What is a fixed price contract? (And when to use one) (2023)

Fixed price contracts are among the simplestall forms of construction contracts. They offer entrepreneurs freedom and flexibility and homeowners a piece of security. The contractor determines in advance how much the project will cost, taking into account their profits and contingencies, and working within the contract. The owner knows that the project will not exceed a certain sum.
Afixed price contractIt is a kind of contract with a default value that does not change throughout the project, regardless of the time spent on the work or the materials purchased.

This is how fixed-price contracts work

In the case of a fixed-price contract, the contractor prepares an offer taking into accountWorkplacein great deliberation. The contractor sends the offer to the owner or general contractor. After agreeing on how much a project will cost, they sign a fixed price contract stating that the contractor will do the work for that amount. Working hours and material costs changed after this point in time are irrelevant.

This contract format works well for simple projects where the scope is very clear. When the builder is clear about what they want and the contractor has detailed plans to go through, a fixed price contract can make a lot of sense. But there are always pros and cons to consider.

Types of Fixed Price Contracts

The United States government favors fixed-price contracts for all goods and services. These agreements can minimize risk and maximize value for taxpayers. With a contractual cap, the contractor must control their costs to complete the project on budget.

However, in order to adapt to different scenarios, thefederal employment regulations(FAR) describe different types of fixed price contracts. Options give the competent authority some leeway to adapt the contract to the situation.

Fixed fixed price contract

Fixed contracts at a fixed priceleave the contractor very little room for manoeuvre. These contracts are not modifiable and the contractor must complete the project at the agreed price. The contractor assumes 100% of the profit or loss during the project.

Incentive Contracts

Fixed Price Incentive ContractsUse a formula to find profit. A fixed price incentive contract uses the final negotiated price and compares it to the target price to adjust the project's profit.

Each project has a target cost and a target profit that are added to the target price. Projects also have real costs and real prices. Real price is the sum of real cost and real profit.

The formula can be a bit complicated, but it basically means that the closer the contractor gets to the target price at the end of the project,the higher the target win percentage they can maintain.

Fixed price contracts with economic price adjustment

Fixed price contracts with profitable price adjustmentGive the contractor a small insurance policy.

The price may be adjusted up or down due to specific contract terms beyond the contractor's control. For example, if the cost of materials exceeds the cap, the contract value may increase to cover the increased cost.

price adjustment agreements

There are two types of price reset contracts; prospective and retrospective. Both set ceiling prices at the start of the project, which is the maximum the government is willing to pay for the work.

Contracts with probable redefinitionAllow price adjustments at a specific time or points in time throughout the life of the project. The government only uses these contracts when a fair deal can be negotiated for the early phase of a project, but not for later phases. In general, the price period is at least 12 months.

Contracts with retrospective redefinitionallow the contract price to be adjusted after the project is completed. This type of contract applies to research and development contracts rather than construction contracts.

Fixed fixed-price expense contracts

Fixed fixed-price expense contractsThey require the contractor to put in a specified level of effort (work) during a specified period of time. The government pays a set price for this work.

Effort level contracts are not common in construction. Rather, they are more popular for research and research assignments. The end result is usually a results report.

The pros and cons of fixed price contracts

As well asflat-rate agreements, Fixed price contracts certainly have their pros and cons. They can be incredibly profitable, or they can be the only reason a contractor loses his shirt on a project.

Advantages of a fixed price contract:

• Easy to understand -One of the advantages of fixed price contracts is thatthey are easy to understand. The owner knows exactly how much the project will cost and the contractor knows how much they can afford. The owner or GC does not have to worry about material costs or increased hourly costs. The contractor does not have to compile any complicated bills or invoices either.

This simplicity also helps to avoid possible deviations. Because everyone understands the scope of the project and the value of the job, fewer points can lead to disputes.

• Risky but profitable -Although a fixed price contract can be very profitable,There is a higher risk than some alternatives. Bidding on these types of contracts requires someonehighly valued on accurate estimates.

If the contractor manages to complete the project well within the bid, they can make a nice profit. But if a contractor's offer is too low orSite conditions are differentfor what they expected, they could end up losing quickly.

Disadvantages of a fixed price contract:

• unexpected delays– Some problems are not common. When there is a shortage of materials or difficulty finding affordable labor, the overall cost of completing the job can skyrocket. These problems are not the owner's problem. The contractor must include them in the order value.
• Changes take timeEven a fixed price contract may be subject to change. Perhaps a material is simply not available, or the deadline for completing the work has to be extended due to unforeseen circumstances. In this case, the correct way to deal with a changecreate a change order.

Creating a change order is not a complicated process, but it is an additional step that the owner and contractor must take that other contract formats do not require. For example, additional cost or time and material contracts can be much more fluid and adaptable when changes need to be made.

Changes in the scope of work

When a project is moving forward under a standard fixed-price contract, there isn't much leeway for the contractor to renegotiate the price. If there is a shortage of materials, price gouging or a shortage of workers, the contractor must take care of it. You can contact the landlord and possibly change the rental agreement, but the landlord is not obliged to do so.

However, if the ownerChange workspace, you can see a change in the contract price. If the owner changes plans, changes materials, or changes the contractor's workload, the price may go up or down.

Don't take any of these changes at face value, even if the change reduces the workload. Contractors must ensure they receivea change orderfor any design changes. In the event of a payment dispute, the documentation is the only proof that you have completed the project under the contract.

Choose the right contract type

If you're bidding on a federal project, you're likely tied to the type of contract chosen by the government agency. For other projects, choosing the right type of contract depends on many factors.

Not sure where to start? Learn about moreCommon types of construction contractsand how they work:

• Top price guaranteed
• additional costs
• unit price