Fixed price vs. cost-plus

Definition

Fixed-price contracts give the client cost certainty and place overrun risk on the supplier, whereas cost-plus contracts pass actual costs through to the client with an agreed margin. The choice depends on how well the scope can be defined: well-specified work suits fixed price, while uncertain or evolving scope suits cost-plus. Hybrid models such as target-cost or guaranteed-maximum-price contracts blend the two.

Example

A software build with a stable specification is contracted fixed-price, while the discovery phase is billed cost-plus.

Why this is a business risk

Choosing the wrong pricing model for the work creates structural misalignment. A fixed price on an ill-defined scope incentivises the supplier to minimise effort and generate change orders, eroding the cost certainty the client thought they had. A cost-plus model on well-defined work removes supplier cost discipline and inflates the client's bill. Both errors increase the risk of disputes and cost overruns.

How to manage it

• Assess scope clarity before choosing the pricing model: use fixed price only when the deliverables, quality standards and timeline can be fully specified.
• Consider a phased approach: cost-plus for initial discovery or design, then fixed price once the scope is defined.
• Build change-order controls into fixed-price contracts so that scope changes are priced and approved before work starts.
• For cost-plus, set a target cost or guaranteed maximum price to give the client a financial ceiling and the supplier an incentive to stay within it.
• Document the basis for the pricing model choice in the procurement file to support governance and audit reviews.