Cost-plus contracts can look like the safest option for a custom builder or remodeler.
If material prices increase, labor takes longer, or the client changes the scope, the contractor passes those costs through and adds the agreed fee. On paper, that appears to reduce the builder’s risk.
But cost-plus does not eliminate risk. It moves risk into documentation, approvals, collections, cash flow, and client trust.
When the scope is unclear, allowances are vague, decisions remain open, and work moves forward on verbal approvals, a cost-plus project can become a financial and legal problem after the money has already been spent.
In this episode of The Construction Leading Edge Podcast, Todd Dawalt explains the hidden risks of cost-plus and time-and-materials work. He also shares three practical controls that can help builders reduce budget surprises, protect cash flow, and create real transparency before committing additional project costs.
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Who This Episode Is For
This episode is for construction business owners who use cost-plus contracts, time-and-materials agreements, allowances, or open-book pricing.
It is especially relevant if you:
- Build custom homes or complete high-end renovations
- Use cost-plus or time-and-materials pricing
- Begin construction before design, selections, or scopes are complete
- Regularly move forward based on verbal approvals
- Have clients who receive project-cost information after money has already been committed
- Experience disputes over labor hours, markups, trip charges, or coordination time
- See client confidence decline as the project budget increases
- Have slow collections because every invoice becomes a discussion
- Depend heavily on allowances and unfinished decisions
- Want a stronger preconstruction and change-order process
Problems This Episode Helps Solve
This episode helps answer questions such as:
- Are cost-plus construction contracts really low risk?
- Why do cost-plus projects create budget disputes?
- How can builders prevent a client’s budget from becoming a surprise?
- What is the “just enough to start” trap?
- Why does open-book pricing sometimes reduce trust?
- When should a change order be approved?
- How can contractors protect their leverage before committing project costs?
- What should be documented before a cost-plus project begins?
- How often should clients receive updated budget information?
- How does preconstruction reduce cost-plus contract risk?
Episode Summary
Many builders believe cost-plus contracts protect them because the client is responsible for actual project costs plus the contractor’s fee.
Todd explains that the pricing structure may reduce some estimating risk, but it creates different risks. The contractor must document costs, communicate budget changes, secure approvals, collect payment, and maintain the client’s trust throughout the project.
The danger becomes more significant when cost-plus creates psychological permission to begin before the project is ready.
The scope may be incomplete. Selections may remain open. Allowances may be vague. Labor rates, assumptions, and exclusions may not be fully documented. The team continues working because everyone believes the details can be resolved later.
This is the “just enough to start” trap.
At first, the project may appear healthy. Work is progressing, the client is making decisions, and invoices are being paid. But as upgrades, allowance overages, changes, and scope additions accumulate, the final cost begins to look very different.
Todd calls this the budget heart attack. It often appears late enough that significant costs have already been incurred.
Once the client feels financial pressure, the microscope effect begins. Every labor hour, vendor invoice, markup, trip charge, and administrative cost receives more scrutiny. Invoice approvals slow down, collections become harder, and the builder’s cash flow is squeezed.
Todd also distinguishes open-book exposure from transparency. Showing the client a cost after the money has been spent is not necessarily transparent. Real transparency means the client understands the budget impact before the next dollar is committed.
The solution is not relying only on stronger contract language. It is reducing project risk through a more complete and documented preconstruction process.
Before construction starts, define the scope, complete the design, reduce or eliminate allowances, finalize selections, document assumptions and exclusions, establish decision deadlines, and gather subcontractor pricing.
When changes occur, price and approve them before committing the cost. Then keep the client informed about the current budget, pending changes, schedule impact, open decisions, and upcoming commitments.
Key Takeaways With Timestamps
00:00 – Cost-plus does not eliminate project risk
Todd introduces the idea that cost-plus moves risk into documentation, approvals, collections, communication, and client trust.
01:20 – Why cost-plus can appear safer than fixed price
Builders may believe they are protected from price increases, extended labor, or scope changes because actual costs are passed through to the client.
02:25 – Cost-plus can reward the “just enough to start” mindset
The pricing structure may make it easier to begin with unfinished scope, selections, allowances, and project decisions.
03:10 – Loose documentation can become a legal and financial problem
Todd discusses a renovation dispute in which incomplete pricing and written approvals contributed to serious allegations and potential damages.
04:35 – Verbal approvals and vague allowances create risk
Each undocumented decision or change can become another point of disagreement after the cost has already been incurred.
05:15 – The cost conversation may happen after leverage is gone
Once labor has been performed and materials have been purchased, the builder has less leverage to resolve a disagreement over price.
06:05 – Cost-plus makes it easy to postpone clarity
Phrases such as “we’ll figure it out later” or “we’ll clean it up on the next bill” allow unresolved issues to continue moving through the project.
07:20 – The budget heart attack often appears late
Clients may not understand the combined effect of upgrades, allowance overages, and changes until the project is well underway.
08:15 – Financial pressure changes the client relationship
When clients realize they may exceed their budget or financing, they may begin questioning whether they were misled or taken advantage of.
08:45 – The microscope effect begins
Every hour, invoice, markup, trip, and coordination charge receives more scrutiny once the client feels budget pressure.
09:35 – Invoice disputes create cash-flow pressure
Slow approvals and collections can squeeze the contractor because vendors, employees, and trade partners may already have been paid.
10:15 – Cost-plus can limit the builder’s upside
The contractor may face greater administrative work, greater scrutiny, and client pressure to reduce fees or markups.
11:10 – Open-book exposure is not the same as transparency
Showing the client what was spent after the fact does not provide the same clarity as discussing and approving costs before they are committed.
12:05 – Confusion damages client trust
When the total project cost continually moves without clear advance communication, the client may feel that the target is changing.
13:05 – The real solution is stronger preconstruction
Todd argues that risk should be reduced before the project begins instead of relying only on the contract to protect the builder later.
13:50 – Move planning work to the front of the project
Complete the design, scope, selections, specifications, assumptions, exclusions, decision deadlines, and trade pricing before construction.
14:40 – Do not commit costs without approved budget
Major labor, material, and trade costs should be priced, reviewed, and approved through a signed change order before the work proceeds.
15:10 – Use estimates and not-to-exceed amounts when needed
When an exact change price is unavailable, document approved rates, expected quantities, and an agreed limit before beginning the work.
15:30 – Update the client before surprises occur
Clients should understand the current budget, pending changes, open decisions, schedule effects, and upcoming commitments before the next dollar is spent.
16:15 – Remember the three core lessons
Cost-plus moves risk, the hidden trap is beginning without clarity, and unresolved details become more expensive when they are handled during construction.
Key Concepts From This Episode
Cost-Plus Risk Transfer
Cost-plus may reduce the contractor’s exposure to certain estimating errors or price changes, but it does not remove risk.
The risk shifts into documentation, approvals, billing, collections, communication, client confidence, and cash flow.
Just Enough to Start Trap
The just enough to start trap occurs when construction begins before the design, selections, scopes, assumptions, pricing, and decisions are sufficiently complete.
Cost-plus can make this easier because the team assumes unresolved costs can be addressed later.
Budget Heart Attack
The budget heart attack is the moment when accumulated upgrades, changes, allowance overages, and added scope reveal that the project’s final cost may significantly exceed the client’s expectation.
This often occurs after substantial work and spending have already taken place.
Microscope Effect
The microscope effect begins when a client feels financial pressure and starts closely examining every project charge.
Items that previously received little attention may become the subject of prolonged questions, disputes, and delayed payment.
Open-Book Exposure vs. Transparency
Open-book exposure allows the client to see project costs.
Transparency requires more than access to invoices. It means providing enough information for the client to understand and approve the financial impact before the cost is committed.
Financial Control
Financial control means the company does not commit project costs without an approved budget.
For changes, this usually requires documented pricing, written approval, and a signed change order before the work proceeds.
Resources Mentioned
Construction Leading Edge Resources
Recommended Next Step
Review one active cost-plus or time-and-materials project.
Identify every open selection, unresolved allowance, vague scope item, undocumented assumption, verbal approval, and pending change. Then assign a decision deadline and determine what must be priced and approved before additional costs are committed.
If the company’s preconstruction and change-management processes are loose, reactive, or dependent on verbal agreements, apply for a Business Evaluation Call.
Client Success Stories
Want to see how other construction business owners are applying these ideas?
Watch client success stories from builders, remodelers, and general contractors who have worked with Construction Leading Edge to reduce chaos, improve their systems, and build companies that run with less owner dependency.
Related Episodes
Episode 442: The Nail the Handoff Framework: 4 Crucial Handoffs to Increase Profit and Eliminate Chaos
Todd Dawalt explains how construction companies can reduce chaos, protect profit, and free owners from the day-to-day by focusing on four crucial project handoffs from sales through operations.
Episode 430: Nail the Handoff System: Build a Rock-Solid Preconstruction Checklist Your Team Actually Follows
Todd Dawalt explains how builders can eliminate chaos, delays, profit bleeds, and field confusion by designing a team-owned pre-construction process that fully hands projects from the office to the field.
Episode 438: Your Customers Experience Your Systems, Not Your Intentions
Todd Dawalt explains why customer trust breaks down when a builder’s systems cannot support their promises, and why pre-construction is the key system for creating clarity, confidence, and a better client experience.
FAQ
Are cost-plus contracts safer for builders?
They may reduce some exposure to material-price changes, labor overruns, or evolving scope. However, they can increase risk related to documentation, approvals, client communication, collections, cash flow, and trust.
What is the biggest risk with a cost-plus contract?
A major risk is beginning before the scope, design, selections, assumptions, pricing, and approvals are clear. That allows costs to accumulate before the client fully understands or approves their impact.
How can builders prevent budget surprises on cost-plus projects?
Complete as much design, scope, selection, specification, and trade pricing work as possible before construction. During the project, provide frequent budget updates before committing additional costs.
Should builders perform change-order work before receiving a signature?
Todd’s recommendation in this episode is not to commit major labor, material, or trade costs until the change has been priced, reviewed, and approved in writing.
What is the difference between open-book pricing and transparency?
Open-book pricing shows the client actual project costs. Transparency gives the client clear information about the financial impact before the money is spent.
Why do cost-plus clients begin questioning every invoice?
When the projected total exceeds expectations, clients may feel financial pressure and begin scrutinizing every labor hour, vendor invoice, markup, and administrative charge.
How does preconstruction reduce cost-plus risk?
A complete preconstruction process clarifies the design, scope, selections, specifications, trade pricing, assumptions, exclusions, decision deadlines, and remaining risks before work begins.
Todd Dawalt
Founder of Construction Leading Edge and host of The Construction Leading Edge Podcast
Todd Dawalt is the founder of Construction Leading Edge and host of The Construction Leading Edge Podcast. Since 2014, Todd and the Construction Leading Edge team have helped construction business owners systematize their companies, reduce chaos, improve profitability, and build businesses that run with less owner dependency.
Full Transcript
Todd Dawalt (01:49.43)
Most builders and contractors believe cost plus contracts are low risk. But the truth is they show up in lawsuits roughly two to three times as often and in arbitrations, nine times as often as fixed cost contracts. Why is that? Well, it’s because cost plus doesn’t remove risk, it just moves risk out of estimating and into documentation, approvals, collections, and client trust. So…
What’s the one thing that determines whether Cost Plus protects you or blows up in your face? What is the hidden trap that Cost Plus can put you into and how do you protect your profit and how do you protect your business from the hidden risks of a Cost Plus contract? That’s what we’re going to talk about in this episode. You’re listening to the Construction Leading Edge podcast from constructionleadingedge.com.
where it’s all about systematizing your construction business to maximize freedom, impact, and wealth. My name is Todd DeWalt, and my team and I have helped over 400 construction companies eliminate chaos, grow their profits, and grow their team. So whether you’re a general contractor, like a custom builder or a remodeler who does mostly cost plus contracts, so maybe you’re thinking about getting into cost plus contracts, or you’re any…
any type of contractor that does time and materials work, maybe even just on change orders, this one is for you. So today I want to talk about one of the biggest misconceptions in construction, specifically in custom home building and remodeling. A lot of builders think that cost plus contracts are the holy grail. They think if I can sign a cost plus contract, I’m not locked into a fixed price. I’m covered. If material prices go up, I’m
I’m covered if they blow their allowance, I’m covered if they make changes, I’m covered if labor takes longer, I’m covered if the clients can’t make decisions. They believe cost plus limits my downside. That’s not actually true. It does limit something, but it doesn’t limit your downside. I’ll explain that later. And on the surface, I get why people would think that I’ve been in construction for 30 years now.
Todd Dawalt (04:10.504)
and have managed over 300 million dollars worth of work. And on the surface, on paper, it may feel safer. The cost plus contract may feel safer because it’s like, hey, I’m going to get paid for cost plus my fee. But in the real world, cost plus contracts can be some of the riskiest contracts you can use. In my experience, all of the disputes
that I was involved with as an owner’s rep, as a contractor, or when we got out of fixed fee or out of a lump sum and we got into cost plus. So in the real world, cost plus contracts can be some of the riskiest contracts you can use. That’s why according to the author of Markup and Profits, cost plus contracts end up in lawsuits.
two to three times more often and they end up in arbitration nine times more often than a fixed cost contract. And it’s not because the pricing model is evil, it’s not because the Cost Plus model doesn’t work, it’s because Cost Plus has this hidden danger, this pitfall that a lot of builders don’t see coming.
Todd Dawalt (05:33.807)
And that pitfall is what I call the just enough to start trap. The cost plus contract rewards the just enough to start trap. Let me show you what I mean. Here’s a story that might keep you up tonight. This is a true legal case study. There was a high-end renovation project. The remodeler, who wasn’t a criminal,
He wasn’t stealing funds. He wasn’t trying to scam anyone. He started this modest sized project under one pricing structure, which was a fixed cost. And then the owner decided to make some changes and increased scope. So they agreed to a time and materials approach, a cost plus approach as the scope evolved. So the budget started to climb.
The client kept adding on more scope. Now, in a cost plus world, you might think, hey, the client saw the receipts, they saw the progress, they were in on the meetings, they approved everything because they made the selections, they approved the selections, now they owe the money. That’s not how it worked out. In this case, because there were overages, was the get toward the end of the project, the final invoice came in, the…
The homeowner wasn’t happy and felt like things weren’t handled properly. So the homeowner didn’t pay the final invoice, got into litigation. And then the homeowner sued the builder for consumer fraud. Negligence, not just the overages, not just for the cost of what he felt was problematic, but he sued.
for consumer fraud over the way that the project had been documented and handled. Now in this particular state, they have a, this was in New Jersey, which is the gold standard for consumer fraud. And they have a really interesting, if you’re in New Jersey, I hope you know about this, they have what’s called treble damages. All right, in New Jersey, there’s something called treble damages. If a homeowner,
Todd Dawalt (07:51.053)
wins a Consumer Fraud Act lawsuit, the court is not just allowed to, but the court is mandated to award triple the amount of the actual financial loss that was proven. So, for example, if a builder’s fraud caused a homeowner $50,000 in damages to fix a roof that was messed up, the court must award the homeowner triple that amount, $150,000.
and what triggers consumer fraud. In this case, there are specific technical violations that triggered the Consumer Fraud Act. The builder didn’t have a clearly stated final price, they didn’t get things signed, they didn’t have written change orders for every single budget increase. Because of that and a couple of other technical violations like failing to provide a written contract for jobs over $500,
leaving a start and end date out from the contract, failing to include a description of the work or specific products and materials that are going to be used, and another technical violation is requesting final payment before the work is completed and inspected. If any of those technical violations are made by the builder, then that triggers the consumer fraud. So think about this, in a cost plus contract,
Todd Dawalt (09:16.78)
If the scope is unclear, you can’t commit to a start and end date. If selections aren’t made, you can’t include a description of the specific products and materials that are going to be used. So in this case, cost plus contracts, one could argue, automatically create technical violations that trigger the Consumer Fraud Act.
So in this case, for this builder, what started out, felt like flexibility, trying to help the client out, turned into a legal and financial nightmare. Now, I’m aware of a current situation with a contractor in this particular state who’s dealing with a very similar situation. Cost plus contract, customer…
made a lot of changes throughout the process. got to the close to the finish line and the customer wasn’t happy and they found a lawyer and now they’re in this consumer fraud and the builder is being sued for triple these treble damages. And it’s not just New Jersey. Several states have laws similar to this, including Pennsylvania, Massachusetts.
Several states have laws similar to this, maybe not as aggressive as New Jersey, but Pennsylvania, Massachusetts, Texas, Ohio, just to name a few, have laws that protect the homeowner from fraudulent, evil builders. So that’s the trap. It’s the just enough to start trap. And in these states,
Todd Dawalt (11:16.366)
So that’s why I call it a trap. It’s the just enough to start trap. Doing just enough to start is a trap. And in several states, this trap has really sharp teeth. Legal teeth that automatically, if you do just enough to start, even under a cost plus contract, it can trigger a consumer fraud claim.
Cost Plus is not a safety net when your process is loose. It’s actually, it’s an audit nightmare. If you’re moving forward on verbal okays, vague allowances, starting with incomplete selections, undocumented labor rates, then you’re not just building a project. What you’re doing, I want you to, if you’re doing just enough to start under a Cost Plus contract, you’re not building a project.
What I want you to imagine is that you’re assembling a steel bear trap, the kind you used to see in cartoons with really sharp teeth, and you’re assembling this trap, maybe a series of traps.
Todd Dawalt (12:42.606)
Cost Plus is not a safety net if your process is loose. What it is, is it’s a risk nightmare and it’s an audit nightmare. So if you’re moving forward with unclear scopes of work, starting without selections being made, unclear costs, unclear schedule, then you’re not just building a project. What you’re doing is you’re assembling a series of bear traps. Imagine these steel traps with sharp teeth.
You are assembling, you’re opening up the jaws and setting these traps for yourself, hoping that you’re not the one who gets caught in it. Every project you start without a clear scope of work and a clear schedule and clear cost, every verbal okay, every allowance, every undocumented change that you say you’ll figure out afterward, it’s another steel trap.
that you’re setting for yourself, hoping that you are not the one who gets caught in it. And the thing is, the argument always shows up after the cost has been committed. That’s what I really want you to catch here. With cost plus or T and M, argument about money always, maybe it’s not always, but if there’s a dispute, it almost always happens after the money
after you have committed the money, after maybe you’ve spent the money, therefore your leverage is gone. Let me say that again. In cost plus, the argument about money almost always happens after your leverage is gone, after you’ve done the work, after you have the invoice, that’s when the argument comes up. And that’s one of the biggest hidden risks. Okay?
So if you’re on a fixed price contract and there’s a scope change or there’s a disagreement, at least in theory, the conversation happens before the work moves forward. If somebody has an issue with the cost of something, then you talk about it before you do the work while you have leverage. On a Cost Plus project or a T change order, for example, lot of builders slide into this mindset of, let’s…
Todd Dawalt (15:03.842)
Let’s just keep things moving, we want to take care of the client, we want to keep the schedule. We’ll figure this out as we go.
We can start this project with an allowance. You don’t need to figure out, you don’t need to do all of this hard work of picking out your light fixtures and plumbing fixtures right now. Let’s just get a contract signed, we’ll carry an allowance for it, we’ll figure it out as we go. Something comes up, hey, we’ll make a note of it, we’ll sort that out later, we’ll clean it up on the next bill, it’s cost plus, right? And that is the Just Enough to Start trap.
doing just enough to start saying, we’ll figure it out later. And cost plus contracts make that trap incredibly easy to fall into. The contract gives you permission to start before you’ve really created enough clarity to control the job. Let me say that again. Cost plus contracts can give you psychological permission to start before you’ve really created enough clarity to control…
the job and reduce your risk. And once you do that, there are a bunch of other hidden risks that show up. A lot of other things pop up. See if any of these sound familiar. The first is what could be called the budget heart attack.
Todd Dawalt (16:28.942)
A lot of cost plus jobs feel great early on. They get started. There’s plenty of money available. There’s this number with one or two commas in it. Hey, there’s plenty of money. Yeah, we have to figure a lot of things out. Everybody’s excited. It’s the honeymoon phase. Clients making selections as they go along. Structures going up. The work is moving.
first couple of invoices get paid, and then you hit about the 60 to 80 % mark. And that’s when the client starts to realize what this project is actually going to cost. All of those little upgrades that they approved along the way, all of those few changes, all of those, hey, while we’re at it, we should do this things, all of those.
Allowances that went over 10 to 20 % each, all of those little scope additions, they started stacking up. And here’s the thing about changes and overages, they only add up when you finally add them up.
And that’s when the client realizes they may have blown their budget. That’s when their construction loan might start feeling a little tight and they realize that they are going to have to dip into their pocket. They don’t have enough financing to finish this job. That’s when the financing pressure shows up. And then they start having these feelings, these emotions like they’ve screwed up. They maybe feel like they’ve been taken advantage of. They start…
feeling like they’ve made a big mistake, they’ve picked the wrong builder, they start doing things like starting to try to claw back their money. And that’s when the emotional temperature changes and the honeymoon is over. And this happens, this doesn’t happen at the beginning, it happens in the middle of the project at the 60%, 80 % mark. Maybe, like some of these disputes we’ve talked about, they happen at the end. And when that happens, when that emotional temperature changes,
Todd Dawalt (18:37.614)
See, this sounds familiar, maybe you’ve been in this situation. The microscope comes out. This is the second hidden risk, the thing that gets triggered is the microscope effect. When the client starts to feel pressure, when they start to feel like maybe they’ve made a mistake or they have to start clawing money back or they feel like they’ve been taken advantage of, they start looking at everything under a microscope. Every invoice, every hour of labor.
every supplier bill, they start looking at markup, they start looking at things that they didn’t even bat an eye at at the beginning, right? They start looking at every hour of labor, they start questioning your overhead, they start asking you to reduce your fee. Every little thing that they ignored earlier suddenly becomes a big deal. That’s when they start asking, why am I paying for this?
Years ago, I interviewed a good friend of mine named Spencer Padgett on the podcast, and he told a story about a forty thousand dollar Snickers bar. When he was a custom luxury, custom home builder, they were getting toward the end of a project and it was a cost plus contract and the homeowner was looking through an invoice from Home Depot and there was a Snickers bar on there. And that
cause the customer, this was a whatever a Snickers bar cost, a couple of bucks maybe, but that along with some other things that were going on, maybe caused the customer to ask, hey, why am I being charged for a Snickers bar? Well, what had happened was the superintendent had ordered, had gone there to pick up some materials and just grabbed a Snickers bar, maybe thought, hey, what’s the big deal? This is a multi-million dollar home. I’m just going to throw a $2 Snickers bar on there. Well, Spencer went on to
to tell the story that that customer started scrutinizing that invoice and every other invoice and said that that Snickers bar ended up costing him $40,000. The customer found $40,000 of costs that he wasn’t comfortable paying because he put everything under the microscope. And here’s the third hidden risk. Once
Todd Dawalt (21:00.842)
Once the invoices become a debate, once they get the microscope out, the billing, the cash flow slows down. Everything starts to slow down. Approvals take longer. Questions pile up. Your pay requests that they used to pay in 10 days start to get delayed. Meanwhile, you’ve already committed the money. Maybe you’ve burned the labor.
Maybe you’ve already paid vendors and subs because things were going well and you want to take care of your people. Obviously, you’re paying your overhead costs and these things are racking up while your payments are slowing down. So, even if the contract looks like it protects you, your cash flows is still getting squeezed. Even if you’ve got an ironclad contract, you have to…
Deliberate with the clients, sometimes you have to debate with the clients, you have to wait for them to pay, even if it goes to arbitration or litigation or you have to file a mechanics lien. Yeah, your contract may say you’re going to get paid, but it slows things down. Meanwhile, you’re still committing these costs.
And here’s another thing a lot of builders don’t talk about enough. Cost plus may seem to limit your downside, but it doesn’t actually. In some cases, may increase your downside, it definitely, cost plus contracts definitely, 100 % of the time, limit your upside. You cannot earn more profit. You cannot submit an invoice if you have a cost plus…
20 % contract, you’re not going to get paid more than 20%. So it may seem like Cost Plus contracts limit your downside, but they really don’t, in truth. They could increase your downside, but they definitely limit your upside. And that’s a big hidden trap, because when a client hears Cost Plus, they’re thinking transparency. And they think that transparency should mean
Todd Dawalt (23:18.102)
lower margins, lower markups, more scrutiny. So now you’re expected to show everything. You’re expected, they’re expecting you to justify everything, to, you have to defend everything and somehow make less money while doing more administrative work. At the beginning I said that cost plus contracts don’t remove risk, they just move the risk.
out of estimating, and they move the risk from the front end of the project, and they move that risk into documentation, approvals, questions, and client trust. Some would say that you’re going to spend two to three more times more effort, two to three times as much effort and time administering a cost plus contract as you would on a fixed cost contract.
So it’s not a low-risk situation. That is not a low-risk scenario. It’s high scrutiny, it’s high paperwork, it’s high emotional volatility with limited upside. And when the client doesn’t feel clarity, what they experience is not transparency, right? The clients are going into this thinking, I’m going to get transparency, I’m getting…
the most bang for my buck, it’s as possible, I’m going to get transparency. What they get is confusion. And confusion kills trust.
That’s the piece that a lot of people miss. People say, well, Cost Plus is transparent. Not automatically. The Cost Plus contract does not automatically create transparency. What it creates is open book exposure. And those are not the same thing. Transparency is when the client has clarity before the next dollar is committed. Confusion is when they see the cost after the money has already been spent.
Todd Dawalt (25:29.676)
and now they’re trying to reverse engineer what happened. Let me say that again. True transparency is when the client has clarity before the money is committed. Confusion is when they see the cost after the money has been spent and now they’re trying to reverse engineer what happened. And that’s why Cost Plus can quietly damage trust way faster than a fixed price contract. See, on a fixed price contract,
The client may not love the number, but they understand the agreement before the work is done, before they get an invoice. On a sloppy cost plus job, they feel like the target keeps moving. And when that target keeps moving, trust starts to break down. So let’s put this all together. Why are cost plus contracts
dangerous. What are some of the not so apparent or hidden risks of a cost plus contract when they go bad? Because number one, they reward, they give permission to do just enough to start. Number two, they push the cost conversation until after the leverage is gone. They push any cost conversations. This is where problems happen, is when cost conversations
happen after the work is done and your leverage is gone. Number three, they can create a budget heart attack situation where the client suddenly realizes what this project is going to cost in the middle of the project or even worse at the end. Number four, they trigger the microscope effect, which causes a lot more administrative efforts on your part. Number five, they limit your upside while not really limiting your downside. And then number six,
When you add up all of these things, when things go badly, they can create confusion that kills trust. And that’s one thing that clients want. They want to be able to trust their builders.
Todd Dawalt (27:46.317)
Now, with all that said, I’m not here to tell you that cost plus contracts are bad. That’s not the point. Cost plus can work. It can be the right pricing structure in the right circumstances, but only if you do one thing right. Cost plus obviously works for a lot of people, but it doesn’t work for a lot of people. And when it goes badly, it goes really badly.
And in some cases, it goes so badly that it’s an extinction level event for that company. And the tragedy is they never saw it coming. They’ve been using a cost plus contract with all of these hidden traps for years and then thinking it was limiting their risk. And in reality, it wasn’t. And it just had to be exposed to the right situation. And it becomes an extinction level event, meaning the business goes away.
And I’m not just talking about the business. In some cases, the corporate veil is pierced and the owner becomes individually liable for these costs. I’m not here to say the cost plus is bad. I’m not here to say cost plus is evil. I’m not saying that you should abandon that. What I am saying, you need to do one thing right, okay? And this is the part I want you to remember. The solution is not a better cost plus contract.
Okay, it’s not spending tens of thousands of dollars with an attorney on an ironclad contract to cover every eventuality, to cover every potential risk. The goal is to reduce the risk upfront. Okay, the solution is a robust, documented pre-construction process that keeps you out of the just enough to start trap. That’s the answer. That’s the real risk.
Prevention, that’s how you control the risk. It’s not necessarily with the contract itself. It’s not with the pricing model itself. It’s with pre-construction, a robust, well-designed, documented pre-construction process. Because look, if you want cost plus to actually reduce your risk, you have to create the clarity before construction starts. Okay, think about it.
Todd Dawalt (30:12.416)
All of these things we’re talking about, you’re doing all of these steps at some point. The problem is you’re just doing them too late. Let me explain. Here’s what this looks like. Here’s what a good pre-construction process looks like to protect your risk in any kind of contract, but especially in a cost plus contract. This means that you define everything before you start.
You have a clearly defined scope of work, you lock down selections as much as possible. I would say the standard is all selections are made, all light fixtures, plumbing, flooring, cabinets, complete. The design has to be complete. You eliminate allowances. You document assumptions, you document exclusions.
You have clear specifications on what you’re going to build. You have a schedule. You assign decision deadlines. You identify any open loops before they become problems.
So this means you have a 100 % complete design, a detailed scope of work, complete selections and specifications, and subcontractor pricing in a schedule. So think about those. You may be thinking, wow, that’s a lot of work to do upfront. When is the ideal time to determine how much a project is going to cost and what you’re going to build? Think about it. You three options. Which of these three options is the ideal time to know
what you’re going to build, for you to know and for the client to know what you’re going to build and how much it’s going to cost. Number one, at the end of the project. Number two, in the middle. Or number three, before you even start. The ideal time is before you start.
Todd Dawalt (32:07.734)
Secondly, when there are changes, this is so important in any kind of contract, when there are changes, you must get budget approval before you commit cost. When there are changes, you must get budget approval before you commit cost. That means no labor, materials, subcontractor costs gets committed before it’s priced, reviewed, and approved with a signed change order. You don’t…
commit cost until you have budget to spend. And that’s a change order. If you don’t have budget to spend, you don’t commit that cost. You don’t authorize the work, you don’t order materials, you don’t write a purchase order, you don’t commit cost until you have budget to spend. the only way to get budget to spend is with a change order.
You may be thinking, we’re in the middle of a project, how do we do this? Well, here are a few tips. Get an estimated change order in place. If there’s an additional scope, something pops up that in the middle of the project and you need to keep moving but you don’t really know what it’s going to be, you need to get an estimated change order in place, a not to exceed amount. You have to have budget to spend before you commit money.
Every contract should have this provision in there that you only do work with an approved change order. So follow it. The customer’s already signed off on this. So get an estimated change order in place. If you think it’s not to exceed, if you think it’s going to be $5,000 to $8,000, get an estimated change order for $8,000 with a not to exceed amount. And that way you have budget to spend. When you commit that money, I want to…
If you need more, you get an additional change order. If you don’t spend that money, then you just reduce that with another change order if you need to. So get an estimated change order in place. Get approval on time and materials rates in estimated quantities before you get started. You must have budget to spend before you commit cost. And if they won’t sign a change order, don’t do the work. Period.
Todd Dawalt (34:32.738)
So those are a few tips. this financial, having these financial controls is crucial. You can’t commit budget you don’t have, and you only get budget with a signed change order.
I’m aware of a situation right now where a was working on a very large project under a cost plus contract. There were some unforeseen conditions that came up. The design team approved the additional work. Said, yes, it has to be done. There’s no other option. They were given direction from the design team on what to complete. They had a cost plus contract.
They engaged the subcontractor to do the work. The subcontractor left a big chunk of the material cost out of his estimate, which was passed along to the client. The work was done. And then the invoice came in, and this big chunk of material that wasn’t on the original estimate was in the invoice. And the client had a big problem with this.
Under the Cost Plus contract, it said they are responsible for it. Everybody agreed this work was done. But the client didn’t see that number in the estimate. then they started pulling out the microscope. Things are getting ugly. So had they followed this financial control that says…
We only commit budget when we have, we only commit costs when we have budget to spend. If they had followed this financial control, they would not be in this situation. They would not have committed the costs because they didn’t have the budget. So I’m gonna say it again. This financial control is crucial. You can’t commit budget you don’t have. You only get budget with a signed change order.
Todd Dawalt (36:34.518)
Always get budget approval before you commit cost.
That one discipline alone, that financial control, would save a lot of builders from getting sideways. Because in cost plus work, the worst time to negotiate cost is when? After the cost has already been incurred, after the work has been done, because you have no leverage.
And third, update before surprises happen. So these are a few things to remember. Number one, define before you start. Number two, when there are changes, get budget approval before you commit cost in the form of a change order. Number three, update before surprises happen. If you want Cost Plus to actually feel transparent, the client has to know where the budget stands and the schedule stands right now, what could be drifting.
any pending or potential changes that are out there, potential impacts to the schedule, what decisions are still open, and what the next commitments are.
what these commitments are gonna do to the total cost. You don’t notify them of these issues with the invoice. You notify them before the next dollar is spent. That’s what real transparency looks like.
Todd Dawalt (39:46.926)
Okay, we’re back.
Todd Dawalt (39:52.079)
So let me wrap this up with three things that I want you to remember. First, Cost Plus does not eliminate risk, it does not remove risk, it just moves the risk. It moves risk from the front end, from estimating and pre-construction, into, it moves that risk into communication, approvals, documentation, trust, and cash flow. It just moves the risk. Second, the hidden trap is,
the just enough to start trap. Cost plus contracts are a slippery slope into the just enough to start trap because it makes it really simple to start projects without clearly defined scopes, without selections made, with allowances, incomplete decisions and loose approvals that start turning into expensive and uncomfortable conflicts. Third.
If you don’t create clarity before construction starts, you’ll be forced to create it during construction. Let me say that again. If you don’t create clarity before construction starts, you’ll be forced to create it during construction. After the work has been done, and that is always more expensive. It’s more stressful. It’s harder than it needs to be, and it. It’s harder on.
trust. Okay? So those are the three things I want to leave you with. And if you’re listening to this and you’re realizing that your pre-construction process is not where it needs to be, if you were to give yourself a letter grade A, B, C, or D, you might realize your pre-construction process is a C or a D. It’s loose, it’s kind of reactive, it’s overly dependent.
on verbal approvals, maybe your pre-construction process is non-existent, it’s just all in your head and maybe you’ll just tell yourself, well, we’ll tighten it up on the next job. You need to fix it now. I hope you’ve seen the risks of a cost plus contract when you don’t have a good pre-construction process because the real risk is not the cost plus contract.
Todd Dawalt (42:16.846)
All right? It is not the contract. It’s weak pre-construction. Sort of like hundreds of years ago, people who sailed across the ocean would die of scurvy, and they didn’t know what was causing it. There was this painful, deadly disease, and they didn’t know what caused it, and it was caused by a vitamin C deficiency. Just like that,
A lot of the problems with cost plus contracts are caused by a pre-construction deficiency. Contracts fine, the customers fine, the teams fine. The problem is a pre-construction deficiency and it causes really painful symptoms.
So, if that’s you, if you want help building out a more robust, well-designed, documented pre-construction process that protects your business, protects your cash flow, protects your margins, and keeps you out of that just enough to start trap, gets you out of constant firefighting mode, then I would encourage you to go schedule a business evaluation call with my team. On that call, we’ll help you identify where your process is weak.
where risk might be slipping through. And we’ll talk about what a proper pre-construction process would look like for you. And we’ll talk about, if it makes sense, we’ll talk about our Systematize Your Construction Business Program, where we can help you, guide you through the process of creating that pre-construction process that we’ve helped hundreds of people put in place that improves margins, eliminates firefighting, reduces risk, and just makes…
life a whole lot better. So the link to schedule that business evaluation call is in the show notes or you can just go to constructionleadingedge.com forward slash apply, A-P-P-L-Y to book your business evaluation call. These are not for everybody. You need to qualify. You need to be an active construction business owner doing over a million dollars a year in revenue. We only work with a handful of people a month.
Todd Dawalt (44:31.79)
We only onboard a handful of clients a month. We’re not right for everybody, and we’re pretty selective about who we work with. So we’ll talk about that on the business evaluation call. check the link to book that call in the show notes or go to constructionleadingedge.com forward slash apply to book your call. And that’s it for today. Thanks for listening. I’ll see you next time.
