target profit margin and more inclined to submit change orders for any deviations from the original design.

👉🏼 Read more about how lump sum contracts work in construction. 

Cost-plus

For projects with some uncertain project expenses or where owners want a bit more oversight, cost-plus contracts take into consideration accumulated costs from the general contractor during construction and a predetermined fee. The fee is set between you and the owner and can be a percentage of accumulated costs or a fixed dollar amount.

PRO – Instead of running a declining budget, you can track and report expenses as they occur on the job site. Your risk is lower because even if costs rise you’ll be protected.

CON – Along with meticulous expense tracking for reimbursement, you can’t possibly know the full cost ahead of time. Furthermore, some of these contracts include “not to exceed” clauses which hamper how much you can spend.

Time and materials

Under a time and materials (commonly known as T&M) contract, the owner reimburses the contractor for an agreed-upon price for time and materials as well as the profit rate. Similar to a lump-sum agreement, this contract is pretty straightforward but allows for flexibility in costs of materials and accounts for labor rates.

PRO – Mitigates the risk for contractors as it takes into account fluctuating material and labor costs. And since the owner will see costs of both, it limits any cost-cutting methods.

CON – Unless there is a not to exceed (NTE) clause, there is an increased risk for owners. Disputes also can arise between owner and contractor if prices of materials or labor rises. If the contractor put an initial allowance in a budget, it can also eat into their profit margin.

Unit price

A unit price contract details prices per unit. For labor, materials, supplies, overhead, profit and more, the owner will pay the contractor based on agreed-upon rates per unit. For example if a contractor is hiring X laborer, there is a fixed cost for their hours or if they buy Y material, there is a fixed price for the multiples of the material. This type of project contract is helpful for situations where it is unknown the multiples of said unit as it provides transparency of costs for additional labor, material, etc.

PRO – Since each variable is a fixed cost, tracking and billing is much easier than in other types of contracts. It is also useful for jobs that have an unknown duration or scope.

CON – A huge negative for owners is that they will not know the full project scope at the beginning and cannot properly run a declining budget. As the unit costs multiply as the project proceeds, they will not know the total number and units required. And on the contractor side, while it provides transparent cost structures, it doesn’t allow for flexibility in raising any of the units during the project.

Guaranteed maximum price

Under the guaranteed maximum price (GMP) contract, owners can fully understand the maximum price they will be paying for the work because the maximum amount you’re paid is capped. Any costs that come up that exceed that maximum amount are your responsibility and the owner will not be liable. As such, you act as a construction manager at risk (CMAR) who dutifully oversees the project to ensure you are not spending any dollars over the maximum budget.

PRO – On the owner’s side, this type of contract clearly defines how much they will have to pay. It includes all costs (and profit) and at times minimizes change orders as project plans are fully developed before starting construction.

CON – You must have a keen eye when tracking costs associated with each line item and this shifts the risk to mostly be on your shoulders. This can be a positive too, but the pre-con phase and estimating are critical here.

Other Types of Contracts

There are a few other types of contracts you will encounter or that you may want to consider using in different situations and types of jobs.

Design and build

Instead of addressing design and construction as two separate entities, the design and build contract addresses both sides simultaneously. This type of contract speeds up the process but it can lead to higher costs because it eliminates the competitive bidding phase. The process definitely saves the owner time at the onset, but the downside is that it is impossible to get an accurate final price when the project is kicked off.

Incentive construction

As the name suggests, the incentive construction contract incentivizes you, as the contractor, if you are able to deliver the project by a certain date and do so under the agreed upon cost. These contracts can help create a collaborative process but require more negotiations to determine the incentives and milestones.

Integrated project delivery

Relatively new to the industry, this type of contract is a multi-party agreement between the owner, designer and builder. Integrated project delivery contracts spread out the risks and rewards and are popular for those who want to embrace collaboration. All parties agree to a lump sum profit if the project meets its designated financial outcomes.

Which Construction Contract Type is Best?

So which contract type is best? As with most things, it depends. The type of contract you and the owner agree to use will vary based on the job, its requirements and the needs of the owner. Here’s how it usually boils down.

  • Well defined scope = lump sum
  • Transparent/open book = cost plus
  • Unclear scope = time and materials
  • Repeated work with undefined volume of scope = unit price
  • Fixed budget presented by owner’s = guaranteed maximum price

Types of construction contracts

Regardless of the contract chosen, make sure to read through each condition carefully so you can mitigate your financial risk throughout the project. And remember, there is no ‘perfect’ contract, each has its own benefits and drawbacks, but it’s important to understand the contractual agreement and risks associated before signing on the dotted line.

Further Reading: Foundations of Construction Management for SMBs

Jarone Ashkenazi

Written by Jarone Ashkenazi

Jarone started his construction career working for a commercial general contractor in Los Angeles, before transitioning to being an Owner’s Representative for the past eight years. Jarone has led multiple projects and has been integral in cross-departmental communication and implementation of processes with design, leasing, planning and facilities/operations teams. From preconstruction, which included dealing with landlord work letters, General Contractor interviews, bidding and scope buyout, to construction and managing the General Contractor and other vendors, to eventually punch and close out, Jarone has consistently delivered projects on time and within budget.

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